Family office or business? Where to put your money

Family businesses and family offices may start out hand-in-hand, both focused on sustainable investment growth. But as they grow, investment strategies diverge and the recent economic downturn has challenged conventional financial wisdom for both family businesses and family offices.

So how should these two establishments approach sustainable investing? Let’s first examine the family business, where the operating asset may represent as much as 80 per cent of a family’s wealth. The business provides the family with an income stream and making sure their company flourishes is the family members’ top priority, says William J. Boer, president and founder of Grey Dunes, a US consulting firm. “When you’re investing in a family business, you’re reinvesting capital, not diversifying. What’s critical to recognise for longevity is that any business can become obsolete.”

In order to hedge the risk of corporate failure, the liquid assets of family business owners should be invested in a conservative portfolio, Mr Boer says, particularly if their underlying business is highly susceptible to market changes. The capital invested outside the family company should be sufficient to fund a transition period if their business value were to drop drastically.

Fixed income choices tend to be favourites, he says. “A manufacturing family often puts money into real estate, owning the real estate of the company separately as a secondary investment. Should the family sell the company, they might retain control of the real estate [to generate an income stream].”

Family offices must balance the family’s lifestyle goals with the need to preserve capital

The priorities of family offices are quite different. “I see a family office focusing on wealth preservation and sometimes income generation, seeking conservative real returns and managing family interests and relationships, while a family business is likely to be focused on wealth creation,” says Guy Rigby, head of entrepreneurs at financial advisers Smith & Williamson. “Investment priorities in a family office, which already owns significant wealth, are likely to be much more varied.”

Family offices must balance the family’s lifestyle goals with the need to preserve capital. “The family has already hit a home run and accumulated all this wealth, they don’t want half their portfolio invested in risky bets,” Mr Boer adds.

But it is tricky in the current climate to match the returns a family was accustomed to getting. Instead, some family offices are now considering investing in businesses. “Many of these family offices trace their wealth originally to a business and they truly understand the fundamentals of business success. With a company, at least you’ve got this asset you can control; it’s not a capital market instrument where something could happen to Greece and you’re going to go down when everybody else goes down,” says Mindy Rosenthal, executive director of the US-based Institute for Private Investors (IPI), an educational, members-only organisation for high-net-worth families.

Conventional wisdom suggests that family business owners are best served by investing in industries outside their operating assets, so as to diversify their portfolios. But research done post-2008 favours a strategy of investing in known industries. “If you’re an expert in shipping, maybe you should invest in ports development where you probably have connections and expertise,” Ms Rosenthal says.

Such a strategy has long been a subject of debate, says Mark Evans, executive director of The Coutts Institute, the wealth division of Royal Bank of Scotland Group. “There is often a real conflict between the wealth manager’s view that risk management is best achieved through diversification and the business person’s view that risks are best managed by focusing your efforts where you have the expertise,” he says. “Professional investment managers base their analysis of risk on academic theories that suggest risk is minimised by diversification across a range of asset classes which are not closely correlated.”

Joe Schmieder, of US-based advisers The Family Business Consulting Group, says his clients are more successful when their outside investments are aligned with their core businesses, where they have similar cultures. “I have a client whose company does street infrastructure. They started to get into furniture and other investments that were more interesting than watching the concrete dry. None worked and now they’re back to buying companies in their core competency – and they’re doing great,” Mr Schmieder says. “I’m always amazed how poorly the families who have invested outside their niche have done.”

One solution for family business owners who want to diversify outside their core competency with less risk is networking with other family business owners through organisations like the IPI or the Family Office Exchange (FOX), based in Chicago. “Many family businesses would be likely to stay in the same industry [with their investments],” says Heather Asher, senior relationship manager for the family office market at FOX. When they meet other business-owning families, they can gain expertise and insight on outside investments from insiders, and provide that kind of advice to others. “They can teach and receive the benefit of learning from their peers,” Ms Asher says.