In most cases, families that own businesses don’t just own the family business. They also have additional assets, such as real estate and liquid assets. With most family businesses, it’s not just about a single asset, it’s about multiple assets. Indeed, in most cases, it’s about multiple family members, often with divergent interests, controlling multiple assets.
All these assets and divergent family interests can create governance problems. Such families face complexity at ownership level and on the asset level. Many families want solutions that help them deal with these complexities. Most follow one of these four patterns:
- The uncoordinated family. In this situation, the family opts for no governance whatsoever. It feels that the legal framework around inheritance will suffice. Obviously, the appeal of this approach is that the family doesn’t have to bother with a governance structure – and, of course, it is free. But I believe this strategy creates a race to the bottom. Conflict arises, and intensifies with time, because no framework has been created to deal with the complexities of the family. A good example of this approach is what happened to Michael Jackson’s family after the singer’s death. Turmoil ensued because the family did not set up a formal framework to manage its assets.
- Embedded family office. This is when the family business takes care of the family’s monetary affairs as well as the management of the business. Usually, in this type of situation, the CFO or senior accountant manages the family wealth as well as the company’s finances. From the family’s point of view, the advantage is that it is cost-efficient. You don’t have to hire anyone, nor do you need to set up a family office. But this approach can create problems in the business, particularly around loyalty. Is the CFO or accountant loyal to the company, or the owner? Who are the CFO’s or accountant’s masters? Should the CFO or accountant be paid more for these services? In most cases, the family will want the family wealth management efforts to be free. Problems around loyalty, and business efficiency, get even more complicated when there are minority interests in the business.
- Family offices. This is when the family thinks the level of complexity around ownership of multiple assets is so high that it sets up a family office, which can help to deal effectively with these complexities. It allows the family to hire experts to do this, and it can provide a holistic overview of all the family’s assets. It also separates the business from the family’s other wealth.
However, setting up a family office is in no way a guaranteed route to success. They are costly to set up. And the person who is hired to run the family office – usually a banker or a lawyer well known to the family – is in a very powerful position. The person who runs the office may pursue interests that are aligned to their own rather than those of the family. Sometimes, in extreme circumstances, the CEO or CIO of the family office could become aligned to the managers they have hired. Managers of the family office could get kickbacks from managers they use, so the CEO or CIO might want to persuade the family to use that particular manager.
In order to avoid any of these potential pitfalls, a family office needs to be structured in a very professional manner, involving the appropriate family governance and supervision like an Investment Committee or a family advisory board.
- Trusts or foundations. This cuts the family out of ownership of the assets altogether. The family becomes the beneficiary, but loses all its rights over the assets. In this case, the trustee has all the power and the family is removed from the equation. A big problem with trusts or foundations is that there is rarely any oversight on whether the family’s money is being used efficiently and effectively by the trust.
None of these scenarios offers a foolproof way to deal with the complexities of families and their assets. Nevertheless, it is important for family businesses to know about some of the pitfalls involved in following any of these paths – and to guard against them when they arise.
Prof. Dr. Thomas Zellweger, Chair of Family Business, University of St. Gallen