The following is an excerpt from UBS Family Office Solutions | UBS Family Office Quarterly
Family offices are inefficient. This is why they exist. Families build family offices because they face a complex and interrelated balance sheet of people and relationships, businesses and portfolios, residences and assets.
Often, people and relationships have overlapping yet individual goals, objectives, interests and initiatives. The enterprise and its assets are typically held in entities and trusts, all having unique tax, cash flow and liquidity profiles. The total connection and interrelation of these people, activities, assets and entities makes for a challenging enterprise to manage for many family offices, not only technically but also from a relationship management standpoint.
The family office needs to be able to manage, administer and provide actionable insights that enable the family to execute on their goals and objectives. To be successful, it is prudent to have a framework to guide the family office in identifying functions and building their solutions.
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The challenge facing family offices
Due to the wide-ranging nature of a family’s particular needs across their enterprise and balance sheet — including investment, tax, legal and risk — they need elements of an accounting department, investment advisor, tax advisory firm, law firm, human resource advisory, IT firm, residential real estate manager, insurance and risk advisor, financial planner and modeler, just to name a few. Indeed, family offices are often operating elements of several service firms under one roof. Unfortunately, there is no single app that can manage all of these disparate yet interrelated initiatives for a family. Many families form family offices because of the complexity that is necessary to manage.
To illustrate, many family offices comprise under 10 employees.[1] Because of the staff numbers and the nature of services required, many family offices often feel stretched by a family’s requirements.[2] Staff wear many hats and are often cross-functional. This contrasts starkly with professional service firms whose associates sub-specialize within their respective legal, tax and investment domains. Family office employees are expected to be both generalists and specialists at the same time. This is a challenge, as nearly all family offices lack the requisite scale to provide every single solution in-house or have sufficient staff to enable sub-specialization.
Less staff can increase risk, particularly around the quality of financial controls. With fewer people providing more services, the quality of service is bound to be affected, and this can lead to burnout and staff turnover. The loss of a single employee in a five-person family office represents 20% of the workforce, which can adversely affect the client-family relationship. Family office staff often possess significant institutional family knowledge, such as the interconnectedness of how the enterprise fits together.
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Optimal outcomes
For many family offices, it is necessary to define desired sourcing outcomes based on the family’s goals and objectives. While some goals and objectives are unique to each family, there is considerable similarity from family to family. These include growth of assets, appropriate diversification and optimal tax efficiency. For a family office as an organization and its capabilities, these can also include:
- Managed risk across assets and operations
- Efficient operations
- Low staff turnover
- Informed decision-making ability
- Strong relationship management with family clients
This is not an exhaustive or definitive list, but generally speaking, the family and the family office need to know where they are today and where they are going in the future and have a plan for how to get there. How a family office is built, designed, adapts and evolves is crucial in meeting the goals and objectives of both family and the family office.
A family office often makes the decision to buy, build, insource or outsource the following functions: investment management, research and analysis, accounting-related, legal and tax return preparation, as well as technology-related.
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The consideration framework
In determining which solutions are needed and how to build them, it is prudent to have a framework that considers many factors. The following factors and considerations can be used and applied to the solution sourcing process. Each consideration and how it is applied will be different for every family office based on complexity, budget and family style. These considerations will need to be updated as the solution marketplace and family complexity evolves.
Capability: A primary consideration in solution sourcing is the level of capability required to deliver the desired outcome. Does adequate capability exist in the family office, or can it reasonably be outsourced based on other factors such as cost? From there, it is understanding the marketplace options to deliver the capabilities required to provide the outcome.
Cost: Cost is another nuanced factor. There are both the initial and upfront costs, such as onboarding, as well as ongoing costs, such as maintenance and management. Other considerations include whether costs decrease over time, as happens with technology, or increase, as often occurs with human capital. Costs also include service cancellation terms or severance costs when someone is let go. It is helpful to think through various costs throughout the entire life cycle of a solution.
Connection: Connection is another critical consideration. Connection relates to how close family office staff need to be to the data, information, resource or solution. Often having a close connection to the data or information is necessary to make an informed decision or provide adequate service, especially in families with a lot of complexity. A family’s enterprise is an interrelated and complex whole, often with disparate or siloed parts. Therefore, a close connection is often necessary to be able to understand how all aspects of the enterprise fit together, as well as how a decision made in one part may have impacts elsewhere.
If a function is outsourced to a service firm or professional, information is distributed away from the family office. This is often the case with accounting-based information. How frequently family office staff need to obtain information is a factor in determining whether outsourcing is a viable option. If the family office must call the service professional to obtain information to make a decision on a regular basis, an external solution might be ill-advised. If it is only episodic, an external solution might make more sense. Other factors determining the efficacy of outsourcing include how tightly integrated a resource or solution needs to be with family office staff and loss of fidelity during information transition.
Control: Control concerns the ability to manipulate or control a solution. For example, financial planning, modeling and asset allocation decisions often evaluate a host of different options. This often requires both technology and information to model and compare various scenarios, necessitating a high level of control over the solution that would make an external solution ill-advised. Understanding the required control level is important.
Coordination: Understanding who in the family office or at an external solution will coordinate the function is another important consideration. With an external solution, this could be a service team or single point of contact. You’ll want to look at how coordination might change over time, including both internally and at the solution. With an external resource, keep in mind that the initial team that onboards family office staff to the solution or resource may not be the same service team that manages the relationship. Coordination is also related to risk, since who or what is executing which part of the function helps ensure adherence to security and necessary controls.
Clarity: Understanding how any function is built and how it adds or detracts from a family office’s transparency is paramount. If a process is too cumbersome with too many steps, it could hinder transparency in the family office operating environment. An outsourced function could also detract from clarity. While clarity often depends on the complexity of family office activities, having a well-thought-out and appropriate process for how any function is delivered can help create better outcomes.
Constancy: Constancy concerns the necessity to have a permanent or continuous solution either inside the family office or externally. A resource inside of the family office offers the value of continuous institutional knowledge, especially if there is a high degree of complexity. In certain instances, it may be valuable to have a permanent solution for a particular function that resides outside of the family office. Having a permanent solution or knowledge base impacts family office operations as well as the client experience the family office offers. Other times it is necessary to reduce key-man risk inside of the family office. Each family office will associate a different weight for the level of constant functioning from its solution.
Current: Current is also another important factor to consider. Specifically, “current” involves the ability to innovate, evolve and adapt as a viable solution source. This often occurs in the tax and legal landscape, as well as with investment and technology solutions. External solutions operate in a competitive environment and must continually adapt and stay abreast of industry changes or the regulatory environment. External solutions also serve a wide variety of clients with diverse fact profiles. This diverse exposure provides external solution providers with skills that enable them to stay sharp and navigate different situations.
Family offices have significant knowledge of complex family enterprises and how different aspects work together. For instance, they understand the potential impacts of decisions across the enterprise. This allows them to efficiently navigate family complexity.
While family office staff have extensive institutional knowledge of the family and enterprise, they do not serve a varied client base that allows them to build deep expertise across sub-specializations. This is why the family office staff, even while working in a vertically integrated environment, still require trusted professional service firms to consult. Otherwise, you run the risk of creating an environment where overstretched staff experience inertia and have little incentive to innovate and revise practices that might disrupt the status quo. All these reasons highlight the importance of an open architecture approach.
Conflicts: Conflicts are a crucial yet underappreciated dynamic in a family office. Conflicts are mostly associated with external firms or counterparties and not the family office itself. Yet internal family office conflicts also exist and need to be carefully considered. The more functions, responsibilities and solutions that reside within the family office itself, the less objective the family office becomes about the quality of their offering. It can be a challenge to be solution-agnostic when you are the solution. If known to the family office and the family, these conflicts can be managed. However, many family office functions are technical and require specialization. Indeed, this is why the family hires professionals. It can be a challenge for the family to understand the technical complexities of estate planning, taxes, legal structures and even investments. Yet the family needs the ability to ask the right questions, understand the conflicts and provide sufficient oversight.
For example, suppose an internal investment staff member determined the portfolio allocation and sourced the managers. If the portfolio consistently underperforms, how should the family respond? Will the family have the time or inclination to ask the right questions, compare the performance to a benchmark or other similar analysis? It is much easier to change external investment advisors than in-house staff. This also highlights the necessity for family involvement and robust family office governance.
Change: Change is the ability to switch solutions with ease when needed, whether in-house or external. As noted earlier, it can be challenging to change an internal solution. Changing an external solution may be easier or more difficult, depending on the contract terms and on the extent of integration, as with software platforms such as consolidated reporting. Having the ability to change solutions might become important if better solutions arise in the market.
Confidentiality: Confidentiality relates to how information is distributed away from the family office. Generally, this should be a non-issue, as most sophisticated external service firms understand why confidentiality is so important for their clients. Indeed, information security is in a service firm’s own best interest as well, since a breach of trust could prove ruinous to their business. However, some jurisdictions may place a premium on and impose more requirements for a family’s safety and security, so families often prefer a narrower information distribution and prefer to keep information in-house.
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Solution sourcing analysis
Each family office will assign different weights and priorities to each function and solution. This can result from distinctions in enterprise complexity or budget. Here, the solution discussion is limited to the accounting function, although it can be applied across all functions of a family office, including investment, legal, technology and private foundation management. For example, the investment function will or at least should have a high focus on capability as well as conflicts, whereas the accounting function should more highly consider what is necessary to enable a family office to make informed decisions regarding cash flows, liquidity, budgeting and forecasting.
It’s not merely a question of insourcing vs. outsourcing. It is also identifying, for example, what makes sense in terms of what technology can be adopted and controlled internally and what might be the right mix of external solutions or professional service firms to augment and complement the internal solution to obtain the desired outcomes.
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Illustration: Accounting function
Accounting is a core family office function. Accounting needs are often the reason that many family offices are started. Accounting data is the foundation for making all decisions, including changes to the investment portfolio, managing cash flows and planning for liquidity, and modeling ways to make large purchases or gift transactions for estate planning. Accounting brings clarity to a family’s complexity. It is also a source of risk for many families, since they have dozens, if not hundreds and thousands, of transactions a month across various individuals, vendors and entities.
The desired outcomes for the accounting function are often:
- Financial control strength
- Accurate record of all financial transactions
- Ability to budget, forecast and make informed decisions
Unbundle the components of the functional value chain: To help you choose what and how to source, it is helpful first to unbundle various functional value chain components. It is not just a question of whether you should outsource accounting, as there are various components within and adjacent to accounting. The unbundling process helps reveal who or what is responsible for each aspect of the accounting function. More clearly defining responsibilities can also improve overall family office governance.
As part of this process, it is helpful to understand both the inputs and the outputs of each aspect or activity and how the outputs will be further used. Key is determining how the activity is constructed and whether it can yield the desired outcome. For example, inputs might include accounting data and transactions. From there, information goes into general ledgers and sub-ledgers and then to various accounts. Financial statements are then produced. The solution chosen should enable the family office to understand the outputs in sufficient detail to enable use and further manipulation. This discussion assumes that the general ledger and sub-ledger for family office activities is provided inside of the family office by a controller.
Additional accounting function components:
- Bill-pay and related bookkeeping
- Consolidated investment performance reporting
- Payroll
Bill-pay and related bookkeeping: Bill-pay is the personal accounts payable and receivable function for a family. Families have several if not dozens of residences requiring payments to utility companies, landscaping firms and maintenance providers, as well as real estate tax payments that need to be made. Bill-pay includes credit card and bank accounts for often dozens of individuals and entities, which receive and send payments from various sources. Sometimes these transactions number in the hundreds if not thousands.
This is a big source of risk for a family as well as a high-volume activity for the family office staff. While this task is highly administrative, it is also a critical factor in the user experience the family office provides. The function often takes in dozens of paper or digital statements from banks, as well as paper receipts and invoices from various vendors, and records and reconciles them for accuracy.
The family wants to know that their bills are being paid on time and accurately. Having a system in place that minimizes manual input, reduces the risk of fraud and detects changes in trends is critical. For example, a water bill that is extraordinarily high might indicate a broken water pipe at a residence, and the right system will help identify this much more efficiently than not having a system at all.
There is also the element of expense reporting, which will include data on how much it costs to maintain an asset such as one or more vacation homes. Expense data is also critical to understand, as it helps determine necessary liquidity and burn rate, which feeds into family investment portfolio construction.
Solution options: The bill-pay function can be built inside of the family office with existing staff, with or without associated technology, or it can be outsourced to an external firm and coordinated by family office staff. Adopting or using dedicated technology should reduce manual input and risk to the workflow and approval process. Many bill-pay activities in a family office are manual and often prone to error. While delegating bill-pay functions to existing staff may not have a direct cost, as no new expense items are put on the family office budget, it does take up time that the staff is not spending elsewhere.
If bill-pay is outsourced, it allows a family office to focus on higher value-added activities, as well as to introduce a layer of financial controls in the family office operating environment. In addition, this can lead to a higher degree of segregation of duties and control inside the family office, as an external firm is providing the bill-pay function and reconciling the data. However, the data and information that external bill-pay firms generate must be sent back to the family or family office, as it is critical in budgeting and forecasting. It is also often essential in supporting the basis of asset values and tax reporting when specific assets are sold, such as residences.
However, families who prefer a higher degree of confidentiality may decide to keep the information distribution of their bill-payment activities within the family office.
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Consolidated investment portfolio reporting
Consolidated reporting is another function that is critical in many family offices. This is because families often have assets spread across multiple custodians and also have an array of managers for specific individuals, entities and trusts. This dynamic is a challenge for a family office to manually track, and it also introduces a level of risk. However, there are consolidated reporting platforms which can track the allocations across managers, entities, trusts and individuals.
While consolidated reporting isn’t always considered part of the accounting function of a family office, a strong argument can be made for its inclusion. Outsourcing would include not only looking at consolidated reporting platforms in the market but also understanding how to manage the platform once selected, either internally or externally.
Solution options: The family can choose to either directly implement a consolidated reporting platform or outsource its administration to an externally managed service provider. The managed service provider sits between the family office and the technology platform, helping to manage the technology for the family office. Either consideration also involves understanding which consolidated reporting platform within the market is the best fit.
Having a person inside the family office provides several advantages, including: close connection to the data and control over technology that allows for manipulation — which can be relevant for planning and forecasting portfolios. However, the family office must have the ability to provide this function in-house and be comfortable with a high degree of dependence on the person remaining in their role and operating the platform. It also means that an existing employee or a new employee must learn and operate the platform, which might detract from their duties elsewhere.
Family offices often choose this as the default option, as there is often no new accounting expense, since the employee would already exist within the family office and would just reposition their duties to include operating the platform.
The other option is to choose a managed service provider to operate the platform on behalf of the family office. There are certain trade-offs that can be expected to this model, however. If an external solution is chosen, it will be a permanent solution and cannot leave the family office, as often happens through natural employee attrition. It might also mean that the external operator is more efficient, since the firm is doing the same function for often hundreds of other similar clients. The downside is that the family office has little to no control over the platform and might lack connection to the information necessary to make informed decisions.
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Payroll and reporting
While it is adjacent to accounting, payroll is another function that a family office requires, both for direct family office staff, as well as domestic staff such as nannies, housekeepers, estate managers and even aircraft crew.
Payroll and reporting solution options: The family office can choose to either have this function done in-house or contract with a dedicated firm that specializes in the service. If the function is provided in-house, it would include the need to not only report and calculate benefits to domestic and family office staff but would also require staying on top of various federal, state and local employment regulations and regimes. This is a time-consuming task with a high degree of risk due to employment law issues. The question is whether the family office has the capability to provide this function in-house. Outsourcing the function should reduce risk to the family office and the family in general.
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The outcome: Effective financial planning and analysis (FP&A)
Choosing an accounting solution depends on whether a family office can provide effective FP&A. This would include planning, forecasting and budgeting across people, assets, entities and activities. It also entails understanding all cash inflows, outflows, sources and uses of cash to enable actionable insights. Building a budget for a household across all entities, assets, liabilities and then consolidating that budget for the total family can help to ensure global cash needs are met. The solution would include identifying any variance between budget and actual numbers.
This is why providing most general ledger functions in-house often depends on the level of connection necessary for a family office. Many family offices have too much complexity to warrant having the solution outsourced to an external firm. However, the resources in the market are also changing, adapting and evolving; and this function, over time, will start to be outsourced more frequently. The question remains, however, as to whether the family office provides effective financial planning and analysis — this is what will dictate how the accounting function is built.
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The determination
Following a process is key to building the appropriate solution set. In choosing an external solution, it can be helpful and even prudent to conduct an RFP process. It is also helpful to have a short written narrative explaining why a particular solution was chosen. Over time, the solution market will evolve, family office employees will move on and the family complexity will change. Having written documentation to reference is important, as the family office itself evolves and new solution mixes are chosen.
This process can lead to higher staff retention and improved family experience. It also supports managing the family wealth like a business: organized, controlled and efficient.
Footnotes
[1] UBS GFO Report 2024 p. 60
[2] Id.