Building a Family Office to Steward Family Wealth and Values

Building a family office to steward family wealth and values

UBS Family Office Solutions Group | Family Office Contents

Co-authors Centers of excellence 3 Introduction 4 Ann Bjerke Executive summary 5 Head of Advanced Planning Family Office Solutions Group Chapter 1: What is a family office? 6 One North Wacker Drive, 37th Floor Chicago, IL 60606 Definition of a family office 7 History of family offices 7 (312) 525-7532 Scope of family office services 8 ann.bjerke@ubs.com Types of family offices 10

David Leibell Chapter 2: Evolution of the single family office 12 Senior Wealth Strategist, Advanced Planning Structuring a single family office 14 Family Office Solutions Group Legal and tax considerations 16 1285 Avenue of Americas, 12th Floor Recent case law: Lender and Hellmann 17 New York, NY 10019

(212) 821-7063 Chapter 3: Funding the family office 20 [email protected] Choice of entity 22 Ownership of management company 24 Securities law considerations 25 Brian Hans Senior Wealth Strategist, Advanced Planning Staffing the family office 26 Family Office Solutions Group 1285 Avenue of Americas, 12th Floor Conclusion 27 New York, NY 10019

(212) 821-6912 [email protected]

Special thanks to Lisa Maurer Senior Strategist Family Office Solutions Group Family Office Advisory Centers of excellence

The Family Office Solutions Group The Advanced Planning Group delivers the entire wealth (APG) consists of former practicing management offering exclusively to estate planning attorneys and ultra high net worth (USD 100 accountants with extensive private million+) and family office clients in practice experience and diverse areas a seamless and dedicated manner by of specialization, including income and providing holistic advisory support and transfer tax planning, asset protection customized solutions. The group brings planning, business succession planning the best of UBS insight and expertise and charitable planning. APG provides to our exceptional clients. Whether comprehensive planning and it’s investing for a legacy that lasts sophisticated advice and education to for generations, pursuing successful UHNW clients of the firm. APG also business ventures or having serves as a think tank for the firm, philanthropic impact, you have the providing thought leadership, resources all under one roof. creating a robust intellectual capital library of whitepapers on estate Within the Family Office Solutions planning and tax topics of interest to Group sits our Family Office the ultra high net worth space. Advisory practice. This team facilitates discussions with clients An additional resource for UBS clients about family office structure. It serves and prospects is our Family Office as a thought partner for families Compass, which is intended to be a considering options for managing their practical guide for families setting up family’s wealth and resources, and for their own dedicated family office. The families with an existing family office. Compass takes you through a It advises families across North America structured process and prompts your on family office organizational design, thinking about your family’s needs and structure and governance, as well as how your family office should be set operational best practices and strategy up to meet these needs. You will also to manage and sustain their wealth for find examples of how other families future generations. have designed their family offices. Please reach out to your Financial Advisor to request a copy.

3 of 28 Dear reader,

There is a saying that goes, “If you have seen one family office, you have seen one family office.” Family offices are as different as the families they serve—one size does not fit all. For families who are seeking to coordinate and consolidate their investment management and planning, a well-structured family office can play a crucial role in the preservation and growth of wealth through the generations.

Just as every family is different, so too We have written this paper to guide is what’s required of every family office. you through some of the issues faced Since business families established the by family offices. After all, good first family offices in the early 20th planning has timeless benefits. Indeed, century, their number has steadily some of those original family offices increased, with the first decades of formed over 100 years ago are still the 21st century seeing the most rapid presiding over the founders’ legacies, growth. As they have multiplied, family continuing to serve their families well as offices have taken different forms, they adapt to changing circumstances. depending on a family’s needs.

At UBS, we partner with families across Regards, the world, helping them establish and manage family offices suited to their goals and circumstances. We offer you the benefit of our expertise in structure and governance, as well as operational best practices and strategy for managing and sustaining wealth across generations. Ann Bjerke Brian Hans David Leibell

4 of 28 Executive summary

A family office safeguards a Most family offices evolve A family’s businesses, wealth family’s wealth and values to suit a family’s changing and needs evolve over time. across generations. It needs, starting within a family Revisiting the family office’s implements investment, business and then becoming management and wealth planning and a stand-alone organization. structures ensures that it philanthropic strategies The funding, legal entity, adapts to those changing designed to achieve the ownership and activities of a needs. A successful family family’s long-term goals. family office all have office not only preserves Depending on the family’s implications that require wealth but also helps to objectives and wealth, the thoughtful consideration. achieve philanthropic size and structure of each objectives and preserve family office will differ. family values.

5 of 28 What is a family office?

Families create family offices to manage their wealth while nurturing their identity and values. They look after a range of areas from wealth management to wealth transfer, philanthropy and family governance. Definition of a family office

The Family Office Exchange (FOX), a connected to the family’s wealth cohesion for families around their membership organization of family objectives. Typical family office wealth.”2 In its ideal form, the family offices, defines a family office as “a services include providing directly or office helps steward family wealth by unique family business that is created coordinating with outside supporting the following four to provide tailored wealth professional services such as tax, dimensions of the family: management solutions in an investment management, wealth integrated fashion while promoting transfer (including estate and 1. Business legacy and preserving the identity and philanthropic planning), risk values of the family.”1 The family management, family governance and 2. Financial legacy office acts as the quarterback for the financial education and development stewardship of the family wealth, of the talent of family members. In 3. Family legacy coordinating with the family’s addition, the best family offices have outside professional advisors and a higher purpose, which is “to bridge 4. Philanthropic legacy3 creating and implementing strategies generations to create continuity and

¹ Family Office Exchange,Fox Guide to the Professional Family Office (2014), at p. 3. ² Kirby Rosplock, The Complete Family Office Handbook: A Guide for Affluent Families and the Advisors Who Serve Them (2014) at p. 1. 3 Ibid., at p. 9.

History of family offices

In the US, the early family offices were established by business-owning families that made their wealth during the Industrial Revolution. One of the first family offices was established in 1882 by John D. Rockefeller Sr. as a mechanism for centralizing the family’s wealth and philanthropy. Numerous other business-owning families of great wealth followed Rockefeller’s lead, such as the Mellon, DuPont and Phipps families.

The growth of family offices connected to family business continues today. A recent study found that more than 70% of family offices surveyed originated from an existing family business, with 60% of those surveyed continuing to own an operating business.4 Because these entities are private and emphasize confidentiality, it’s difficult to get a true number of the family offices currently in existence in the US. It’s estimated that there are more than 3,000 single family offices (SFOs), and at least twice that number embedded within private operating companies (primarily family businesses).5

4 Kirby Rosplock, The Complete Family Office Handbook: A Guide for Affluent Families and the Advisors Who Serve Them (2014) at p. 7. 5 The UBS/Campden Wealth Global Family Office Survey, 2019.

7 of 28 Scope of family office services

Understanding the services a family office oversees or provides directly gives a strong indication of how it operates in relation to a wealthy family. There are six basic categories of services that family offices typically provide:

1. Strategic wealth management: 2. Investment planning: Whether 3. Trusts and estates: This service This involves long-term strategic investments are handled in-house involves overseeing the structure planning for accomplishing family or outsourced, proper investment and execution of the legal wealth objectives for current and oversight—including asset documents necessary for efficient future generations. In addition allocation, portfolio construction, wealth transfer. The family office is to determining goals, strategic creation of investment policy also the keeper of these wealth management includes statements, manager selection documents, often overseeing their building the family’s governance and due diligence—is at the core administration and working with structures, including family of family office functions. Also those serving in any fiduciary role. boards and councils, as well as included in this category are Many wealthy families choose family mission statements investment recordkeeping and to establish a private family trust and constitutions. reporting (including consolidated company under the laws of a trust reporting). and tax-friendly state (e.g., South Dakota, Nevada and New Hampshire) to act as trustee of the various family trusts. In fact, in some circumstances, the private family trust company can act as the family office or the family office can be an affiliate of the private family trust company.

8 of 28 Family education involves teaching each generation of the family necessary skills to ensure they will be effective shareholders, directors Figure 1. What can a family office do? and managers.

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4. Philanthropy: This service 5. Family governance and 6. Tax and financial planning: Tax includes developing strategies for education: Once family planning includes the oversight of helping the family be effective governance structures are in place, personal and business tax returns. in its charitable giving. Creation the family office coordinates the Financial planning includes cash and oversight of the family’s necessary meetings and flow management and budgeting giving vehicles, such as family communications to make sure for individual family members foundations and donor-advised such governance structures are along with bill pay and concierge funds, are also a component working effectively. Family services such as management of of family office philanthropic education involves teaching each family real estate and art. services. Involving the rising generation of the family necessary generations in the family’s skills to ensure they will be philanthropic initiatives can be effective shareholders, directors an effective way of transferring and managers of the values and engaging younger various family governance family members in the overall structures and businesses. family governance structure.

Source: UBS Family Office Solutions Group, Feb. 2020.

9 of 28 Types of family offices

Family offices are as unique as the families they serve. They should be structured in a manner that best represents the particular needs of the family. When a wealthy family is considering a family office, there’s a steep learning curve. Numerous for-profit entities provide family office services. These include private banks, private wealth divisions of large brokerage firms, registered investment advisors, accounting firms, private client law firms and consultants. All have their place in the structure and execution of family office services, but the family first needs to consider the type of family office it will create or participate in. These include:

10 of 28 Some family offices have tremendous in-house expertise, operating closely held businesses, and decide to use that expertise to make direct investments.

Single family office (SFO):An Virtual/coordinating family office Family-owned multi-family office entity that manages the financial and (VFO): A VFO outsources most if (MFO): A company that manages personal affairs of one wealthy not all activities, gaining access to the wealth of a group of wealthy family. Such an entity typically has people, products and services when families. It’s usually owned by one several staff members including a needed. It typically employs one or or more of the founding families. chief executive officer, chief two people to handle day-to-day The idea is to reduce the overall cost investment officer, staff operations and coordinate outside of services when compared to a accountants, bookkeepers and advisors and outsourced services. full-fledged single family office. employees handling family real It’s usually headed by a senior family estate, art, and family education and member, the family business chief Commercial MFO: Typically a governance. Complicated tax financial officer or a trusted boutique investment firm owned planning, certain investment professional, such as a CPA or by a third party that provides classes (for example, hedge funds attorney. Many private banks and investment and certain other and private equity) and wealth private wealth divisions of large ancillary services to wealthy transfer planning are typically brokerage firms have set up families. These businesses range outsourced. Some family offices, specialized departments to provide from pure investment shops to however, particularly those affiliated these entities with full service around those that provide a full range of with family businesses, have investing, along with specialty advice family office services. tremendous in-house expertise in wealth transfer, succession operating closely held businesses, planning, philanthropy, family and decide to use that expertise to education and family governance. make direct investments in these types of entities. There can be a dedicated family office location, separate from the family business, with little or no crossover staffing and its own tech infrastructure for privacy and confidentiality purposes.

11 of 28 Evolution of the single family office

Most family offices begin within the family business before evolving into dedicated entities. Structuring family offices takes careful planning, including legal and tax considerations. Since the majority of family offices Embedded family office: An family matters (e.g., estate tax evolve from a family business or the embedded family office provides planning). Finally, if the family sale of a family business, services to family members within decides to sell the business or bring understanding the evolution of such the family business. There are in outside investors, it will need to entities helps put the spectrum of typically no separate employees. address those “personal” expenses family offices in context. Most family Services are provided by family that the business has been covering. businesses, no matter what the asset business employees, specifically level, provide family office-type long-tenured, trusted employees. Separate VFO: Sometimes services to owners and their family Most services are outsourced under motivated by the scale of family members. It isn’t uncommon for a the oversight of a family member wealth or the increasing number of family business to also be called the or trusted employee. This type of family members, with a separate family bank. The formalization of structure can work well for smaller VFO, family office services are moved these services into a family office families in the founder or sibling out of the family business to a structure depends on several factors, generations or families with total dedicated entity that only handles including: wealth less than $250 million, family office services. While most when hiring dedicated employees services continue to be outsourced, 1) the size of family wealth; may be unwarranted or cost- management is professionalized and prohibitive. There are several dedicated specifically to the family 2) the current generation of the downsides to this type of structure. office. These types of entities work family business (i.e., a family office First, family business employees may well with families with total net serving the founder and his or her not be particularly skilled in providing worth of $250 million to $1 billion. descendants or a family office oversight of family office services serving third, fourth and fifth such as investments, wealth transfer SFO: Once a business-owning family generations); and family governance. Second, crosses the billion-dollar mark, things these employees may favor tend to change. More of the 3) the size and complexity of family members active in the administrative services are brought the family; business to the detriment of inactive in-house. In addition, SFOs typically family members. Third, these entities have a chief investment officer who 4) cost; and tend to have less confidentiality and may invest in many asset classes privacy for family members. Fourth, in-house. The SFO tends to have the 5) the willingness of family members the employees often have other greatest internal costs, but these can to work together on their personal duties, so there is a competition be offset by the fact that investment financial matters. The stages of between business-related duties and fees to outside providers are family office evolution when family office-related duties. If there’s reduced by in-house management connected to the family business a major transaction, an employee and economies of scale due to the are typically: may be distracted from handling size of assets under management. important but perhaps less urgent

13 of 28 Structuring a single family office

If a family determines that a single family office is the best approach for coordinating and centralizing the management of the family wealth, it is important to follow a methodical process in order to help ensure the delivery of the scope of services needed by the family, achieve the desired legal and tax results, and establish a governance structure that will serve the family over multiple generations.

14 of 28 Mission and strategy. A family family business (if there is one), the situation is a good place to start. Who office mission may include: family office and family philanthropy. currently advises and supports the Family decision-makers and family? What is working and where 1) preservation and regeneration stakeholders should consider holding are the gaps? Are the existing tax and of family wealth; several meetings at the outset to legal advisors sufficient or should new ensure that opinions, concerns and advisor partnerships be established? 2) a coordinated approach ideas are raised, debated and This will help the team determine the to decision-making; resolved. Communication on topics role the family office will play. It will like involvement of spouses, also help determine which services 3) development of family talent investment philosophy, employment should be handled directly by the and entrepreneurship; opportunities for family members at family office and which should be the family office and processes for outsourced. The business plan should 4) support of family unity; and making hiring decisions can be also address governance, legal important at the outset to ensure structures, staffing, tax, accounting, 5) strategic philanthropy. the family is on the same page. The IT, etc. One mantra the team should strategy is not stagnant: It should be remember during the business While the mission of the family office reviewed and revised every few years planning process is: may be initially determined by the and upon the occurrence of “Don’t overbuild.” senior generation establishing the significant changes in family family office, it will likely evolve over circumstances. It is important to understand the time as rising generations become upfront legal, tax and accounting involved in decision-making Business plan. Once the mission and costs to establish and maintain a and governance. strategy are in place, the next step is single family office. A recent UBS a business plan. Creating an Global Family Office survey estimated Once the initial mission of the family effective business plan for the design that the annual cost of a single family office is clear, strategies to achieve of a family office requires putting office (including outside investment the goals are easier to evaluate. A together a team, including family management fees), expressed as a crucial element of strategic planning members, trusted advisors and, under percentage of assets under for a family office is to align the goals some circumstances, a family office management, is typically between of the family with the goals of the consultant. Mapping out the current 105 to 118 basis points.6

6 The UBS/Campden Wealth Global Family Office Survey, 2019.

15 of 28 Legal and tax considerations for structuring a single family office

The legal structure of the SFO may generate tax benefits for the family. As a result of recent tax law changes and legal developments, many families are revisiting the structure of their family office in order to avail themselves of the ability to deduct investment management fees for income tax purposes.

Background entities, including family offices, imposed strict standards for Historically, expenses incurred for engaged in investment management determining whether investment the production of income or the may no longer be able to deduct management and related activities management or conservation of these expenses. constitute a trade or business. property held for the production of Investing one’s own assets does income (e.g., investment advisory Under Code §162, expenses incurred not rise to the level of a trade fees) were deductible under §212 of in an investment management or business. the Internal Revenue Code (the Code) business are fully deductible. The to the extent those expenses 2017 Act’s elimination of Some of the relevant factors that (together with other miscellaneous miscellaneous itemized deductions courts have considered are whether itemized deductions) exceeded 2% of (including those under Code §212) the enterprise has a full-time staff, if adjusted gross income for a given tax did not impact the ability to deduct the nature of the services provided year. However, the passage of the Tax expenses under Code §162 for are commensurate with those Cuts and Jobs Act of 2017 (the 2017 expenses incurred in an investment provided by investment managers in Act) changed these rules. management “trade or business.” the marketplace, whether the Therefore, an investment investment manager receives Code §67(g) was added by the 2017 management enterprise that is compensation and the type of Act, which suspended the deduction recognized as a trade or business compensation received, and whether of miscellaneous itemized deductions can still deduct investment the owners of the service provider subject to the 2% floor for tax years management expenses. and the “client” are the same. 2018 through 2025. As a result, unless a deduction for these expenses Regarding what constitutes an is available under another section of investment management trade or the Code, certain individuals and business, courts have historically

16 of 28 Recent case law: Lender and Hellmann

The US Tax Court has addressed the question of whether an investment management activity rises to the level of a trade or business in two recent cases. The first case isLender Management LLC v. Commissioner of Internal Revenue, T.C. Memo. 2017-246 (2017). In the Lender case, the Lender family (who founded Lender’s Bagels) established an investment management arm of its family office in the structure shown in Figure 2.

(continued)

Figure 2. Structure of Lender Management LLC

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17 of 28 Recent case law: Lender and Hellmann (continued)

Continued from preceding page benefits programs and other expenses involved in running the operations of Lender Management LLC served the entity. as the investment management company and it provided investment The Tax Court held that Lender management services to the three Management LLC was engaged Investment LLCs. The Investment in a trade or business and that its LLCs were owned by various Lender expenses were deductible under §162 family members. The two Lender of the Code. The court identified family members who owned Lender the following specific factors as Management LLC also held minority being significant in its determination interests in the Investment LLCs. that Lender Management LLC was In order to facilitate investment engaged in a trade or business; management and diversification for (i) Lender Management LLC’s Lender family members, the three compensation structure was similar Investment LLCs were established. to that of a private equity or hedge Each LLC invested in a different asset fund manager as opposed to just class, one invested in private equity, representing returns of a passive another in hedge funds and the last investor because of the profits interest held publicly traded securities. for its services in addition to its management fee; (ii) the difference In exchange for acting as sole in ownership of Lender Management investment manager for each of the LLC and the Investment LLCs; and three Investment LLCs, similar to what (iii) the fact that Lender Management would be seen in a private equity or LLC had full-time employees and hedge fund, Lender Management substantial operations in managing received a profits interest as well as a the investments of the management fee from the Investment Investment LLCs. LLCs. Lender Management LLC deducted expenses related to salaries The second recent case regarding and wages for its staff, repairs investment management and maintenance, rent, taxes and trades/businesses is Hellmann v. licenses, depreciation, employee Commissioner of Internal Revenue,

18 of 28 Those family offices and others engaged in the investment management activities may enjoy material tax savings by following the structure and rationale set forth by the Tax Court in the Lender and Hellmann cases.

Tax Court Order, Docket No. 8486-17, Lender some of the family members If otherwise in line with the family’s filed October 1, 2018. The Hellmann were geographically dispersed, objectives, those family offices case was settled by the taxpayers and did not know each other, and had and others engaged in investment the Internal Revenue Service prior to a very different investment goals and management activities may be decision from the Tax Court after the objectives. able to deduct expenses (including initial court proceedings. However, third-party management and related the Tax Court issued an order in the In the Order, the Tax Court in fees) by following the structure case, denying the taxpayer’s request Hellmann reiterated the importance and rationale set forth by the Tax for a ruling that the facts of the of the following factors in the Court in the Lender and Hellmann case were so similar to the Lender analysis of whether an investment cases. Specifically, the management case that a trial was unnecessary management enterprise constitutes a company should: and the taxpayer should prevail as a trade or business: matter of law. In the order, the Tax 1. Be owned by different family Court discussed the Lender case and 1. The nature and extent of members or in different contrasted the facts of the the services provided by the percentages relative to the Lender case with the facts of employees of the family office; owners of the investment LLCs or the Hellmann case. “clients;” 2. The expertise of and the time The Tax Court noted that the spent by the family office 2. Receive a profits interest structure in Hellmann lacked the employees as compared with and a management fee for disproportionality of ownership as outside investment managers and its compensation; between the management company consultants; and the assets being managed that 3. Provide extensive services rather was present in the Lender case. In 3. The differentiation of investment than only administrative or “back the Hellmann case, the same four strategies for different family office” services; and family members who owned the members based on individual management company also owned investment desires and needs; and 4. Have full-time employees. the assets being managed in the same proportions. In addition, the 4. The proportionality between the Tax Court highlighted that the family share of profits indirectly flowing members in the Lender case were to each family member through more akin to independent clients their share of ownership of the than in the Hellmann case because in family office relative to that same family member’s ownership of the managed funds.

19 of 28 Funding the family office

The funding, legal entity, ownership and activities of a family office all have implications that require thoughtful consideration. Many family offices fund their profits interest, or carried interest, operations and expenses through meaning that the family office only a profits interest structure as was receives cash to cover expenses if the present in the Lender case. The investment LLCs are profitable. If, in favorable tax treatment and ability any given year, the cash received due to deduct investment advisory fees to the profits interest is insufficient and other professional fees is possible to cover expenses, the Smith Family only if the family office assumes Office, or its owners, would be liable meaningful economic risk. In the for the balance of the expenses. This chart below, the Smith Family Office structure substantiates the position would receive a management fee that the family office is a bona fide and economic return through a trade or business.

Figure 3. Smith Family Office structure

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Source: UBS Advanced Planning Group, Feb. 2020. UBS Financial Services Inc., its affiliates and its employees are not in the business of providing tax or legal advice. Clients should seek advice based on their particular circumstances from an independent tax or legal advisor. 21 of 28 Choice of entity

An additional element of the strategy special attention to other, less that might be considered is the use of a desirable tax consequences that C corporation rather than a limited might arise. Two such considerations liability company for the legal form of are the personal holding company the management company. tax rules and the accumulated C corporations are entitled to a earnings tax rules. presumption under the tax law that they are engaged in a trade or business, The determination as to whether a and accordingly, that a C corporation’s corporation is a personal holding expenses are properly deductible. From company and, if so, if it is subject to a tax standpoint, this may strengthen the personal holding company tax is an the argument that the management analysis subject to many nuances and company is engaged in a trade or exceptions. In general terms, a business. However, the presumption personal holding company is a under the tax law that a C corporation is corporation (i) that receives engaged in a trade or business is predominantly income from passive rebuttable. In other words, simply sources (interest, dividends, rents, etc.) incorporating an enterprise that would and (ii) of which five or fewer not otherwise pass muster as an individuals own, directly or investment management trade or indirectly, more than 50% of the value business will not carry the day, but it of the stock. In addition to their may be used by a management regular corporate income tax liability, company as a positive factor tending to personal holding companies are show that it is engaged in a bona fide subject to an additional corporate trade or business activity. level tax on their personal holding company income (a defined term). As However, when considering such, many family office investment C corporations it is important to pay management companies will fall within

22 of 28 Analyzing whether a corporation is a personal holding company and, if so, if it is subject to the personal holding company tax is subject to many nuances and exceptions.

the definition of a personal holding higher individual federal income tax If, however, the family office acts as company and should consult with rates by retaining the funds in a holding company, then this is an their tax advisors relative to the corporate solution. Accordingly, family issue. If, for example, the family office application of the personal holding offices that structure their investment owns an interest in a commercial company tax rules. management companies as office building through one or more C corporations should consult with their limited liability companies and there’s The accumulated earnings tax is tax advisors regarding the potential litigation against the owner of the real another additional corporate-level tax application of the accumulated estate, the court would look through imposed on corporations that retain earnings tax. the LLCs and the family office for earnings in excess of what is necessary purposes of determining diversity. to meet the reasonable needs of the In addition to the tax issues, there’s an If the family owns the family office business. Without the accumulated often overlooked privacy issue. For through one or more trusts, that earnings tax, corporations would be purposes of diversity jurisdiction in structure will become a part of the able to avoid having their shareholders federal court, the court looks through court’s records. pay tax on dividends from the any entity other than a corporation. If corporation by retaining the cash a family office is organized as a limited The parties to the litigation can seek a within the corporation. As a result, liability company, this potentially can protective order barring the disclosure unless the corporation can show that expose the family’s wealth structure (or of that information, and a court often retained earnings are intended to meet at least a part of it) to the public. will grant it. However, it’s unlikely the reasonably anticipated needs of that, if a third party—such as a media the business, the accumulated If the family office doesn’t hold any outlet—challenged the order, the order earnings tax may apply. Given the underlying investments, then this isn’t would survive scrutiny. reduction in the corporate tax rate that an issue. In many cases, a family’s came as a result of the 2017 Act, the investments are held through trusts, The importance of this issue varies IRS is more likely to focus on LLCs or other entities, and the family from family to family. Some families corporations seeking to avoid issuing office is only providing management aren’t concerned about the potential dividends that may be subject to and other services to those entities. exposure. Other families are more protective of their privacy.

23 of 28 Ownership of management company

Income tax considerations are critical Due to the intra-family nature of the when considering the ownership of family office structure, if the carried the management company (i.e., Smith interest is undervalued or overvalued Family Office), and for those reasons, it relative to what the value would be in may not be advisable for the the commercial market, a taxable gift management company to be owned by could result. Furthermore, the carried Generation 1. However, transitioning interest should be carefully analyzed ownership of the management regarding whether it would be company to younger generations may considered an interest to which §2701 result in gift and estate tax of the Code applies. If §2701 of the consequences. If the management Code applies to the carried interest, an company is funded through a profits unintended gift might result. interest, a proper valuation of the carried interest should be obtained.

24 of 28 Securities law considerations

Family office management and The definition of “family client” is to offer investment opportunities advisors will need to be familiar with complex and important to understand. to key talent as means to create an the federal and state securities laws It covers certain family members, attractive compensation package. The which can affect their operations. certain trusts and entities operated for definition of “key employees” includes Because a family office will generally family clients, key employees of the an employee of the family office (or an provide advice relating to the family’s family office and certain family-funded affiliated family office, also a defined investments in securities, it will be charitable organizations. Family term) who is an executive officer, subject to regulation and registration members include all lineal descendants director, trustee, general partner or any requirements under the Investment of a common ancestor (up to 10 other employee, other than a clerical Advisers Act of 1940 unless it falls generations removed) and spouses or or secretarial employee, who has within an exemption. The Dodd-Frank spousal equivalents of those participated in the investment activities Act created a rule in 2011 which descendants. The family member of the family office for at least 12 provides an exemption for family definition includes individuals adopted, months. Former key employees are offices from regulation and registration stepchildren, foster children and also recognized as key employees, as an “investment advisor” if they former family members (e.g., divorced such that a former CEO, for example, meet certain requirements.7 family members). Note that the can maintain her investments with definition does not include in-laws. the family office but cannot make The “Family Office Rule” contains Accordingly, if a family office provides additional new investments after she complex definitions and requirements investment advice to the mother-in-law no longer works at the family office. that family offices need to examine of a family member, for example, closely in light of their particular facts it may lose the ability to claim the and circumstances. Generally, to be exemption from regulation under the considered a family office that qualifies Advisers Act. The family office may be for the exclusion, it must provide able to request a “no-action” letter investment advice only to “family from the SEC on this issue. clients,” be wholly owned and controlled by family clients and cannot The inclusion of “key employees” hold itself out to the public as an under the definition of family client investment advisor. creates the ability for a family office

7 Rule 202(a) (11) (G)-1 under the Investment Advisers Act of 1940. 25 of 28 Staffing the family office

Proper staffing is crucial to the success of a family the staff increases, the family should be thoughtful office. Family offices often begin by transitioning a about providing employment opportunities to family key administrative employee from an operating members and how that may impact the dynamic and company to a full-time employee for certain performance of the family office. They may want family members and evolve to a larger staff. Key roles to consider creating employment policies that set include a Chief Executive Officer, Chief Investment forth the requirements and credentials necessary to Officer and Chief Operating Officer and often require work in the family and create guidelines for resolving in-house legal counsel, compliance officers, trust conflict in a system where a family member employee officers and foundation personnel. As the size of may also be a client.

Compensation of family office employees

Recruiting and retaining key employees for family office When designing compensation packages, family leadership roles often requires creative incentive-based offices should consider whether the incentive compensation. Many family offices allow certain key compensation programs are aligned with the family’s employees to co-invest in direct investments (and may goals and balance the potential longer-term make loans to employees to facilitate the investment) investment strategy of the family with the and participate in a carried interest in order to share shorter-term liquidity needs of the employees. As in the profits of investment ventures at a lower capital these plans can become very complex, it is important gains tax rate. It is also possible for a family office to to consult with qualified counsel to structure and create a plan that grants performance shares, units or implement an appropriate and tax-efficient cash that vest over time or after attaining certain goals. compensation structure.

26 of 28 Conclusion

As a family’s businesses, wealth and needs evolve over time, the family should revisit the management and structures in place that serve and implement their vision. With strong commitment and governance, a family office, in its many forms and iterations, can provide a family with investment, organizational, legal and tax benefits.

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