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Fund structures for family offices

What is the connection between family offices and investment funds? Joe Truelove, Director at Carey Group, explains why both increasingly need each other and the benefits to be gained from the convergence…

What exactly is a family office?

There is no strict legal definition of what a family office actually is but the term, although not new, has become incredibly popular and covers a variety of meanings. A family office is normally used to describe the employees of an ultra-high net worth family. They might help an entrepreneur to run a business empire or manage the family's property and liquid wealth and attend to the needs of individual family members.
 
Single family offices are those groups or teams who look after the affairs of only one family while multi-family offices, as the name suggests, look after more than one family. A multi-family office may provide a complete service to a range of families or provide them with purely investment management services.
 
A number of fiduciary service providers have also decided to extend their service offering and describe themselves as multi-family offices and in this situation they may provide trustee services together with a concierge or lifestyle service for a number of their more valuable clients.
 
Part of the reason for this increased interest in family offices is the difficulty in fund raising since the credit crunch from large institutional investors which has made the family office sector more important as a target for fund raising by fund managers.

What considerations normally dictate the selection of an appropriate structure for a family office?

Many of the usual considerations for fund managers are equally valid for family offices. From a family perspective the ability to plan for succession within the business or to inherit wealth is a key consideration. A desire to form a tax neutral structure will be driven by the residence and domicile of the family members, the location of the assets and the nature of the assets themselves and whether they generate income or capital growth. A key consideration is confidentiality, security is also vital.

How do family offices normally structure their affairs? 

There will often be a trust or maybe a foundation which will control the wider structure which in turn own the assets. Increasingly family offices are setting up private trust companies through which they may have greater influence over the trustee function in question without prejudicing the wider planning.

These are perfectly valid structures for family offices to utilise, but there are other cases when a family office begins to behave more like a fund manager and a fund like structure then becomes more attractive.

At what point does a family office become an asset manager?

As some fund managers have struggled to raise funds for pools of investors they have been managing assets on a deal by deal basis for single investors or on behalf of joint ventures or club deals. A fund manager who manages assets on behalf of a small number of families is effectively a multi-family office.
 
Dissatisfaction with some fund managers and a reluctance by some investors to invest in "blind pool funds" has led to family offices deciding to co-invest alongside fund managers or invest directly on their own account on a deal by deal basis, so family offices have effectively become asset managers in their own right in some instances in preference to investing indirectly through investment funds.
 
There is therefore a convergence between boutique fund managers and multi-family offices.

Why would a family office need to use a fund structure? 

As a family office graduates from single family to multi-family office there will be a requirement for a fund structure. This is because the collecting together of assets from different families really is a game changer. A small number of families investing together doesn't necessarily require a regulated fund to be formed but the legal framework of a fund structure provides clarity on the rights and obligations of the investors and the manager.
 
Two key elements which might make a family office wish to adopt a fund type structure for the assets it manages are control and incentivisation. Control is an element where a fund structure can provide an element of control to the family office in the same ways a fund manager controls a private equity fund: the family office can own the shares in the general partner who manages the limited partnership and contracts on behalf of the investors. By extension a fund structure also permits the family office to be remunerated in a way which is consistent with fund managers and aligns their interests with the families whose assets they manage. This would typically entail charging an annual management fee plus a carried interest fee with respect to illiquid investments. This incentivises the family office to maximise returns.

What fund structures might they use?

A single family office may wish to appoint an external investment manager to provide investment management and may not wish to invest into an existing fund structure where their assets will be mixed with those of other investors because they wish to retain control and exclusivity over those assets. This scenario is often referred to as a "managed account". A managed account however is strictly a contractual arrangement with no standard legal form, by forming an appropriate fund structure however to house the managed account and by appointing an independent auditor, specialist directors, an external administrator and a custodian the family office may feel that it is gaining greater transparency such as independent pricing and asset segregation than relying on one institution.
 
The structure will depend on the asset class into which the family offices intend to invest. Illiquid assets are typically associated with closed ended structures and in the private equity and property world this will often mean that a limited partnership is the weapon of choice. In fact the concept of a family limited partnership has been discussed as an alternative to a traditional trust.
 
Another vehicle which lends itself to both single and multi-family office asset management is the protected cell company (PCC). In a single family office context the cells can be used to segregate the assets and also the liabilities into distinct pools, maybe by asset class or geography. Large single family offices with liquid assets may wish to appoint different investment managers to manage each pool of assets and to segregate them from one another in a structure which they control.
 
The PCC can also be useful to investment managers who wish to add cells, raise cash and invest in different time periods so each cell has a distinct vintage. Alternatively some fund managers use a cell per asset acquired to facilitate club deals whereby each deal is offered to a pool of investors who can opt in or out of each particular transaction.
 
There are significant cost benefits to be achieved by utilising a protected cell company structure rather than setting up multiple fund structures. Legal set up costs will be saved if a PCC is used because adding a cell to an existing PCC is much more cost effective than forming a brand new legal entity. There are reduced operating costs too because the company secretary, board of Directors and audit fees are shared across the PCC rather than having separate boards and company secretaries each time.
 
Maybe this is the first time that the family office has been advised to structure its affairs using a recognised investment fund domicile where it doesn't have a place of business or staff and for this reason the appointment of a corporate service provider is necessary.

How are they regulated?

There will be a range of jurisdictions and each may provide distinct regulatory options depending on investor sentiment, the value of the investment to be made by each investor, the number of investors, their relationship to one another and whether the structure will be marketed or placed in any way. Where the structure is formed and managed will have an impact on the regulatory regime which will apply.
 
For a single family office, in many jurisdictions, there will be no regulated activity taking place. With multi-family offices the pooling of assets by two investors in a structure with independent investment management taking place may trigger the structure to be regarded as a fund in some jurisdictions. The use of a fund structure and more than one investor does not however mean that the structure in question is a fund.
 
In Guernsey a joint venture, club deal or multi-family office structure may simply be regarded as an investment vehicle as distinct from a fund and not therefore be subject to fund regulation however, if one or more of the investors preferred to invest into a regulated fund, the manager of the structure could opt for it to be regulated. This flexibility is a key benefit of Guernsey as a fund structuring jurisdiction for family offices.
 
Similarly the management company or general partner of the fund could also opt to become regulated. For some multi-family offices building track record within a regulated investment vehicle and with a regulated investment management company may provide an opportunity to open up the fund to other investors at some point in the future.

Conclusion 

As the family office sector evolves fund structures are becoming increasingly relevant and beneficial to manage the assets within the family. The use of a fund structure provides a recognised and well established legal framework which allows the family office itself to evolve into a multi-family office or boutique wealth manager. This is in addition to permitting a family office to have greater control over the assets being managed and providing the opportunity for the family office team to be incentivised in line with their peers in the traditional fund management environment. The application of regulation and the use of independent administrators, auditors and Non-Executive Directors gives additional comfort to the family whose assets are being managed that there are appropriate checks and balances and that the assets are being securely held.
 
The combination of ultra-high net worth families utilising bespoke structures which may include trusts or foundations investing via fund structures like protected cell companies and limited partnerships will challenge both traditional trustees and specialist fund administrators and therefore care should be taken that an administrator and trustee with the requisite mix of skills is selected. In particular certain fund administrators specialise in private equity or property and others have expertise in liquid securities or hedge funds, few have systems and expertise to cope with a wide range of alternative asset classes particularly when assets like super yachts are included.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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