Fortify Your Family Office through Best Practices and Internal Controls

By Gemma Leddy, CPA, Partner-in-Charge, PKF O’Connor Davies Family Office

Single Family Offices (SFOs) are unique organizations and the saying that “no two family offices are alike” rings true for those who work in this industry. Nevertheless, SFOs share common needs, goals, and challenges. Most often, an SFO consists of a mix of family members and employees working with advisors and outsourced service providers. Many emerge from a successful family business or significant liquidity event and others evolve organically over decades to serve families across many generations.  While the structures and forms vary widely, the purpose of the Family Office ‒ at its core ‒ is to manage, maintain and preserve the family’s wealth, lifestyle and legacy.  

Challenges in the Family Office Environment

Most SFOs have complex legal and tax structures, including family limited partnerships, trusts, foundations, corporations and partnerships with investments in liquid investments and illiquid holdings (e.g., hedge funds, private equity, venture capital, real estate, direct and co-investments). Effective oversight of these structures and holdings while managing the family’s philanthropic initiatives and complex lifestyles can present significant challenges to an SFO.

Successful family office management requires a combination of talented and experienced personnel and an effective operational infrastructure built on sound governance, policies, procedures and controls. This can be especially challenging for an SFO, which are typically small organizations with few employees covering a wide range of responsibilities. SFO personnel often wear many hats handling many diverse priorities while managing important functions that may fall outside of their specific expertise.  

When it comes to SFOs using emerging technology, it usually involves significant upfront and recurring costs and the tools can fall short in providing comprehensive solutions. As a result, many SFOs postpone decisions to improve their operations. The consequences of inaction, however, can be costly and expose the family and SFO to undue risks and expense.

Establish and Implement Best Practices and Internal Controls

As family wealth is transitioned and new wealth created, families are focused on taking a fresh look at how they manage their organizations. Changing tax laws, technology advances, cybersecurity concerns and the vast array and complexity of investments and assets held by a family have driven the need to formalize family office operations and employ a more business-like approach. This would include establishing a framework of best practices and internal controls surrounding the financial management functions of an SFO.

This process begins with assessing risks to the family and SFO, understanding their risk tolerance and implementing risk reduction strategies. Policies, procedures and tasks should be developed, documented and communicated to all participants. Roles and responsibilities will need to be clearly delineated, and a system of ongoing monitoring should be established to ensure controls are functioning and effective.   

Key Functional Areas of an SFO

The following are the major operational, management and administrative functions of an SFO along with our suggested best practices and related internal controls.

Accounting and Reporting

The accounting and reporting function is vital to provide stakeholders with timely, relevant and reliable information to make sound decisions. Consider implementing the following objectives.

• The SFO should have a keen understanding of the specific information needs of all family stakeholders, including family members, trustees, beneficiaries, family office management and advisors. Most often, reporting is needed for financial planning, cash management, tax planning and compliance, trust and estate planning and administration, charitable giving, legal and fiduciary oversight and investment monitoring and oversight.
  
  
• Ideally, the accounting and reporting system should encompass all family entities, including individuals, trusts, partnerships, corporations and foundations to allow the SFO to capture the universe of the family’s assets, liabilities, income and expenses and maintain a centralized database of financial transactions and activity. This allows for more efficient accounting, reporting and internal control processes and procedures.
  
  
• Standard SFO reporting includes Statements of Net Worth, Changes in Net Worth, Income and Expenses, Cash Activity and investment reporting, including investment income and activity, holdings, value, cost, tax basis and performance, and risk metrics.
  
  
• The accounting system should produce reporting at an entity or consolidated level and may include supporting schedules to provide additional details. The reports should provide the necessary level of detail to make them meaningful to the reader. There are many more types of reports required by the family and SFO ranging from investment and performance reporting and tax-basis tracking to art and collections tracking, charitable activities, and residential and construction costs ‒ just to name a few.
  
  
• The accounting system should also capture and tag transactions at a detailed level to allow for flexible and ad hoc reporting. Ideally, reporting should be generated directly from the accounting system, which ensures more reliable, timely and accurate reporting. Reporting should also be customized to meet the specific needs of the reader. While SFO management may require detailed reports and schedules, family members may prefer to see snapshots of synthesized data with a summary of highlights.
  
  
• The accounting system should be maintained in “real time” with adequate processes and procedures to ensure the integrity and reliability of the data. In addition, periodic accounting reconciliations and review procedures, typically performed monthly, should be established to ensure completeness and accuracy of information and transactions.

Cash Management

Effective cash management is integral to managing the family’s wealth and lifestyle. The SFO should launch specific tasks, including the following.

• Establish guidelines and policies to manage funding needs, excess cash, credit lines and debt, and a reporting mechanism to monitor them.
  
  
• Prepare annual and multi-year cash needs forecasts and budgets to project cash needs for operations, investments, debt service, lifestyle needs, gifting, philanthropy and taxes.
  
  
• Monitor spending against budgets and update cash needs projections accordingly. Review and discuss spending targets with family members.
  
  
• Establish funding protocols to support SFO and family lifestyle costs, investment requirements, tax and other obligations and include sufficient cash reserves for cash flow fluctuations and unexpected expenditures.
  
  
• Frequently monitor cash and credit card accounts and transactions. Integrate online bank/credit card access with the accounting system to account for, reconcile and monitor balances and transactions and promptly identify unauthorized or fraudulent transactions. Set up banking and credit card alerts for large and unusual transactions and consider implementing Positive Pay, an automated fraud detection tool offered by the Cash Management Department of most banks.
  
  
• Establish a secure bank reconciliation process with robust internal controls including segregation of duties and/or mitigating controls to separate the reconciliation role from the bill payment and cash management role.

Vendor Management and Bill Payment

Vendor management and bill payment functions are often minimized but strong internal controls and oversight is essential to safeguard the family’s wealth. Consider instituting the following practices.

• Implement a vendor selection and contract review process, including authorization procedures for purchases of goods or services. Consider a purchase order system for certain types of expenditures.
  
  
• Centralize the invoice collection and approval process to ensure goods/services are approved and received satisfactorily in accordance with the invoice or contract with a system to “flag” or “escalate” issues or sensitive items that require special handling.
  
  
• Establish accounting entry protocols including a review of the paying entity, expense and budget classification, payment history and funding source.
  
  
• Implement a secure process of review and approval for all expenditures and payments, including electronic ACH and wires, check, debit and credit card charges, and auto payments.
  
  
• Consider implementing an automated bill payment software to streamline and secure the invoice approval and bill payment process.
  
  
• Implement a perpetual payment calendar to ensure that all recurring payments are processed timely and establish processes to obtain W9s and other information for 1099 reporting.
  
  
• Establish expense and credit card usage, limits and monitoring protocols and procedures.
  
  
• Implement additional procedures for large or unusual purchases (e.g., construction costs, asset purchases, etc.) to ensure that contractual terms are met, tax issues are addressed (e.g., property tax, sales and use tax, gift tax, etc.) and insurance policies are updated.

Wealth Strategy and Investments

The following best practices and controls can be coordinated with the SFO and their Wealth Managers.

• Obtain a deeper understanding of the family’s liquidity needs, tax profile, charitable and estate planning goals and objectives, risk tolerance and interest in ESG (environmental, social, and governance) and impact investing.
  
  
• Implement an integrated family investment policy, allocation strategy and investment mandate compliance for the family, which can be customized for family members, trusts and family investment entities.
  
  
• Institute a due diligence, investment oversight and reporting process for investment managers, direct and co-investments, and custodians.
  
  
• Evaluate investment accounting and reporting processes to ensure integration and reconciliation of custodian reporting with investment manager and SFO accounting records including tax lots, valuations, corporate action monitoring and performance reporting, and risk metrics.
  
  
• Implement processes and controls for tracking and processing alternative investments including subscriptions, commitments, capital calls and redemptions with monthly reconciliations to investment statements and annual reconciliation to K-1s.
  
  
• Consider upgrading to a system or service provider to aggregate multiple custodians and alternative investments on one platform to provide consolidated accounting, investment performance and tax reporting.
  
  
• Consider establishing an investment committee to oversee and monitor the family’s investment strategies.

Human Resources, Payroll and Benefits

Families and SFOs value their trusted employees, and a strong human resource function is crucial to binding their relationship.  Some of the practices to ensure these relationships are robust include the following.

• Review new hire practices for both family office staff and household employees including recruiting processes, employment and credential verifications, and background checks.
  
  
• Establish a new hire/termination process to ensure IT, office, residence and other access is effectively managed.
  
  
• Implement employment agreements including confidentiality clauses.
  
  
• Create an employee handbook to outline legal and organization policies, procedures, employee benefits, professional requirements and behavioral expectations.
  
  
• Document job descriptions including roles, responsibilities and performance expectations. Consider and address understaffing/overstaffing issues.
  
  
• Develop continuing education and training programs to keep knowledge and skills up-to-date and compliant.
  
  
• Implement an employee evaluation and compensation process to conduct periodic performance and annual compensation reviews.
  
  
• Establish procedures and controls for employee changes, time tracking, payroll processing and tax and other compliance.
  
  
• Periodically review employee benefits and HR providers to assess costs, services and benefits and periodically evaluate against comparative quotes.
  
  
• Understand legal and compliance requirements for all jurisdictions; review the SFO’s practices and implement an ongoing system to monitor compliance with federal, state, local and international regulations.
  
  
• Consider using a Professional Employer Organization (PEO) or Human Resources Consultant to provide additional guidance and support.

Tax and Compliance

Whether managing tax compliance in-house or using an outside CPA firm, planning, organization and an in-depth understanding of the entities and activities is key. Some of the undertakings required include the following.

• Maintain an organization chart to identify all legal entities and ownership, maintain formation documents and agreements, and review jurisdictional filing requirements and deadlines. Periodically review from a legal, tax and risk perspective.
  
  
• Evaluate the entity structures for tax efficiency, asset protection and compliance with federal, state, local and international regulations.
  
  
• Establish year-end tax close processes including reconciliation of accounting records to tax documents (e.g., K-1s, 1099s, etc.). Track tax documents and other information required for tax filings including expected receipt dates.
  
  
• Establish an agreed-upon timeline with your CPA for tax estimates, extensions and tax filings, allowing sufficient time to review and approve the filings and arrange for tax funding.
  
  
• Maintain tax basis for all assets including investments, personal assets, residences, art and collections, direct and co-investments, hedge funds, private equity and venture funds.
  
  
• Stay on top of tax law changes and discuss impending transactions with your tax professional.
  
  
• Periodically update and review your estate plans with your trusts and estates attorney and CPA.

Information Technology Infrastructure and Software

Rapid changes in technology and heightened cybersecurity concerns create an urgent need for expert guidance and support. Areas of focus include the following.

• Evaluate the IT environment for security, backup systems and business continuity.
  
  
• Consider an independent review by a cybersecurity consultant to review risks for family members, family office staff and domestic employees.
  
  
• Evaluate Family Office Software: Accounting, Reporting, Bill Payment, Investment Accounting and Reporting. Consider whether the existing systems are being used effectively and are meeting current and anticipated future needs. Research and consider alternatives including outsourced solutions.
  
  
• Evaluate document, task and workflow systems. Research and consider alternatives to streamline operations and strengthen oversight and controls.
  
  
• Obtain information to evaluate the security and privacy protocols used by third parties (e.g., vendors, key advisors, etc.) who host your information.

Opportune Time for Reflection

SFOs play an essential role to safeguard the family’s assets, carry out family directives, provide relevant, timely and reliable financial information for sound decision-making and to ensure that fiduciary, legal, tax and other regulatory requirements are observed.

As families prepare to transfer significant wealth and responsibility to the next generation, while facing the prospect of sweeping tax law changes, the proliferation of cyber threats and after-effects of the pandemic, it has never been a better time to focus on strengthening SFO operations.

A common misperception is that implementing best practices and internal controls will be costly and require a complete overhaul of the family office. In reality, even small organizations can improve their operational effectiveness, streamline their processes and manage risk while maintaining their existing staff. This can be done in stages over time and once the process is started, a path to a more secure and sustainable SFO is within reach.

About the Author

Gemma Leddy is a Partner of PKF O’Connor Davies and head of the Family Office practice. She has spent over 25 years working with high profile and ultra-high-net worth individuals, multi-generational families, CEOs, executives, entrepreneurs and their closely-held businesses.

Prior to joining PKF O’Connor Davies, Gemma was the Chief Financial Officer and Controller of a private family investment firm headquartered in New York City. She was also a Partner in a mid-sized New York City certified public accounting firm and led their Family Office and Business Management Division.

At PKF O’Connor Davies, Gemma and the Firm’s Family Office team provide comprehensive financial management and CFO services including investment and partnership accounting and reporting, administration, tax planning and compliance, cash and financial management, insurance oversight, advanced planning and business advisory consulting services.

Gemma’s experience encompasses a wide range of industries, including investment companies, art and antique galleries, museums, technology and human resource service companies, real estate, manufacturing, retail, construction, magazine publishing, charitable organizations and private foundations.

In 2016, Gemma was named as one of the “50 Most Influential Women in Private Wealth” by Private Asset Management magazine (PAM).

Gemma Leddy, CPA
Partner-in-Charge, PKF O’Connor Davies Family Office
gleddy@pkfod.com | 646-699-2870