The Family Investment Pot

Many of the historical “Great Families” became well-known because of their vast fortunes.  Some of these families fell into irrelevance, while many are still well-known today.  The Vandebilts, Du Ponts, and Cargills all hold a certain station in the United States that few other families have.  While many of these fortunes decrease through time- through fraud, bad investments, or just the act of dispersion with each generation being larger than the previous- the families and their descendants tend to stay wealthy decade after decade.  Some are quite far-reaching, such as the Du Pont family, with an estimated 3,500 family members and a total family wealth of $14.3 billion.  Others remain more concentrated, such as the Cargill/MacMillian family, which has 23 members and $49 billion in wealth.

What has been the key to the staying power of these families?  All grew large fortunes through building businesses, but once a substantial wealth is accumulated, preserving it becomes much more important.  Most of these families today continue to invest together by building new businesses, buying commercial real estate, or investing in stocks, bonds, and hedge funds.  Using a combination of LLCs, partnerships, and trusts, these families can work together to pool resources and ideas so that everyone does well.  Through the use of smart planning and structuring, these families ensure that future generations will remain in the upper echelon of family fortunes.

Almost none of us will become billionaires.  In fact, very few of us will grow our net worth to $5 million, $10 million, or more.  However, that does not prevent us from using some of the secrets that the ultra-wealthy use to make sure our children, grandchildren, great grandchildren, and beyond have the resources available to help them achieve their dreams.  In the meantime, you may be able to pool resources with siblings, parents, or even cousins to gain access to investments that would otherwise be out of reach.  This process is fraught with peril as any endeavor with family is, but if done correctly, can bring your family closer together while helping everyone grow wealthier as well.

Why Invest with Family

Investing money together as a family raises far more issues than pooling your money with strangers.  It creates personal and emotional ties that go beyond money.  If you lose money with a random stranger, odds are high that you’ll never know the consequences of that loss.  If you lose money with your brother, you still get to see him every holiday.  Nonetheless, investing together as a family can be done successfully, if done correctly.

Pooling family money makes sense when someone has very specialized knowledge that can be used to make an outsized return, or where a large pot of money is needed for a specific investment.  For example, if a family member is an accomplished investment manager, and is willing to assist their family by pooling assets together and managing them as a group, it could be beneficial to all.  Or, if a family member has a commercial property or small business investment that seems likely to have an above average return but requires more capital than any single family member has, pooling capital can allow the deal to go forward.  Most commonly, investing in family run businesses often includes multiple branches of the family and multiple generations each owning a piece.

The greatest reason to invest together is to ensure that your family maintains wealth over multiple generations.  As seen above, many of the Great Families in history continue to invest together today.  Investing as a group binds generations and different branches of the family together, forcing them to gather on a regular basis and stay in close contact with one another.  During these regular meetings, experts and mentors can be brought in to help create a greater level of financial literacy for all family members.  A family investment pot can also provide funding or ideas that any one person may not have been able to achieve otherwise.  New businesses or sizable real estate deals can all be made possible using family money and can help build a greater family legacy.  Finally, and maybe most importantly, investing together can help build a sense of family identity.  Like some of the great families in history, you can make the name and history of your family mean something more than the typical family.

Secrets to Making It Work

Investing together as a family is tricky.  Really, really tricky.  Lost money and hurt feelings are just a few of the issues that can come up.  First, you have to ensure that everyone is on board and willing to work together.  Only then can you even think about pooling money.  In fact, helping others invest for themselves or finding third party capital may be better alternatives.  If, after thinking about it carefully, your family still wants to invest together, then following these ground rules will help it be more successful:

  1. Have a mission statement: Put together a mission statement that extends to everyone involved, spells out what you are trying to accomplish, and makes sure you are all on the same page. Misunderstandings related to investment objectives, liquidity, expected returns, and potential risk of loss are the greatest causes of failure and hurt feelings.  Not every investment will work out, so make sure everyone understands the rationale behind the investment and where you might lose money.  Also, investment decisions should happen at the appropriate time – over dessert during Thanksgiving dinner is probably not it.
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  2. Get Input from Everyone: Ensure that everyone in the family has a voice.  Expertise is often found in only a few members.  For example, I am the sole investment professional in my family.  Others may have real estate expertise, or be founding a new business venture.  Loud and overwhelming opinions or personalities can sometimes make people commit to things that they’re uncomfortable with or don’t understand.  If these ventures go wrong, these circumstances are when relationships get hurt, possibly for the long term.
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  3. Set Clearly Defined Goals: Clearly defined goals and expectations will be key to a successful family venture.  Decide what you want to accomplish with this pot of money, both personally and together as a family.  Work to form collective goals, and only once those are decided can you begin.  Building wealth for wealth’s sake is a hollow goal, so focus on what you can do together as a family.  Family goals could include everyone having F-You money, or buying vacation homes together on a favorite lake or ski hill, or making a sizable gift to a charity that you’ve worked with in the past.  Make it more than just hitting a number.
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  4. Document Everything: When investing as a family, you have to do everything possible to treat it as though you are not investing as a family!  Document everything, so that there is a clear record of what’s being done and why.  Come up with an investment policy statement, which states the goals, strategies, expected returns, and risks of the joint investments.  Designate a secretary and send out meeting notes so that everyone understands why a decision was made a certain way.  Finally, send out regular statements and summaries of how investments are doing so no one is caught off guard with circumstances that are outside of expectations.
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  5. Have a Well Thought out Governance Structure: A governance structure will allow a family investment pot to operate smoothly and efficiently. It’s important to schedule and arrange regular family meetings.  Depending on the size, a family can go so far as to have family boards of directors, investment committees, or shareholder councils.  Most won’t require this, but having some structure will be crucial.  It’s important to acknowledge that differences of opinion will occur and find ways to resolve them before you all invest together.  A dispute resolution process may be necessary.  It’s also important to determine who does what.  Almost always, one or a few parties will do more than everyone else.  That’s okay.  If necessary, some compensation may be warranted.  However, many will want to do it out of the goodness of their heart.
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  6. Have an Exit Strategy: At some point, members of the family will probably want to get some money out of the pot. As part of the upfront documentation and governance work, incorporate ways for members to willingly leave the family investment pot.  Depending on circumstances, you may even want a way to force a family member out (at a fair valuation, of course).  Many investments have a natural endpoint (such as selling an investment property), but many do not.  Figure out ways to do so, so that family members are not tying up capital for longer than they expected.

Structure

The actual investment structure is one of the easier parts of the family investment process.  The difficult parts are done up front, in getting everyone to agree to invest together, and setting the framework around which everyone is treated fairly.  Most families invest how many other investments are done, through the use of trusts, limited partnerships (LPs), or limited liability corporations (LLCs).  The legal aspects of these are different, but the basic mechanics are similar.

In an LLC structure, an LLC operating agreement is drafted that spells out all the pertinent details described above.  It will spell out the investment strategy, who does what, and ways to contribute more capital or take some out.  LLC agreements can forbid the selling of shares without permission from other LLC members, require regular capital contributions, or be highly specific to a single transaction.  A typical LLC has a managing member, who is allowed to make basic decisions, open bank accounts, and do regular reporting.

Limited partnerships operate a little differently, in that there is a General Partner who controls most everything.  Unlike an LLC agreement, where members can have more say, limited partners are really just capital contributors, although they may have a say in some of the bigger issues.  Importantly, you must explicitly trust the general partner, as they will have the most impact on the investment.  Sometimes investments don’t work out, so you want everyone to be aware of the pitfalls and not just blame the General Partner.

There are a few common styles of family investment structures.  One is a parent or grandparent controlled LLC or LP.  Other family members can buy in with regular contributions, or can be given shares as a gift.  This is a great way for a family elder to maintain control, while still giving away part of their wealth through time.  Another would be a pooled authority LLC, where decisions are made by voting.  This can be clunky, but if control is an issue, voting can be done with results for big decisions being required to be unanimous if necessary.  Pooled authority LLCs may be used when all members are contributing somewhat equally, and several family members want to keep some control.

Types of Investments

Investments in a family investment pot can be invested in any way the family sees fit.  A small family business is common.  For example, if parents built a successful business and want to pass it on to the next generation, they can begin to bring in their children as equity owners in the LLC or corporate structure.  They can even gift shares each year without tax consequences up to the allowable IRS maximum (a great way to pass down wealth through time and without taxes).  Through the use of bonuses and earn out structures, they can transfer more and more ownership as the next generation begins to take the reins and contribute more.

Another common use would be to invest in real estate holdings.  Let’s say a family member comes across a great deal for 50-unit apartment building, but with a cost of $5 million.  They’ll need to come up with at least $1 million for the down payment, plus a sufficient amount in reserves.  If the family member does not have that amount of capital, they could offer to bring family members into the deal and create a family LLC or LP that would buy the apartment building.  Most functions can be outsourced, as third party property management is available most anywhere.  The initial family member would only be responsible for reporting and disbursing profits as they come (well, hopefully they earn profits).

Finally, certain investment strategies have minimum investment requirements that may be too much for any single family member to meet.  If you can gain access to a top tier venture capital firm, then you should find a way to invest.  These firms have anywhere from a $1 million to $5 million minimum commitment size.  Pooling family resources and having the LLC or LP commit to the fund will help raise the required capital needed to invest.  Private equity, hedge funds, private credit funds, and real estate funds all have similar requirements.  This could be a way to gain access to top quality investments and investment managers.

Avoiding Trouble

Investing together as a family can be a minefield of conflict and issues.  However, doing so can be highly rewarding to all parties involved.  It can help bring the family closer and bind generations together, while hopefully making everyone some money.  Misunderstanding strategies, goals, and risks are the biggest pitfalls.  Make sure everyone understands what they’re getting into, as unexpected bad outcomes are often the root cause of failed family investments.  If you’re making a specific investment, in either a small business or real estate deal, ensure that the family LLC is properly capitalized.  Inadequate capital and lack of cash flow are often the reason businesses and real estate transactions fail, so make sure that enough capital is invested up front, or that all members can contribute if and when needed.  Finally, although it’s a bit odd to say, treat everyone as strangers when investing together.  Document everything, make sure everyone gets a fair shake, and make sure all legal work is in order.

Keep building my friends.

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