This article belongs to our exclusive single-family office guidebook, where we give guidance on the most relevant topics for newly established and already existing family investment vehicles. It was contributed by Tsitsi Mutendi, co-founder of family office consultancy Nhaka Legacy.
In July 2019 Campden Research estimated that there were 7,300 single family offices worldwide, up a significant 38% from 2017. The largest proportion of those 7,300 family offices were based in North America (42% or 3,100 offices), followed by Europe (32% or 2,300 offices), Asia Pacific (18% or 1,300 offices), and the emerging markets of South America, Africa and the Middle East (8% or 600 offices). The total estimated assets under management of family offices was standing at $5.9 trillion, while the wealth of the families behind them totaled a vast $9.4 trillion.
Shifting economic and market forces, and the continued globalization of society, commerce and regulation as well as a global pandemic, 2 years from the Campden Research the number of Family offices is growing faster across the world.
Family Office advisors are now being retained to help the family plan for the future and Family Offices are playing a wider role in the ‘wealth’ education of the next generation.
Key to this Education lies specific risks that need to be on the radar to ensure that Family Offices and families of wealth keep the family and its wealth securely protected. This may not happen 100% of the time but being aware if the risks and actively actioning against them is key to ensuring safety.
Seven of the most critical risks that Family Offices big or small should take notice of are:
1. Family Risk
Family risks can be many and at times very destructive if not handled with care. Relationships within families are delicate and involve complex emotions and feelings that can be triggered and overflow into the financial capital of the said family. Family risks include, but are not limited to sibling rivalries, the control exercised by the wealth creator, which is the patriarch or matriarch of the family; differing generational aims; health matters; critical human resources risk; or succession issues. The types of Family Risks can be further broken down into sections. Family relationship risk focuses on family relationships and the family legacy. These decisions are not merely financially oriented because they can affect the livelihoods and quality of life for parents, uncles, siblings, cousins, and other family members. Family Offices have historically been known to overlook or not focus on this particular risk cluster and have instead left the family to independently resolve these issues. This is a fatal mistake and has often led to the family overlooking or ignoring underlying problems that have led to the Family at times losing their wealth from a social and financial and human capital perspective. A thorough Family Governance exercise, which is inclusive of all family members, often brings these issues to light and offers an opportunity to address them. Moreso, the Family Governance exercise review leads to Family members aligning to shared history, shared vision, and ultimately building or rebuilding trust. Governance is not the tools themselves (Family constitution, Family Council, or Family Assemblies) but the process, consolidated and assisted by the tools. The process itself is not a once-off exercise. So even if you have Family Governance in place, it is always a good exercise to test it out and get a trusted advisor to come in and facilitate stress tests to the system in place.
2. Business Risk
Anything that threatens a company’s ability to achieve its financial goals is considered a business risk. These will be those risks that a Family-owned or controlled company will face in the regular course of its business and how those risks should be identified and managed. To name just a few.
- Economic Risk. The economy is continuously changing as the markets fluctuate.
- Compliance Risk. Business owners face an abundance of laws and regulations to comply with.
- Security and Fraud Risk.
- Financial Risk.
- Reputation Risk.
- Operational Risk.
- Competition (or Comfort) Risk.
- Competitive Risk.
- Legal Risk
- Strategy Risk
When a company experiences a high degree of business risk, it may impair its ability to provide investors and stakeholders with adequate returns. Several different factors influence business risk. Depending on the family’s involvement in the businesses that create wealth for them, being aware of the possible risks that the family businesses face is key to being able to mitigate them or to stop them from then destroying the family wealth. The family may not be able to go into multiple businesses they own and do the exercise themselves but they can hire professionals to so so or members of their family office. Getting these regular reports will not only help the family be aware of their business operations but it allows them to also contribute to the conversations around how best to manage or let go of ill-performing assets. Overall understanding each of these factors as reflected by your own Family Office is key to mitigating these risks.
3. Management Risk
Management risks relate to the process of appointing people to run and manage business entities owned by the family. And, most importantly, the role individual family members play in these structures, compared to the executives who are in a professional management capacity and non-executive employees who sit in some governance capacity. Looking at the Management from the various perspectives and the relationships between the various different managers helps to mitigate and manage risks or conflicts that may arise if there is negative conflict. What helps is having a functional family constitution that is a working document that helps govern the Family, the business entities, and the Family Office’s relationship. The constitution when done intentionally and mindfully will define the roles that family members play in running of businesses and investments they own as well as the Family Office. The constitution will put in place the protocols that the Family will have agreed on and have aligned to that ensure that conflict may be minimized or handled with more acuteness and thoughtfulness in judgment.
4. Investment Risk
If and when a part of the Family’s wealth is in investments in any form or category, there will need to be an understanding of the risks associated with investing; how decisions are made in making any such investment; and what processes are in place to manage those investments effectively. Investment governance demands that a family set up an Investment Policy Statement. The investment Policy Statement provides the general investment goals and objectives of the Family and describes the strategies that the Family Office should employ to meet these objectives. Knowing what the investment goals of the Family Office are is critical for the Family Office to be able to gauge the success or failings of employed strategies. An example of investment risks are for example what happened in 2020. The global pandemic of COVD-19 was an unprecedented and unexpected event where all long-term or short-term investments were impacted. For Family Offices and wealthy families, having a clear strategy and direction would be imperative to ensure that the Family Office maintains or grows the family portfolio and has a clear directive on how to act in volatile spaces. As essential as it is, developing a solid investment policy statement is not a typical exercise for most investors. Mostly because it requires a lot of thought and it also requires an understanding of how the market works as well as familiarity with investment principles and practices of the locations and jurisdiction the investments are housed.
5. Reputation Risk
This risk is mostly related to the business the Family owns, or if the Family has a name that is well recognized in their own country, or even more importantly, a name that has global recognition. Such risks may not be necessarily fully recognized or understood. Most people overlook this but with the world becoming a global village and information traveling around the world at the click of a send button this risk can have, material, social and commercial consequences. There has always been the risk that an unhappy customer, product failure, negative press, or lawsuit can adversely impact a Family Office’s brand reputation. And the growth of social media and influencers has amplified the speed and scope of reputation risk. Just one negative tweet, video, or bad review can decrease your customer following, create an overnight loss of value on a company stock value and cause revenue to plummet. There are however ways to prepare for this risk, they include but are not limited to:
• Leveraging strategies to regularly monitor what others say about the Family and its interests online and offline.
• Being ready to respond to comments about the family or its businesses that are posted on various platforms and help address any concerns immediately.
• Keep the quality of what the family or its business show to the public top of mind, so as to avoid lawsuits and product failures that can damage your overall reputation.
6. Technology Risk
No Family or Family Enterprise can ignore the forward march of technology, which, if properly embraced, can be immensely positive, but if underestimated, can be commercially devastating; personally painful and or harmful to a Family’s reputation. Technology risk comes in many forms and the hardest to control and riskiest being Social media. Social media needs to be managed carefully by every Family. Social media is a great way to promote and grow social wealth, create awareness and enhance relationships with the communities the Family aligns with. However, if it’s not executed correctly, social media usage can damage your reputation. Social media is the most immediate threat to your family or your company’s reputation. Because of the generation gap in most Families, one generation may be online and another not. This causes one generation to be exposed unknowingly to a greater audience and at times without consent. It is important to work with family members and employees of the Family Office to align. All players need to be educated on utilizing social media and how the sort of information posted can impact them as a collective. This is a critical task that is the Family Office’s responsibility.
7. Data protection Risk
In a world where all things are online and data-driven, Families of Wealth need to be particularly careful about the dangers of not having the right protections regarding their data. Moreso, families with wide name recognition are vulnerable from many angles but especially two. One where their wealth can be fraudulently stolen, and another where blackmail and the risk of bad publicity is looming from all corners. In 2017, a survey conducted by CSIS and McAfee stated that close to $600 Billion are lost to cyber-crimes annually. The amount is up to one percent of the Global GDP. Individuals, families and major firms have experienced significant losses due to cyber-crimes. It is imperative that Family Offices learn about the various ways that new threats occur and determine how well they can shield their information and systems. Having an in-house IT specialist may be a cautious yet necessary conversation. Data encryption and protection has never been more important and hackers on the dark web have never been more sophisticated. From cellphones to tablets, to personal computers and hard drives, sensitive materials are consistently being shared.
Risk involves the possibility of loss or injury. Noone wants to find themselves exposed to risk or engulfed by the consequences of not protecting themselves from risk. In Families of wealth and family office the possibility and opportunity for overlooked risk is vast. And the solution to identifying risk is bringing in independent eyes with a fresh perspective. Together with the Family Office independent advisors can create strong processes and procedures which can become the critical insurance your family may need to protect themselves against the uncertain world moving at a breakneck speed with equally dynamic challenges.