A Family Office Private Client Services Team Perspective
Family offices, which manage the wealth of ultra-high-net-worth individuals or families, often deal with a variety of assets that can be challenging to administer and value. This challenge arises from the fact that the asset is unique and/or lacks a liquid market. The Private Client Services (“PCS”) team of a family office may serve as a “quarterback” in coordinating communication between different departments within the family office. It is also the team that handles these unique assets in the normal course of trust administration. Here are some examples of “unique and hard to value” assets that family offices might encounter and tips on how to deal with them.
At a Glance
- Consider an insurance specialist to insure valuable and rare, or hard to value assets. This might include art or property in a natural disaster zone.
- If you choose to manage assets such as a jet or yacht in the family office rather than outsourcing, be prepared to hire and consider multiple jurisdictions.
- Private Equity investments and closely held business have a high risk level and potential reward. Make sure these assets are part of your family’s overall plan.
Fine Art, Jewelry, and Collectibles
Ultra-high-net-worth families frequently acquire very valuable pieces of art, jewelry, antiques, and collectibles. Having these types of assets comes with unique considerations. The value of art can be highly subjective, dependent on factors like the artist’s prominence, the piece’s historical significance, and market demand. Nevertheless, value must be assigned to these assets for several reasons: insurance coverage; determining trust and/or estate value (which potentially plays into tax planning); capital gains tax assessment; and fee determination relating to the family office’s assets under management.
The value of these assets is related to other considerations as well, notably security. Valuable jewelry, for example, necessitates at the very least a secure safe in which to store it, as well as an effective home security system. Further, clients should minimize social media posts that could be interpreted as efforts to “flaunt” their wealth and subject them to predators who may wish to target them or their homes. The PCS team can assist in dealing with these types of assets by arranging for valuation experts who are experienced in these assets to determine values, engaging specialized insurance brokers who are experienced with such assets to ensure proper coverage is in place, and arranging for a security evaluation to recommend home security systems and ways to protect clients and family members from compromising their physical safety due to their online presence.
Real Estate Holdings
Particularly unique properties, historic estates, or properties in less liquid markets or areas prone to natural disasters (fires, floods, tornados, or hurricanes, for example) can be challenging to administer, value, and insure. There are myriad considerations when one holds a fiduciary responsibility for such assets. If a property is income producing, consideration must be given as to how this property is to be managed. This could involve hiring a property management company, hiring an individual who lives on site, or taking on the responsibility directly. The first two of these options is ideal, as professionals can then take on the responsibility for dealing with tenant issues, collecting rent, arranging for maintenance and repairs, and being a point of contact for local authorities and vendors. If no one is already identified, the PCS team can assist with vetting companies or persons for this role.
Another important consideration regarding real estate is property insurance. In a time during which natural disasters, such as floods and fires, seem to be on the rise, it is becoming increasingly difficult to find insurance companies who are willing to cover properties in “risky” areas. In California alone, several insurance companies have declined to write policies in certain wildfire-prone areas or have withdrawn from the State altogether. The PCS team can go through the work of vetting insurance companies directly or alternatively engage a boutique insurance broker who specializes in difficult to insure properties. These brokers will help ensure that proper coverage is in place.
A subset of real estate holdings is timber/agricultural land, farms, and ranches. These types of properties come with their own set of considerations and can require specialized management. Issues with these properties include commodity price fluctuations, sustainability practices, environmental and conservation regulations, pest and disease management, weather and climate impact, land maintenance and improvement, labor concerns, market access and distribution, and tax implications. Having people or companies who are experienced in dealing with these issues is critical not only for optimizing the performance of these assets, but for preserving liability protection as well.
Natural Resource Rights
Given the unpredictability of everything from valuation, income, regulatory and environmental concerns to tax implications, natural resource rights present unique challenges to those responsible for administering trusts or entities that own them. Determining the value of natural resource rights can be difficult, especially if the resources haven’t been fully explored or exploited. Valuations may need to consider potential yields, current and future commodity prices, extraction costs, and more.
Revenue from natural resource rights (like royalties from oil or gas production) can be highly variable. This can impact income distributions and financial planning. Natural resource extraction often falls under strict regulatory oversight. The family office must ensure that operations comply with local, state, and federal regulations, and sometimes even international agreements.
The extraction of natural resources can have significant environmental impacts. The family office might be held responsible for any environmental damages, leading to potential liabilities. If the family office leases out the rights to a third party, the terms of these leases are crucial. Regular audits might be needed to ensure the lessee is adhering to the terms and paying the correct amounts. Revenue from natural resource rights might have specific tax treatments, deductions, or credits. The family office must be well-versed in these to ensure compliance and optimize the owning entity’s tax situation.
Given the operational and environmental risks associated with natural resource extraction, comprehensive insurance and risk management strategies are essential. For natural resource rights, working with experts in the field—such as geologists, environmental consultants, and legal experts specializing in natural resource law—can be invaluable. These experts can provide guidance on various aspects, from valuation to operational oversight to regulatory compliance. A family office’s PCS team can be the operational quarterback to ensure the proper experts provide guidance.
Yachts and Private Jets
Administering a family office that owns luxury assets like yachts or private jets introduces challenges. These relate to the intricacies of maintaining, operating, and navigating the regulatory environment of such assets. A fractional ownership program (such as through NetJets or Flexjet) can mitigate the family office’s direct responsibility. However, some clients simply prefer to own their own yacht or jet.
In the event that family prefers direct ownership, they must get the right people and operations system in place. This requires a crew (from pilots to yacht captains to service staff) that must be hired, trained, and managed. It also requires a staff for regular maintenance and periodic overhauls to ensure the yacht or jet remains in good operational condition. Lastly, yachts need docking spaces, and jets require hangars. Both can be expensive and might vary in cost depending on the location and duration of stay.
The global nature of yacht and jet usage means they might traverse multiple jurisdictions. Each may have its own regulations regarding safety standards, certifications, and crew licensing requirements. Environmental regulations and standards, such as those concerning waste disposal or emissions, may become an issue, especially for yachts. Depending on how the yacht or jet is used and where it’s registered or docked, there can be significant tax implications, including sales tax, use tax, or value-added tax (VAT). The family office might consider registering assets in certain jurisdictions to minimize tax burdens.
If multiple family members have access to the yacht or jet, scheduling can become a concern. Clear guidelines and booking systems may help manage usage fairly. Given the high value of these assets, security becomes a prime concern for the family members as well as the yacht or jet. This might include physical security measures, cybersecurity for onboard systems, and even personal security for users. Insuring yachts and jets can be costly. Policies need to cover potential damages, liability issues, and sometimes even ransom or piracy concerns.
Closely-Held Businesses
Owning interests in closely held businesses presents a unique set of challenges due to the nature of such businesses and the intricacies of their operations, governance, and valuations. Closely held businesses often lack a readily ascertainable market value. Regular appraisals by qualified experts may be necessary, especially for tax, distribution, or sale considerations.
Depending on the ownership stake and how the business interest is held, the family office might be directly involved in business decisions. However, even if there is outside management, owners must consider the long-term future of the business, especially if there’s a need to transition management or ownership to the next generation or outside parties.
Since there isn’t a public market for closely held business shares, converting these shares to cash poses a challenge. This is especially then case when the owner(s) need liquidity for distributions, expenses, or taxes. Many closely held businesses have buy-sell agreements. These dictate how family members can sell or transfer ownership. The family office must be aware of and comply with these agreements.
The family office must be vigilant about potential conflicts of interest. This is important if family office staff or family members have roles in the business. Depending on the jurisdiction and structure of the business, there might be risks of business creditors going after assets held in the family office legal structure or vice versa. Proper legal structuring and asset protection strategies are crucial. Given the complexities involved, the family office’s PCS team often collaborates with various professionals, including business valuation experts, tax advisors, legal consultants, and industry specialists, to effectively manage the interest in a closely held business.
Private Equity, Venture Capital & Direct Business Start-up Investments
Administering private equity (PE), venture capital (VC), and direct business start-up investments entails a unique set of challenges given the inherent risks, potential returns, and complexities of these investment classes. Given the intricacies of these investment classes, it’s often beneficial for the PCS team to collaborate with financial advisors, legal experts, and industry specialists. They might also consider co-investing with reputable PE or VC firms that have a track record of success in the field.
Depending on the size of the investment, the owning entity might have governance rights, like board seats or voting rights, which require active participation and oversight. The relationships with fund managers, co-investors, and entrepreneurs will likely yield access to high-quality information.
Unlike publicly traded assets, the valuation of PE, VC, and start-up investments is not straightforward. Periodic appraisals may be necessary, especially for tax or distribution purposes. The valuation might be based on various factors including financial performance, market comparables, or discounted cash flows. Furthermore, PE and VC investments often involve capital calls where the investor commits to providing funding up to a certain amount over time. Family office staff need to ensure the owning entity has the liquidity to meet such calls.
The tax treatment of PE, VC, and start-up investments can be complex. There might be issues related to carried interest, Unrelated Business Taxable Income (UBTI), or structuring investments through offshore entities. The regulatory environment for PE, VC, and start-ups can vary across jurisdictions. This might influence the structuring, operations, and exits of the investments.
Managing Risk
A significant concentration of overall assets in a particular PE fund, VC firm, or start-up exposes the family to large risk. Diversifying across sectors, stages of investment, and geographic regions can mitigate some of these risks. These investment classes are inherently risky. Not all start-ups succeed, and not all PE or VC investments yield high returns. The family office needs a risk management strategy, including due diligence, portfolio diversification, and ongoing monitoring. Given the higher risks associated with these investments, thorough due diligence is crucial. This involves analyzing the investment’s financials, business model, management team, market potential, and more.
PE and VC investments typically have longer investment horizons, often spanning several years. The family office needs to align the family’s objectives and liquidity needs with these horizons.
As PE, VC, and start-up investments tend to be illiquid, there may be lock-up periods, restrictions on resale, or a lack of secondary markets. Consequently, this can pose challenges when the trust needs liquidity for distributions, taxes, or other obligations. Knowledge of the performance and operations of the underlying investments is critical. Those managing these assets should ensure they have adequate information rights and access to periodic updates. Realizing gains from PE, VC, or start-ups depends on successful exit strategies, such as a sale of the company, an IPO, or a buyout. Thus, the family office should have a plan on exit timing and strategies.
Cryptocurrencies
Family offices that engage with cryptocurrency often must remain agile and informed about the fast-evolving landscape. This includes keeping up with technological developments, regulatory changes, and market dynamics. A family office’s PCS team can assist with the above by engaging experts in the field, whether internal hires or external consultants. This can be crucial for navigating the complexities of cryptocurrency as an asset class.
The values of Bitcoin and Ethereum are visible on multiple exchanges. However, the value of less liquid or lesser-known tokens might be harder to determine, especially if they are not widely traded. Furthermore, the value of cryptocurrencies can be highly volatile, leading to significant changes in valuation in short periods. This volatility can make longer-term estate planning or wealth distribution strategies more complex.
Cryptocurrency doesn’t have the same traditional banking and financial infrastructure that other assets might have. This means family offices need to understand crypto-specific tools and platforms. For example, the family office should know how to store cryptocurrencies securely. The family may lose cryptocurrency assets irretrievably if it loses access to the wallet (for example by losing the keys).
Cryptocurrency regulations and tax implications vary by jurisdiction and can be complex. Governments often tax cryptocurrency holdings and transcations in ways that are different from other assets. Furthermore, governments are creating new legislation around crytocurrencies, meaning that the reglulatory landscape might change quickly in the coming years.
Conclusion
Family offices that manage the wealth of ultra-high-net-worth individuals or families encounter a diverse range of unique and hard-to-value assets. These assets, including fine art, jewelry, antiques, collectibles, real estate holdings, natural resource rights, yachts, private jets, closely-held businesses, private equity, venture capital, direct business start-up investments, and cryptocurrencies, each come with their own set of challenges.
To effectively manage these assets, family offices must consider factors such as valuation, insurance, security, regulatory compliance, environmental impact, and tax implications. The Private Client Services (PCS) team within a family office often plays a crucial role as a “quarterback” in coordinating the management of these assets. They work with experts like valuation specialists, insurance brokers, legal consultants, and industry specialists to ensure proper management, compliance, and optimization of these assets.
The complexities involved in administering these diverse assets require specialized knowledge and strategies, making the role of the PCS team and the collaboration with various professionals essential for the effective and efficient management of the wealth and assets of ultra-high-net-worth families.