“Managing the family’s personal assets inside the operating company increases the exposure of both the family and the business to a host of significant legal and operational risks.”

The Family Office Exchange (FOX) ‘Managing Family Wealth Separately From the Family Business’ (2008).

If you ask an executive in a family business what they do for a living, be prepared for a quizzical look as the executive searches for an adequate description of the expansive activities they get dragged into on a daily basis. Aside from their core responsibilities of managing the business and executing the business plan, family business executives are pulled in many different directions. From managing non-core investments owned by family members, paying private bills through to playing the arbitrator in family disputes, the role of the family business executive knows no boundaries.

As family businesses grow and mature, so too do the needs of the family members who own and operate them. However, it is rare that the resources of the family business adapt and evolve to keep up with the family’s changing needs.

Best practice dictates that private family activities should be entirely segregated from business activities. The establishment of a family office enables all family members, whether they are in the business or not, to enjoy services that are difficult to otherwise justify as a business expense, such as wealth management, family education and philanthropy. It also enables a separate family governance structure which can oversee family matters and view the business through a shareholders lens.

So why do families cut corners by refusing to properly resource these functions? Cost and convenience are perhaps the primary drivers. But what are the real costs of getting this wrong?

Here are some of the perils that business owning families expose themselves and their businesses to by failing to separate their family office from their family business:

1. Distraction of executives:

You hired your executive team because they are experts in their fields. You didn’t hire them or her for their ability to play the stock market. Or to pay private family bills. So why are your executives spending so much time on non-core matters? And what are you sacrificing as a result? What additional costs have been layered into the business to resource these functions? What opportunities is the business missing out on because the executive is distracted? Are you giving your managers an excuse for under-performance?

2. Favoritism amongst family members:

Family members working within the family business have much greater access to the executive team and the business’ corporate resources than those who are not. This can foster toxic family dynamics, creating resentment and tension between family members and placing the executive in a compromised position. “Managing the family wealth inside the company can create a ‘second class status’ situation for family members who are not working in the business,” explains The Family Office Exchange (FOX), a leading family office peer to peer network.

3. Poor investment performance:

How can your executive team possibly be on top of both business operations, as well as your share portfolio and investment properties? How much money are you giving away due to a lack of focus and poor investment decisions? Or, worse still, no investment decisions?

Managing a private business and delivering integrated wealth management strategies are two very different undertakings and should not be combined. Each venture requires different skills, employs different service principles and ultimately serves the family members in very different ways.” explains FOX.

 4. Overshadowing the family identity:

It is important that a family has the ability to define its vision and legacy outside the realm of an operating business. According to FOX, “Since the core business is in many cases the source of family income and because corporate responsibilities loom so large, the needs of the business can eclipse all other areas of family life. Embedding a family office within a family business perpetuates the dominant influence of the business, giving it an even bigger presence in the private lives of family members.”

5. Poor governance:

Failing to segregate investment assets from business assets fosters poor governance and therefore poor capital management disciplines. A new project or acquisition within a family business is rarely subject to the same return parameters and hurdles as an external investment. The result? A highly concentrated family balance sheet which is exposed to significant risk if the business falls on hard times.

6. Poor systems & processes:

The systems required to manage a business are very different to those required to manage an investment portfolio. Are you trying to fit a square peg into a round hole by squeezing your share portfolio or investment properties within your business’ accounting package? Or worse still, a spreadsheet? There is an easier way. Families with a dedicated family office generally use specialist systems, such as investment administration software, property management systems and personal tax compliance packages to drive efficiencies and avoid errors in reporting.

7. Discounted business sale price:

Poor governance will also project poorly on a prospective purchaser of the business if the owners are unable to present a ‘clean’ set of financials to a potential buyer. If significant personal expenditure has been channeled through the family business – such as school fees or personal motor vehicle costs – then this will project a poor culture of governance and controls, with the purchaser likely to discount the purchase price accordingly.

8. Privacy risks:

A family entrusts its advisors with a significant amount of highly sensitive and confidential information. Where this trusted advisor is also an executive within a family business, the risk of the information being disclosed to other members of the business is heightened.

FOX explains: “Even when employees are well-intentioned, there can be incidents where documents are left on a printer, files are accessed through the company network or a phone call is overheard. Regardless of the way the information gets out, it is easy for confidential family matters to become common knowledge when housed in a business setting.”

9. Heightened key person risk:

The loss of a key executive can be extremely disruptive for a business at the best of times. Where families also entrust their business executives with responsibility for private matters, the risk is significantly heightened. As FOX describes “… by diverting key company executives to spend time on personal family finances, the family risks concentrating too much critical financial information with one person. Not only is this person a valued and essential business employee but he is now also central to the family’s financial well-being so that the two become intertwined. If that person leaves, the family incurs a double loss.”

10. Legal risks:

Commingling business activities with family assets can put the family balance sheet at significant risk. For example, if the business is holding non-core assets, such as properties, surplus cash reserves or other investments, these assets are at risk if the business incurs a significant legal liability, such as a customer claim, an OH&S incident or a breach of banking covenants. The core tenant of asset protection is segregation of assets in order to pharmacy-no-rx.net quarantine risk.

The hidden costs

The supposed cost savings and convenience of embedding family office activities within a family business are truly a false economy. As FOX puts it, “Saving $400k on up-front costs and fees is of no value if the family later misses out on millions in tax savings or investment gains.”

Irrespective of the cost, it is likely that at a point in time, the family business will simply no longer be able to meet the increasingly complex needs of the family: “as the family grows both in number and wealth, it is critical to address the management of the family’s personal financial future with the same diligence that goes into managing the future of the business,” says FOX.

We work with families to help them demarcate where the family business ends and where the family office begins. We help to focus business executives on their core role of running the operations and helping the family appropriately resource the requirements of their other affairs. This might include brining in investment expertise, administrative support, as well as developing a governance and decision making framework and education programs to engage the next generation of owners.