Families and family assets are increasingly mobile, based in various jurisdictions and subject to a variety of laws and regulations. A family’s main challenges, among others, are to ensure a reasonable return on equity, business continuity over the foreseeable future, as well as sound family governance.
There is a variety of structures families can choose to commit their assets to, each with its own attributes and uses. In this article, I shall focus on the specific characteristics and merits of a family fund – an institutional framework for private wealth.
What is a family fund?
Simply put, a family fund is a closed-ended (or indeed sometimes open-ended) structure set up for family members. The units or shares of the structure are only accessible to the participating members of the family or their wealth administrators.
Funds are popular among wealthy families, investment club members and other partners looking to keep wealth together and invest in a range of asset classes on a collective basis. They allow assets to be consolidated, providing a clearer view of the collective pool of wealth.
Importantly, a fund is a ‘tax neutral’ structure that limits debate around the allocation of capital gains/income by virtue of being a see-through structure that places taxability squarely on the shoulders of the investors.
A fund structure also provides an independent and professional framework to help safeguard the family’s assets and tailor individual family members’ income. Wealthy families may not have the expertise or the time to make well-founded investment decisions. They may therefore appoint an investment manager for the day-to-day investment decisions, an administrator to independently calculate net asset values and an auditor to independently verify the financial records and accounting methods – with each appointment serving to ensure industry best practice and compliance with local and international regulations.
Further, funds can be compartmentalised, making it possible to select several managers or management companies within a single fund, and thus meet the various requirements of different family members. For example, this can be used to allow certain family members to invest in fixed income instruments that are linked to debt financed underlying asset classes if their cash flow needs so dictate. Vice versa, tailored entities can be structured in between the fund and individual investors for specific planning purposes.
A fund can also be structured and operated to meet changing investment objectives in a shifting economic landscape. Shares in a fund may be held by a securities account or even a life insurance contract. They can also be held in a trust or foundation for asset protection and succession planning purposes.
When can you use a family fund?
Family fund structures suit multiple purposes and can be used in a variety of situations. A family fund is a particularly apt choice when seeking to:
- Ensure continuity of the family business
- Safeguard assets from political and economic instability, or spendthrift activity
- Achieve flexibility in reclassifying income and distributions to suit individual needs
- Aid individual planning, given that a fund is tax neutral
- Allocate participation rights with or without voting rights
- Avoid possible intra-family disagreement
- Establish charitable legacies
- Enhance investment opportunities, diversification and liquidity
- Gain easier access to liquidity and leverage.
Setting up a family fund
When it comes to setting up a family fund, there are a number of factors that must be taken into consideration, from the specific purpose met by the fund through to its operational framework. Choosing where the fund is to be domiciled is also an important decision, as every jurisdiction has its own laws and regulations.
In the consultation rounds, the items that need to be discussed in order to outline the operational framework are:
- The regulatory environment regarding the investment policy
- The jurisdiction where the fund should be domiciled
- Its management and corporate governance including directorships
- The general preference of prospective investors
- The estimated costs in establishing and administrating the fund
- Tax efficiency for the fund and the investment manager
- Fund manager incentives including fees and sharing of costs with investors.
Appointing an independent administrator to set up the fund can deliver true value, especially if they are involved in the process from the very beginning. Administrators guide the fund’s investment manager in the initial consultation rounds by connecting them with the right legal and tax advisers based on their specific requirements, thus paving the way to the best possible structure.
In funds we trust
To conclude, a fund offers great flexibility, transparency and versatility and can help to keep the family’s wealth together while satisfying the needs of individual members. When used in conjunction with other wealth planning structures, family funds provide a global wealth management solution encompassing all family members.
Family funds are on the rise for various reasons, mostly to do with their enhanced access to expertise, independent management and controls, and sound planning tools. Funds allow families to obtain the right balance between active involvement and passive investing in an objective and sustainable format. At the same time, they allow for greater scalability and access to external investors, thus potentially enhancing performance. In addition, for multi-family offices and family club transactions, a fund is an ideal vehicle for implementing and governing targeted allocations from each participating family in a ring-fenced way.
For example, at IQ-EQ we have recently assisted in setting up family funds for significant family wealth pools in Colombia and Brazil, including active and passive assets and varying levels of involvement across the different family members. At the time of contribution of the assets, independent valuations took place on the underlying operating companies, thus providing a baseline valuation to establish correct levels of ownership and pricing of instruments. Similarly, investment advisory boards were established for implementation of an investment strategy set out by the family patriarchs.
Finally, it’s important to note that the increasing interest in family funds is happening against a backdrop of greater transparency and regulation. Indeed, a significant advantage of establishing a family fund is compliance with BEPS and OECD requirements. This is not unimportant in today’s world, in which full compliance and sustainability is considered a minimum standard by regulators and investors, requiring careful planning and structuring through a recognised and fully compliant jurisdiction.