It is professionally run, possibly building in the efficiencies available when a number of families share professional management and ownership.THE TERM GOVERNANCE STRUCTURE CONJURES UP THE PENAL COLonies of Australia and the drudgeries of what have come to be known as family constitutions. The words do not radiate freedom, independence, or individuality. In fact, “governance structure” is shorthand for all of the entities and organizations that are used to manage wealth with wisdom and process. They are wealth holders’ tools to build the relationship between themselves and their wealth. They are the roads, the automobiles, and the traffic controls used to journey through life without wealth burdening that journey with chaos.
Nothing requires more customization than design of these governance structures, since together they can provide individual independence or burden. Any well-designed strategy for managing wealth will be or can lead to a governance structure that works. For example, the foundation described in an earlier chapter, unbundled by design and voluntarily bundled by the siblings over time, is one such governance structure, strategically designed to accomplish set purposes. Its evolution brought process and communication tools to the family that ran it and a foundation for future generations to build on. Every governance structure should be designed as well as that one to further family goals and objectives.
Governance structures fundamentally should serve two purposes. First, they should provide the framework to ensure functionality and efficiencies as family members work together or advisors work for the wealth holder. Allowing the wealth to exist relatively unencumbered by taxes, creating the institutional operating framework for the “business of the wealth,” and imposing expectations, standards, and procedures all require governance structures. Second, good governance structure is key to ensuring succession.
“Succession” is a key ingredient of legacy and multigenerational perspective. Succession requires that wealth and its efficient management pass from generation to generation and is essential for any well-run business but possibly less clearly essential for private wealth. For example, there is a sense among some trusted advisors in India that wealth works best when divided at each generation so that succession can be free floating and spawn as many successors as there are businesses.
In Canada, I was advising two brothers working in the family business with their father, a 70-year-old patriarch. The patriarch had a rule that his two sons could never fly together. That rule was reiterated over the years as one required to ensure that there would always be succession in the family business. If a plane went down with one brother on it, the other brother remained. I met with the brothers the day before the three, father and two sons, were to fly together to Moscow to visit a business partner. The brother admitted that it was unusual for the three of them to fly together, but it happened from time to time. I asked why succession was not an issue when all three flew together, and the brother said he was not sure. I was sure. Succession was the father’s way of saying that in any event he wanted the company (and the support and care) of one of his sons. He did not want to be left alone if they perished together. But he would not face loneliness if all three of them met death at the same time.
Ordered succession is extraordinarily difficult to effect. Consider how many very large companies in the world struggle with succession and fail. Governance structures allow a framework to try to design the “passing of the baton.” But before starting to design the structure for succession purposes, always start by asking why succession is important and what purposes it is to serve.
Succession is extremely complex when addressing an active family business. Keep in mind that portfolio wealth can always be dismantled even if that is not desirable. Even a portfolio of active businesses can be dismantled and, if needed, divided at each generation.
But many of the patriarchs of the world build a business with great care and attention and then look for succession within the family, much as Jack Welch looked for professional succession at GE. More often than not the succession planning in such cases fails.
The starting point in considering succession is to ask what the business is for. One can start with analyzing what about the family business is “family” and what is “business.” How does one define family and how does one understand what the family should get out of the business?
A Japanese business creator whose son took over the running of the business was quite clear in his understanding of what the business was for. It was for a community of employees, and the family was to be the protector for those employees. Whether times were good or bad, the business was not to be sold because too many colleagues were dependent on the strength and values of the family.
A U.S. business creator was also clear. The business was to give the family a certain standing in the community. The business funded arts, health care, and social services through its philanthropic funds, and the creator’s children and grandchildren would make all that possible through the business.
A Scandinavian patriarch had a different vision. The business was entrepreneurial and should be sold to allow all family members to enjoy the opportunity to be entrepreneurial (whether they wanted it or not).
A British family was also clear in that their business was to be a way to keep many generations wealthy—a family legacy that would ensure everyone in the family substantial wealth.
Each of these purposes has different ramifications for succession planning depending on the constituency that is to be benefited. And each has different significance with respect to governance structure, a concept related to but not necessarily synonymous with succession.
Indeed, a clear consideration is whether families’ purposes are served if family members are managers, board members, or simply owners. If they are simply owners, control of the company loses significance and training in management or governance is not required. Indeed, the family members are able to live life free of the responsibility for the business but also exposed to the possibility that the business will fail in its purpose to support the family. Management and leadership might fail or, worse, take advantage of the uninvolved family members.
Purpose will also help analyze how well the business must do. If family members are to be management or board, how well must the company do to succeed in its purposes? And how expert must the family members be? If the business is to allow productive employment by family members, the bar cannot be set too high since it is always likely that family members will be worse managers than other professionals who might be available. And it is always possible that a board made up of outsiders can make for a better business than one made up of family members.
A wealth creator who decided to sell his business said: “This is about business and wealth for my family. Clearly the world will have better businessmen and better governors than even the most brilliant in my family. I created this business without any involvement of my own brothers; why do I now think my genetics will create the finest businessmen? And I would be foolish to think that the most creative and ambitious businesspeople will want to work in management or serve on the board of a business owned and run by a family. I wouldn’t want that myself.” He understood what the business was for and sold it for that purpose. The business was to create family wealth.
Compare that to another family business my father and I observed over three generations. The founder started a manufacturing firm in the 1930s and ran it successfully. After the Second World War, his son took over the business, and on account of careful management and a booming economy particularly benefiting that industry, the business grew dramatically. The personality of the son brought in two fine managers who, with the son, built the business into a major global business. Small ownership interests were given to those managers, and they and the son prospered. When the son’s eldest son left college, the son managing the business considered the business a family business. After all, he took over from his father and wanted his son in his business as well. He let his other children pursue their passions—one son in the business was all he needed. As that son approached the age of 40, with 15 years in the business, his father decided to sell the business for a princely sum. The family would be wealthy forever more beyond its wildest expectations. Two of the three children were overjoyed, but the son who had been in the business was left without a career and without a place in life.
What happened? you ask. Essentially, the management team of son-father and his two colleagues were aging. The colleagues wanted to cash in on the fruit of their labor; the son-father determined that his own son was not of the business caliber he saw in himself. All three on the management team saw that it was time to prove to the world that they had created great value. “Selling this business makes sense for the company, the employees, and my family,” the son-father said to me.
But the 40-year-old was left aimless. For him, “family business” meant his family and meant that he would have a productive way to spend his life. If that was the goal (and that would be a reasonable goal) cashing out made no sense; the family consideration would have been clear regardless of how expert he was. The father of that boy had built the expectation that the business was “for” family engagement, that its purpose was to give his 40-year-old son productive employment and involvement. Instead, after the son devoted his early career to the business, the purpose appeared to change and the business was sold.
In that case, the father subsequently funded a new business for his son. He used a small part of the proceeds from the sale of the family business, but he funded it with too little capital, too much risk aversion. The energy and risk he could put into his own business after World War II was not available to the new business. That business put his son in the hole—financially, emotionally, and in every other respect—and folded after five years.
The case is a classic one of family business succession. Too many times the creator of a family business brings his son or daughter into the business as a family business and then decides either that the son or daughter “is not up to running the business” or that it is time to prove the value created in the business. The creator has not carefully analyzed what is meant by “family business.” The child is left with disappointment. The sale of the business always leaves the child perplexed and often leaves him or her feeling idle and without satisfaction.
These are not stories about governance (though governance is of course involved). These are stories about family management succession. The lesson of each is that any succession conversation must start with an understanding of what the business is for.
It is obvious that designing programs to make the wealth do what it is for requires substantial attention to the wishes and circumstances of the individuals in the family and the family as a whole. That kind of attention is not easy and the designs cannot be made uniform from family to family. On the other hand, most of the world’s governance structuring is created by industries, whether financial services, accounting, or law, trying to manufacture something that can be used over and over again. Unlike human personality, which cannot easily be generalized, a jurisdiction’s taxation is generalized and its management can be commoditized. For this reason, most structuring is most easily and profitably focused on taxation. However, any structuring strategy based exclusively on tax savings treats tax reduction as the purpose and goal of all wealth holders.
When wealth creators walk into my office and say they want to save taxes, I cannot design a structure until I know the answer to the question, what is the wealth for? Taxes may be what the wealth is not for; however, a wealth holder should strive to determine what the wealth is for. He or she should look for structuring strategically designed to accomplish what the wealth is for.
A classic example of structuring that does not work plays out over and over. I first ran into it in Hong Kong. The patriarch had worked with his large global accounting firm to develop the ideal structure—trusts in jurisdiction after jurisdiction, passports from the most favored countries—with taxes magnificently avoided. Taxes were avoided so long as no child or more remote descendant ever became a U.S. person, an expectation that was written into the structure. Yet the patriarch’s own children went to the United States for college, fell in love with U.S. citizens, married, and had children. As the patriarch begged them all to move back to Hong Kong (for tax reasons) one after another disregarded him. Only one returned to Hong Kong with his American wife, and he became the wealth steward, but his children kept their U.S. passports.
Ten years ago, many U.S. citizens renounced their citizenship to save taxes even in the face of a statute containing draconian penalties, including treatment as a terrorist by anyone renouncing under certain circumstances. These people were pleased to be saving taxes, but their expression of accomplishment evaporated when they heard they might not be allowed to have medical attention in the United States, attend children’s graduations and weddings there, or vacation in Northern California. One told me that he realized he might be a “man without a country,” referring to the short story by Edward Everett Hale, a volume I gave many young Chinese people at the turn of the twenty-first century.
There is a fundamental difference between the United States and many other jurisdictions in the world, and that difference leads to considerable misunderstanding. The U.S. tax laws are fundamentally “substantial,” and the tax laws of many other jurisdictions, indeed much of Europe, are “formal.” This means people who think of themselves as living in London can arrange their affairs so that they are taxed elsewhere for certain purposes. They can live the life they want to live and structure their taxes among different jurisdictions.
Selecting the most desirable federal jurisdiction is not possible for the U.S. person. If the wealth inheritor of the Hong Kong patriarch wants to live in the United States, his taxes are U.S. taxes. The only recourse is to substantially avoid the United States. This is often the “tax tail wagging the dog.”
In fact, if wealth is for freedom, the complex trusts and the renunciation of citizenship both fail to accomplish that goal with respect to travel and residency, at least as it involves the United States. So either freedom is lost or the structure is disregarded. That happens repeatedly when structures are designed for tax reasons. If the individual has desires for life that do not fit those structures, his or her options are to disregard structure or forego those desires.
Even without regard to tax jurisdiction, if wealth is for functionality and harmony, tax structuring can be disastrous. One of the earliest “family limited partnerships” designed for U.S. families to help avoid estate taxation was sold by a large accounting firm to a very wealthy family. The structure cleverly provided that once the family pooled all of its assets, any increase in value could pass to the children, thus avoiding the estate tax of the father. The concept made brilliant sense from a tax standpoint. The problem was that the father and his children were estranged and the children were being raised by their mother, whom the father detested. Ten years into the structure, the father was found to have removed many of the assets and the entire arrangement ended up in litigation for many years. The lawyers made money, the father and his children could never settle, and the estate lost much of its value through mismanagement during the court cases. The tax structure, a family limited partnership, required communication and harmony of a family that had neither. Indeed, the structure made harmony and functionality impossible by demanding that the family work together, trying to bundle a family that should never have been bundled.
Whenever tax-motivated strategies are deployed, a strategic consideration becomes what that strategy will do to and teach future generations. UBS was apparently selling tax fraud in the United States. Anyone using UBS for family wealth management must ask what message children and grandchildren are receiving when one’s bank is using tax fraud as a marketing tool.
A parent will often hide assets, such as gold, jewelry, and even cash, to be kept secret from taxing agencies at their deaths—effectively requiring that their children and executors commit tax fraud. Do you really want criminality to be part of your family culture and a burden of stewardship to your heirs?
Structures designed for sale as “tax effective” are rarely strategic if circumstances and wealth’s purposes are considered. On the other hand, structures strategically designed can be very effective in any wealth management program even in terms of saving taxes. We will consider that in more detail in the next section.
One of the most common structuring devices in common law jurisdictions is the trust. Similar purposes can be served by corporations, limited liability companies, partnerships, and foundations in some jurisdictions. Each of these vehicles organizes management and disposition of certain assets. Each is also by its very nature limiting in that each separates the beneficiary of funds from their actual control.
Trusts and other structuring frameworks are therefore inherently controlling—sometimes called the “dead hand” guiding the wealth through generations. They are the platter from which the silent butler, the wealth steward, serves all future generations. Although duration used to be limited in almost all jurisdictions, today trusts can last forever, that is, into perpetuity in many jurisdictions. Perpetual existence is particularly popular with “dynasty thinkers” and with professional trustees enamored with the annuity-like revenue inherent in serving as trustee. But perpetuity is a long time, and I am frequently reminded of the sign on a barn in rural Missouri promoting fundamental Christianity with the question: “Eternity—where shall I spend it?”
The most successful trusts are the most flexible. The creators realize that times and people change. Expressed differently, the purpose of the wealth for me today may not be the purpose of the wealth for my children in 30 years. If the wealth is for control or protection, a trust or similar entity provides that. But flexibility is key to the success of the trust over a number of years.
Strategic design of trusts requires flexibility to be built in: power to change trustees, power to ascertain purposes and times for distribution; power in each generation to be the master of how the assets pass to their own progeny (that is, power for parents to exercise the prerogatives of parenthood); even power for each generation to make its own mistakes.
The trusts that fail almost always fail on account of rigidity. For example, 100 years ago, some U.S. trusts were written requiring all investments to be in railroad bonds. Those trusts were destined to fail with the railroads. As another example, many trusts exist without any power to change the corporate trustee even as the companies serving as corporate trustee are subsumed in other companies. How many of the dowagers naming J.P. Morgan as trustee would have imagined that their grandchildren would be at the mercy of Chemical Bank?
More subtly, so-called incentive trusts may be too rigid and serve little strategic purpose. These are trusts that attempt to control behavior by tying distributions to that behavior. For example, no distribution of funds unless the beneficiary is earning at least $100,000 in active employment; no distribution if the beneficiary marries outside the church; and no distribution until the beneficiary has children. Each of these prerequisites written into a trust assumes continuation of circumstances and values in effect at the time the trust is written. Society may change and a person’s condition may change; in either event, a trustee needs the freedom to accommodate. The incentive trust is a hand deader than a doornail.
Every trust and structuring device should be approached strategically. There can be guidance in the following general rule: “He or she who does not need a trust does not mind a trust; he or she who needs a trust resents the trust.” That rule applies because the well-designed trust demands appropriate management of the portfolio and expects a beneficiary to live on income or amounts not unreasonable relative to the size of the trust. The responsible person will lead his or her life reasonably with or without a trust. The spendthrift will want more than the trustees should reasonably distribute.
Selection of trustees (or similar parties) requires careful analysis and design. If you cannot find someone you trust to make the decisions you would make, you should forego the trust altogether. Look to the trustees to take all factors into account and to exercise judgment in deciding how to handle investments, how to consider distributions, and how to provide for their own succession. In other words, your trustees are responsible for seeing that the trust is managed strategically to accomplish your purposes and the purposes for its beneficiaries.
The challenge of keeping a trust fluid and dynamic is often a question of keeping the trustees dynamic. Many trusts have ancient trustees whose role as trustee becomes for them a badge of wisdom and continuing engagement. Old lawyers forced into retirement by law firms hold tenaciously to their trusteeships. A 40-year-old client resolved the problem of aging trustees by providing in his trusts that any trustee over the age of 60 years would be discharged from service. As the client aged so did the age of discharge until today the client is 85 and the age of discharge is 90.
Terms of trust distribution must be considered carefully and strategically. The age of distribution to beneficiaries really depends on purposes. If the wealth is for freedom and functionality, it might be reasonable to provide for distribution at a young age. “If my son is going to blow it,” said one wise trust creator, “I’d rather he blow it young and then get on with life while he can still build a life. Otherwise, he will sit around waiting to receive the assets and then waste them after he is too old to start fresh.” If the purpose of the trust is pure protection, it may not be necessary to have any automatic distribution.
There are many other strategic considerations in designing a trust. How would the creator define incapacity for a beneficiary or a trustee? Who should be able to remove and replace trustees? Should trustees have the power to appoint their own successors?
Expectations of appreciation in value and what is reasonable to use (whether of income or principal) enter into decisions regarding whether to provide that income is automatically distributed. In other words, a provision that the trustees must distribute income assumes that either income must somehow be a reasonable guide or investment policy should follow determination of a beneficiary’s need. A requirement of income distribution may discourage the trustee from pursuing strategies of capital appreciation.
All of these considerations enter into the terms of trusts and other structuring devices and should never be seen as boilerplate. Yet, for most trust creators, these and other details are simply resolved in a “standard form” of trust.
Trusts and other structuring devices can offer strategic opportunities. These include the many tax reduction opportunities so often promoted by banks, lawyers, and accountants. But there are others. In the 1970s my father and I redesigned a trust that Congress thought it had eliminated and that combined charity and private beneficiaries in a way that looked good from a tax standpoint. It was called a charitable lead trust, and, as we recommended these trusts to some of our clients, we sought and received the first five or six rulings from the Internal Revenue Service holding that the trusts were effective and not subject to tax challenge. In several of those cases, the wealth holders, each a wealth creator, expressed contempt for charity but agreed to establish the trust as a way to take money away from the U.S. government even if some went to charity. In each of those cases, the trust turned the creator and, more importantly, his family into philanthropists because in each case the family came to realize the strategic benefit of relating to community through philanthropy. One of the creators had never given a cent to charity. Today his widow and family have given not only from the trust but tens of millions of dollars beyond those amounts.
We have also used charitable lead trusts strategically to teach younger family members. One was set up several years ago for three children who were named trustees and directed to manage investments and choose charitable beneficiaries each year. The investment strategy was complicated, as the trust required an annual charitable gift well beyond its income. So the trustees had to design a reserve to meet that requirement over five years rather than relying on increasing markets. Implementing that strategy required discussion, understanding, and education relating to issues of volatility, liquidity, and cash retention. Selection of the charities was casual in the first two years and proved unsatisfying, as the children found little accountability by the donees. Within three years, the children were developing processes and communications to elicit grants and to require regular reports. In effect, the trust itself taught investment principles and allowed a relatively comfortable development of collaborative process. The three children learned and worked together in a disciplined fashion. Once again we have found these trusts could play a strategic role in the management of the family wealth.
Estate planning is the process of determining gifts and divisions of property and of designing the structures to be used during lifetime and at death. Trusts and other structuring entities are the tools of estate planning. Often, these tools are used before the framework is ready; the carpenter is hammering nails before the architect creates the building plan. Designing the structure requires strategic consideration first.
Consider a most unstrategic estate plan—that of King Lear. He planned to die with nothing, but he left himself nothing to live on and threw his daughters into dysfunctional chaos. His plan was conceived less for estate tax than for dynastic succession, but under the U.S. estate tax regime, the ideal estate tax plan remains Lear’s—to die with nothing owned and nothing taxed. Yet, how strategic is that? Just like Lear, clients are being urged to make gifts of their residence (“you can always lease it back from your children”), to create trusts that end up leaving them penniless, and to bundle themselves irrevocably with their children, who somehow end up with control.
Strategic consideration of any estate plan can start with several principles. First and foremost, consider what the wealth is for and whether and to what extent you want to retain the unilateral power to consume or use it. You must answer important questions before a tax plan is developed. You cannot answer those questions without some sense of what you are trying to accomplish. What do you want to retain? What value, if any, do you want your children to have? What strategic benefit do you want to derive from charitable gifts?
The ideal estate plan reduces the value of property in the hands of the older generation in a way that increases the value of property in the hands of the younger generation. Great opportunities lie in making gifts and even paying gift taxes. Charitable and private gifts allow tax benefits because they can effect reduction of value in parents and increase of value in children.
Reducing the value of parents’ assets and increasing the value in the hands of their children can be illustrated with an interesting example. There are two copies of a rare book, both owned by a father. Each is worth $50,000. The father gives one copy to his son. When he burns the other, the value of the property in the hands of his son becomes $75,000. If burning a book offends you, give the book to a rare book library, which effectively destroys its market and takes it out of commerce with the same effect as burning it. In either case, the reduction of value in the wealth holder’s asset directly increases that of the child’s.
Estate planning is frequently complicated by collections of tangible property, by real estate, and by property otherwise laden with sentiment. Collectors must ask what their collections are for. If a collection is for legacy and not monetary investment, does it make sense to leave it to the children? In the United States, if collectors leave their collections to their children and an estate tax is levied, the children must pay in taxes an amount equal to the collection’s value—in effect they have to buy it from the collector for its value. Collectors who make their children “buy” the collection are also changing the character of the owners. Whereas the original owners were the collectors, their children become the curators.
What the collection is for effectively solves the problem of turning the “collector” family into the “curator” family. If the collection is an investment, it should be sold. If the collection is a legacy, it should be given to a museum.
Family retreats and family vacation property need to be evaluated similarly. These pieces of property often become divided generation after generation ultimately held by a number of people, some of whom bear the costs and some of whom do not. Dividing the ownership of the property among many people frequently causes friction and unhappiness. Again, the solution becomes obvious when the purposes are set out. If it is investment property, it should be sold. If it is sentimental property, it should be given to a public agency or a charity.
As we can see, strategic estate planning starts with the question of what the individual is trying to accomplish. All plans must further that purpose; and special assets, whether collections or sentimental property, must be taken into account as investments or otherwise.
If estate planning is seen as all about designing lifetime giving to accomplish tax purposes, we can lose sight of an important consider-ation—where one’s wealth should go at death.
Laws of intestacy are enacted to establish where property should go if there is no other direction. Few substantial wealth holders die “intestate,” that is, without a will. But before a wealth holder can shake off intestacy, he or she must examine the purpose of the wealth.
We are talking about “family wealth.” That means it is owned by people who are private parties and somehow are connected to family. Wealth can be “owned” by different members of a family, but it cannot be owned by an entire family as if by one person. A Chinese patriarch once tried to explain that in China, wealth ownership is thought of differently from other places. Wealth, he said, is thought of as owned by the family and not by any individual. Yet notwithstanding that statement, I pointed out that Chinese law has developed trusts for estate disposition allowing an “owner” to decide whether to leave the wealth to family, mistress, or charity. Consider again that individual family members cannot have economic benefit from the full pot of the family wealth, and control cannot be exercised unilaterally by every family member except by excluding every other member. If a table has one pie, each of four diners cannot have all of it. So with family wealth. Somehow members of a family must share it; and if we talk about wealth owned by a family, we necessarily must contemplate some sharing of that wealth.
Family wealth need not be irrevocably for family, though most jurisdictions in the world have some requirement that at least part of a person’s wealth be left to a spouse. However, most wealth holders leave their wealth to spouse and children, as much as a “default” disposition as on account of fondness and affection. If part of what the wealth is for requires an analysis of how much is enough and how much is too much, disposition to charity becomes integral. Trusts can be to deprive children of benefits as much as for protection. A spouse’s interest must be considered in terms of his or her capacity to control the wealth during life and at death. Can the wealth pass to a subsequent spouse? Can the widow or widower decide to treat children differently? All of these issues require careful consideration and strategic analysis.
We all say we want to treat our children or grandchildren “equally” as if the definition is somehow clear when in fact definitions of equality require careful analysis. The common definition seems to be dollar-for-dollar equality—when my son gets a dollar, my daughter gets a dollar. Another definition may be that needs are met equally. While the wealth holder is alive, he or she may pay tuition for one child without equalizing by giving the other the same amount to spend on a luxury car. Should this change at death? Suppose one child has built huge independent wealth and the other has pursued a career as a teacher. Should each receive the same dollar amount?
How do we define equality in gifts to grandchildren when one child has two children and one child has four? Do grandchildren by one child share half as one-quarter each and the other share half as one-eighth each? Or are assets for grandchildren divided equally with an equal share for each grandchild? This is sometimes described as per capita as opposed to per stirpes division. I often find that per capita division for each grandchild becomes more prevalent as the donor comes to know the grandchildren as individuals—and this is because any purpose of wealth must focus on its use by individuals rather than the stock of ancestry.
The questions that must be answered when writing a will or providing for gifts during life are numerous. Each can be answered in isolation from the others, but sound planning for disposition requires harmonization of all the answers. The harmonization follows only when there is a grounded strategy for accomplishing the articulated purposes, an understanding of the role of wealth in the family and among one’s loved ones.
A well-run family office can be the temple for the family wealth, where the high priests gather wisdom and follow process to allow everyone to have the blessings of the wealth. A poorly designed family office can actually keep the wealth from doing what it is supposed to do and can become a dark dungeon enslaving the family and all of its members in dysfunction and without wisdom. Careful strategic consideration must go into whether to have a family office and how to design it. Most family offices evolve out of a business or a close relationship between a patriarch and accountant, bookkeeper, or employee of the active business. Systems and operations evolve often without careful thought other than how to build efficiencies. The office grows “organically,” without much attention to purposes or strategy until processes and relationships are in place and relatively stagnant. By the time the family or a family member wants to consider whether and how the office should work, employees, systems, and “ways of doing things” are often fossilized; infrastructure, administration, and management are not easy to change.
Even if change is possible, family offices are complex, and there are no models that fit all. Instead, someone must sift through best practices, attend sessions and courses on the topic, and hire consultants to help fix or create the family office. The easy fixes are efficiencies; the hard fixes are making the family office meet the family’s needs. Until the development of the Standards of Private Wealth Management, there were no easy systems or processes or even ways to build them strategically. Clearly, building a functioning family office through creation or remodeling is very difficult and requires substantial effort.
If one purpose of the wealth is to allow self-actualization—freedom to be all a person can be—it is difficult for a single-family office to further wealth’s purposes. Creation or remodeling is difficult and time consuming. Even the well-designed and -operated single-family office requires some involvement by family members—as a steward, as a board, or as participants in some other way. Often a family member is designated to run the office, and he or she is then burdened with managing the wealth of the family (with or without compensation).
Within several months of Bernie Madoff’s exposure, I ran into the artist who had attended my talk on freedom from wealth (see Chapter 2). She had achieved “freedom from wealth,” she said, and that had made her happy. But after the events of 2008 she was unhappy again. The spread of distrust had touched her and her family office. I told her I could guess why she was unhappy. She was spending time again in the family office as she and her cousins wondered whether they could trust those running the family office, feeling that they needed to be more engaged in the office. Despite the woman’s decision that she would lead a life of freedom from wealth, the dynamics of the family office and the circumstances of the financial crisis had combined to throw her into administration, governance, and attention to detail at the office. Her freedom was curtailed.
With trust shaken, the artist felt she had no recourse other than micromanagement. As we discuss later, wealth management standards, easily set and assessed, would have allowed her the systems and processes needed to restore her freedom.
We see the difficulties inherent in a family office structure when a family starts to consider the relatively innocuous decision of where to locate the family office when family members live everywhere. Is the location near the patriarch or matriarch? Or, in one case I know, in the city where the trusted advisor to the patriarch chooses to live but far from all members of the family? What is the strategic message sent to the family with respect to control and accountability? When the patriarch of that family dies, the family office may exist for the convenience of the advisor.
Recall the 90-year-old family office executive who called the 60-year-olds “boys and girls” and one of whose “girls” felt like a bird freed from a cage when the office closed. That superannuated executive ran the office as his fiefdom and for the benefit of himself and his staff. The family members were merely cogs in the mechanism of “running an office.” Family offices can take on a life of their own, and family members can become irrelevant. It is challenging for any family to keep this from happening.
Compensation is always a difficult aspect of running a family office. Are family members compensated for their efforts, and if so, what is expected of them? Is this a way of forcing the shackles of stewardship on a family member, and is that fair to that person? How can the employees of a family be compensated so they are clearly sitting on “the family’s side of the table.” Surely, short-term profits should not be the standard. And it may be that investment performance should be seen as completely irrelevant, particularly if the family is relying on “industrial-strength” management.
But the question requiring most strategic analysis is exactly what is wanted in a family office. Fundamentally, “family office” is the tool for making the wealth do what it is for. There are large family foundations that are in fact family offices because the administration of philanthropy allows for all the purposes of the family wealth by building processes and communication to allow the family to work together and with its community. For other families, an investment-only house is the best family office. The reason is not necessarily because investment return is the ultimate goal of the wealth, but because the family has decided that each member should have complete independence while sharing the infrastructure and cost of money management. And some family offices have only “concierge services” because in that way, their individual needs can be best met with respect to those matters least easily commoditized.
In fact, the ideal family office has many of the following features:
It is professionally run, possibly building in the efficiencies available when a number of families share professional management and ownership.
It has a clear plan for succession of management, insulating family as much as possible from the challenges of replacing departing staff.
It allows the family to set policy and detail by articulating what it wants of its wealth without requiring the family to manage policy, detail, or implementation.
It recognizes that the individual is paramount and that the needs of each individual must be met in a customized fashion.
It can be neutral in judgment with respect to individual needs so that it can serve the needs of many generations, many jurisdictions, and many cultures.
It accesses “industrial-strength” due diligence but understands and meets individual investment needs.
It is unconflicted in every respect, and its employees are incentivized by success in helping the wealth achieve its purposes.
If those are the features of the ideal family office, that ideal is almost impossible to find and extraordinarily difficult for any family to build. That it is difficult to build, however, should not keep a family from trying. Any attempt to build or find such an ideal family office should start with an understanding of what the family is trying to accomplish. Then it should progress with strategic analysis of how to build wisdom and process to permeate everything the office does and every service it provides, with the entire structure designed to give each family member freedom and independence.*