Family businesses and the increasing importance of the Family Bank
8th September 2020
The American saying of “shirtsleeves to shirtsleeves in three generations” originated in the late 19th century and continues to ring true for many once-wealthy families around the world, and in this age of relentless and unprecedented disruption, protecting family interests through the generations is harder than it’s ever been. In the UK, only 30 of the companies that made up the original FTSE 100 in 1984 are still around today. Among private businesses, this rate of change is even higher.
Whether it’s new industries, new business lines, new regions, new technologies or new capabilities, businesses that fail to innovate and diversify are being left behind. Many family-owned businesses are run more conservatively and cautiously than their listed or private equity-owned peers, which can often manifest itself in under-investment in the future and leave companies more susceptible to disruption. This is particularly relevant with the digital revolution and not just the amount of change, but also the speed of change.
Never before has the need for diversification been more important. Disruption can take many forms – be it technological, political or scientific, or unforeseeable circumstances such as the pandemic the world is currently seeing to devastating effect. One of the challenges of having simply “the family business” is the reliance that creates on one trading vehicle, with huge ramifications for the business and family members if it encounters difficulty.
Alongside the external factors, there are many internal challenges families face - not least in succession itself. It is all too often the case that, as family operations pass through generations, the next generation is under-prepared for the transition and the root of the problem is a lack of communication and strategic dialogue. More often than not, this is because of the combination of a reluctance in the senior generation to force the conversation of succession and a reticence in the younger generation to push for inclusion, preferring to ‘wait for the call up’. It is no surprise therefore that this leads to deficiencies in strategic direction, leadership and decision-making at a critical time. If you add to that a dilution of ownership and potential syndication of decision-making, it can cause friction – both amongst shareholders and with executives and employees. A third generation family business will often have many more stakeholders than a first generation business. Certain family members might not be involved in business operations and therefore not masters of their own destiny, and unless there is a clear structure with comprehensive parameters in place, this leads to increased potential for conflict.
If family businesses successfully reach their third and fourth generation, new challenges arise. The continued dilution of shareholdings can be to the detriment of the businesses. Often the only way of solving that is by seeking to re-centralise ownership, something that itself brings risk – that re-centralisation needs financing; some family members will have significant amounts of cash but no longer a dividend stream, others will have limited liquidity but a valuable trading asset. The potential for personal conflict naturally grows. Clarity is the key mitigant, and if families want to be able to successfully pass businesses and wealth through generations, significant strategic consideration needs to be given to long-term plans and these need to be formalised.
The issues faced by business owning families are also faced by wealth owning families. Regardless of whether the family has one or more businesses they own and control, addressing asset protection and succession planning in relation to a portfolio of investment assets requires similar attention if family objectives are to be met.
This is just touching the surface of the internal and external pressures that arise, and one thing is clear: in order to address them, families increasingly need to think outside of their main trading and investment operations and undertake more comprehensive long-term strategic planning across the entirety of family interests. More and more families are starting to address this challenge through implementing a relatively new concept: the ‘family bank’.
A family bank can take many forms – it is not necessarily a bank, it can be a private investment vehicle, a legal framework, or perhaps simply just a notion – the key is that it provides long term strategy and clarity to all family members, focused on delivering a platform for preserving and transitioning wealth. There are many benefits of such an approach, all of which centre around the vital ingredients to multi-generational success: succession planning, diversification, purpose and wellbeing. Often most important of all are the discussions that take place within a family about how a “family bank” can operate - just having the conversation and considering the possibilities is an important first step for many families.
The most vulnerable point for family businesses and wealth is often at succession. Invariably families try to walk the tightrope between encouraging the next generation to get involved in the family business and giving them the free rein to make their own decisions and make their own way, meaning that succession planning is rarely as comprehensive as it needs to be. The strategic dialogue between the generations is often very limited in the critical age of 18-25, and not enough thought goes into how to build the skills the individual and the business need or will need in the future. The emphasis naturally then moves to learning on the job, which brings its own challenges.
This doesn’t happen because of lack of interest or engagement from either generation; families don’t feel comfortable having these conversations because they somehow feel too prescriptive at an age where the next generation should be learning, questioning and exploring in equal measure, unstifled by the heavy weight of family duty. It’s the balance of planning for the needs of the business versus empowering the younger generation to plot their own chart.
Many families are also starting to question: what if you upend the traditional approach and, instead of perennially grappling with how best to fit family members into the family business, you approach it from the opposite angle? What about tailoring the family operations to best utilise the skills of the individuals, promoting diversity and thinking about it in the broader perspective of the family bank rather than the family business?
This can foster a valuable entrepreneurial spirit in the next generation, where they can benefit from intra-family financing whilst also receiving a crucial support framework. If the next generation have clarity on the structures in place for the different potential paths they may follow, it increases the likelihood that they make good decisions for themselves and their role in the family, both in terms of higher education and early career choices. It also facilitates a healthier, more timely and more comprehensive conversation between the generations about individual plans and the needs of business operations. There will always be the element which is reliant on the open dialogue between family members, but having the structures in place to facilitate those conversations and provide clarity to all parties will give the highest likelihood of success.
Finding this balance is an age-old challenge for which there is no formula, but it’s something a clear family charter can help to resolve. It helps family members know where they stand and help them plan best for what they are looking to achieve, providing transparency and accountability to all parties.
Thinking more broadly about business and investment interests can help families to think more strategically about long-term wealth preservation. Many families have 80-90% of their interests in one large business. This can be risky, particularly in the context of global change and widespread disruption, and there is no greater demonstrator of this than the havoc COVID-19 is having on good businesses across so many sectors. Asset diversification is healthy, reducing reliance on the core businesses and opening up to opportunities outside. It also means that the varied skill sets of different family members can be more readily maximised.
Each scenario will have a different optimal blend. There are many different variables – not least in the inherent risk profile and existing diversification of the trading businesses and the needs and skills of the family and the individuals within it. Ultimately the goal must be to have a balanced portfolio effect across the entire family interests – but this is a fluid concept.
In some instances it may be appropriate to sell some or all of the main trading business. This might be triggered by many factors – in some cases, simply a knockout offer. There is often a stigma associated with selling the family business, particularly those which have been built up for generations. Again the focus is too much on the business rather than the wider interests of the family. The stigma should be far greater if a generation doesn’t pass on a better business than it inherited, or worse runs it into obscurity or failure. The challenge is ensuring that emotional ties to the business do not inhibit good decision making.
Recognising the need for diversification is only half of the challenge; just as important is actually how to diversify. And it is not as simple as asset diversification – families also need to consider diversification across skills, sectors, geographies, ownership structures and more.
Liquidity events can provide a wealth of opportunity – both for growth and defensively – to families if they can structure their operations appropriately, but also a significant number of challenges. Strategic asset allocation across the full breadth of active and passive family interests is vital, and much of the challenge comes with ensuring there is the right blend of governance and freedom. Providing family members with a stable infrastructure alongside encouraging their own entrepreneurial spirit gives new ventures the best possible chance of success. It also minimises the chances of dispute.
A dynamic approach to family business and investment would reflect the reality that businesses and investments that survive and thrive over generations are those that adapt to changing times and which take advantage of opportunities that arise. Preparing family members for the wide range of possibilities that can bring a family business or investment portfolio forward can, when combined with a “family bank” be an exciting way to develop and capture diverse talents within the family.
A simple example: A family may be celebrating the third generation coming into the ownership of a meaningful family business. Like most business owning families, work is done on developing continuity and governance frameworks designed to protect the family business and to ensure effective family oversight, perhaps as non-operating owners of the family business. But how much work is done by the family to encourage and support the diverse interests of the younger generation? And is there clarity regarding how the family might support and capture entrepreneurial endeavours of the younger generation? If there is no discussion and clarity on these issues, what happens when a child approaches her parents with a business idea that might be worthy of support? If the parents decide to make funds available for the business venture, who enjoys the success of the investment if the business does well? Who suffers if the business fails? The other children in the family may be resentful if their sibling is supported in an investment that then produces enormous success for that sibling given the family investment involved. If the business fails, and the funds are lost, the reduction in the wealth of the parents will affect all the siblings, and not only the one involved in the investment.
A better way might be for the family to develop a “family bank” mindset. This can be an informal approach that is made part of the family succession plan, reflected in trusts, foundations, wills and other tools used in the succession process. The approach can be more formal, and might involve the establishment of a family investment vehicle, and even in some cases an actual “family bank”. But the main objective is to discuss and agree, within the family, an approach to be taken to both encourage and support entrepreneurial activity in the younger generation. And, where appropriate, to have a formula that might allow for such entrepreneurial activity to be “captured” by the family. Among the areas a family might consider addressing would be:
- Funds are set aside and made available to support entrepreneurial activities in the younger generation.
- An approach to evaluating investment possibilities is developed and agreed. This might involve links to third party valuers and business consultants to help guide investment decisions.
- A family member with a business idea presents the idea to the “family bank”. If an investment is to be made, it follows an agreed approach - this might, for example, involve the “family bank’s” investment taking the form of debt and equity - say 80% being in the form of debt, carrying an agreed rate of interest, and 20% being equity. If the investment made by the family member promoting the project is successful, the “family bank” owns a 20% interest in the business and will be repaid the 80% debt. If unsuccessful, the “family bank” has lost its 20% equity investment, but the debt portion is taken out of the relevant family member’s future share in family succession. The percentages and approach matters less than coming to a clear understanding within the family, in advance, on how the family bank might work.
- In order to “capture” the business for the long term endeavours of the family as a whole, the investment by the family bank might carry with it options for the family to purchase the business in different circumstances including, likely, first refusal rights and otherwise.
Diversification typically breeds complexity, which reinforces the importance for a clear vision, strategy and governance. A huge part of that vision is the overarching purpose. Diversification is not only about a diversification of the family business or assets, but also about diversification of ownership. Most families understand the need to diversify their investments - less of a focus for many families is the desirability of diversifying how assets are owned and by whom within the family. All too often, there is one holding company, possibly owned by a single trust, that holds all family investments. But in a world of considerable risk, political and otherwise, diversifying ownership can be important. This might involve having different family members own different portions of the family business and investments, possibly within understandings between family members on how they will support each other in times of crisis. Ownership diversification can also involve using different vehicles to own different assets - having more than one trust, and using partnerships, insurance strategies and other structures to hold assets, creating a diversification of ownership. The ownership of the “family bank” can be part of this diversification. And for some families, the actual ownership of a bank, regulated in its ability to return capital, may be part of an overall asset protection strategy.
There are many stories of families where individuals have been damaged by the wealth they inherit, particularly where it is not tied up in a trading entity. There is the example of a European family where the trading business was sold in the early 1900s and now, 100 years later, only one of the 35 inherited beneficiaries of the trust are actively in work – was that the goal? The structure, meaning and spirit of family constitutions need to afford the family the balance of support and control, freedom and protection. It is not just about purpose in the family context; a family bank structure can help define roles and parameters for individuals as well.
One of the key sources of problems or disputes is uncertainty or misinterpretation of the family constitution or framework. Clarity is needed across a broad range of areas: access to funds, dividend policies, investment strategy, use of the family name, risk management, funding criteria, dispute resolution. Above all of these is one overriding area: purpose. Having a clear common goal helps define and embed culture, values and behaviour and encourages responsible ownership of wealth. With much of the ethos and purpose being intangible, ensuring it is not diluted or deviated from is a challenge, particularly as time passes.
It is increasingly recognised and demanded within families and throughout society that wealth should be used as a force for good, and having a clear benevolent purpose within the structure for all or part of the family interests can ensure the legacy continues long after the creator’s death. Philanthropy has never been more ingrained in wealth owners than it is today, and a large part of that is down to the desire of next gen to change the world for the better.
Having the legal infrastructure in place is only half of the battle, and the success or otherwise of the structure may not be known for one or even more generations. The purpose needs to be simple enough to be interpretable – a mistake many make is to create something so comprehensive that it loses its clarity even for the generation creating it, let alone subsequent generations.
Circularity is increasingly prominent in the structuring and purpose of family operations, and the ideas of circular economy, with its central themes of sustainability, impact and minimisation of value destruction help to protect assets through generations. It is a concept that is gaining increasing attention due to the increasing focus on environmental, social and governance (ESG) investing and sustainability. It is restorative or regenerative by design, structure, and objective: products, components, and materials should continuously add, recreate, and preserve value at all times - and this is extended to the roles of families and family members in protecting family wealth. The circular economy model is wholly aligned to the family bank concept - focusing on the desire and need to preserve wealth, resources, longevity and activities in a way that contribute to the business, community, and society at large. These themes help build a continuous and sustainable inter-generational model that benefits families’ interests - financial and non-financial, collective and individual.
There are many positive and negative emotions that come with wealth – on the one hand individuals feel fortunate and stable but on the other hand many feel the weight of pressure, a level of inadequacy or a lack of direction. Every eminent family has, to some degree, experienced challenges with individual family members, and these can cause immense difficulty from both personal and business perspectives.
The notion of a family bank is not simply to protect financial interests, it’s also a way of providing infrastructure and support for all family members, giving them the best opportunity to positively engage and contribute (whether that’s in a main trading business or helping them pursue their own dreams) within the structure and guidance of the family bank. The quality and engagement of human capital is inextricably correlated with the performance of financial capital, and having the structure in place to provide both support and challenge to each member of the family is undoubtedly symbiotic in delivering financial success. Never before has it been so timely to take an integrated view of health and wealth in family organisations.
Structuring family interests
If the saying “money makes money” is true, then why is it so difficult for so many families to protect and enhance wealth? Economic and political disruption are of course major factors, but there are human reasons – dispute, divorce, disaffection, dysfunction and death to name a few. There are also structural reasons – inheritance tax rates in many of the major jurisdictions around the world are between 40% and 50%.
No family or business is bulletproof, and all are susceptible to external factors. But most of these factors are addressable, and many families are turning to family bank structures to help navigate them. The vital goal for families is to ensure that they minimise exposure where matters are in their control, and to position the people and businesses within the family to best withstand external factors that aren’t.
In delivering this, the most crucial component in a successful and harmonious family operations is clarity for all parties – clarity of purpose, of strategy, of structure and of boundaries – and the way to do this is through a clear and communicable purpose that is understood by each relevant party. Legally documenting such matters can all too easily become over-complicated for the people defining them, let alone subsequent generations trying to interpret them, and thus defeating their very purpose. There is a fine balance between comprehensive structuring and clarity of message. A family charter is not something that gets signed, filed and forgotten about, it is something that needs to be lived and breathed by all the people and businesses it seeks to protect and enhance.
There are many different structures a family bank can take - it is often a trust set up for the beneficiaries with trustees overseeing its operations. Other structures include family limited partnerships, foundations or limited family investment companies with alphabet shares. It is also often valuable for families to have more than one structure in place. There are even ownerless structures such as the Liechtenstein-based Interogo Foundation, which was set up by the Kamprad family, the owners of Ikea. Its stated purpose is ‘to secure the independence and longevity of the IKEA Concept’ and is a self-owned entity which has no individual beneficiary. Funds held by the foundation can only be used in accordance with the foundation’s purpose, providing a vision that delivers focus and clarity to all stakeholders. The Interogo Foundation is one that has a public profile, which might be the right solution for some families; others prefer a more discreet approach. There is no single structure that will work for all families - each will have a different solution that works for them. These concepts are of relevance to families with simpler and lower amounts of wealth as well as to the more complex situations of families at the higher end of wealth. The family bank can address very simple concepts, such as how to fund university and other education of family members in a fair way.
In conclusion, a family bank structure can help a broad spectrum of wealth owners define and address long-term individual and collective goals. Wealth-owning families need to focus more time than ever before on long-term strategic and administrative planning - not just for the active and passive assets held, but also for family members and future generations thereafter. There are challenges that come with looking too far into the future, but not to do so risks being caught under-prepared for transition, succession and ever-growing disruption. External change and pressures beyond families’ control are significant enough without adding to those challenges through insufficient long-term planning. Done right, it can provide family members with clarity, purpose and harmony, and the platform to safeguard and enhance wealth through macroeconomic and geopolitical volatility over multiple generations.
Ispahani Advisory www.ispahaniadvisory.com advises family businesses on business strategy, governance, people, and education. The firm operates in the UK and internationally across EMEA and APAC. It specialises in working with family and private businesses, wealth owners and private foundations.
The information and comments contained herein are for the general information of the reader and are not intended as advice or opinions to be relied upon in relation to any particular circumstances.