Family wealth management centres on the preservation of a “family’s hard-earned wealth and compound[ing] it successfully over time”
(Haynes Daniell and McCullough, 2013, p.xvii)
It is different from the wealth management of non-family businesses in that it has a longer planning horizon and it focuses on preserving capital for future generations. Moreover, equal attention is given to issues related to the family and wealth, as investment decisions should be in line with the family’s core values, with the intention of generating sustainable returns for current and future generations. This becomes increasingly important in preserving the family legacy and avoiding conflict as family businesses grow and become wealthier.
From Rags to Riches to Rags Over Three Generations
‘The third generation curse’ refers to a phenomenon whereby family wealth is squandered by the business’ third generation. The business is founded by the first generation, at which point a wealth base is created. The second generation strengthens the family wealth and improves the business, based on the prior generation’s values and vision, until it is taken up by the third generation which lacks the motivation of its predecessors. Although this phenomenon is very common, not all families lose their wealth in this manner. Very often, the reason why family wealth is exhausted is the founder’s lack of instructions as to how to manage the wealth once he/she steps down (Hargreaves, 2014).
Preserving Family Wealth
Family business owners are faced with a challenge whereby as of a young age, their children feel entitled to family wealth and might lack the motivation to take the business forward. Jaffe and Brown (2009) suggest that parents should develop a stewardship relationship such that upcoming generations are taught to take responsibility for the preservation of family wealth and to pass it on as a gift to future generations.
Furthermore, families should not have all their wealth locked in the business. Successful family wealth management requires wealth diversification. In addition, good governance is a necessity in making portfolio diversification more appealing, leading to improved financial performance (Zafft, 2002). Interestingly, a recent study revealed that micro and small family businesses are more likely to have their wealth concentrated in one business, without having any investments outside of the business (Farrugia, 2016).
The family’s investment portfolio would ideally be separated from the business activities and protected in the interest of all family members. These investments can be deposited in a separate company whose shares will be allotted amongst the family members, having different shareholder rights based on their level of involvement and their role in the business. In order to ensure transparency and neutrality, this company should be managed by a group of professionals from outside the family.
When the business operations are being transferred from one generation to the other, those members wishing to involve themselves in the family business can split the operations amongst them, based on their personal interests and capabilities. The separation of the operating activities from other family wealth ensures that even if one of the operating divisions is no longer successful, the wealth accumulated by older generations is safeguarded.
The setting up of a family trust can also support the preservation of family wealth by consolidating the wealth, rather than allowing it to get fragmented with the emergence of each new generation. Additionally, a professional trustee could ensure that decisions are made efficiently and that wealth is rendering optimal returns in the interest of all family members.
The Family Office
Family offices are typically established by wealthy families to administer their wealth, help in developing their future plans and to offer consultancy services. Single-family offices offer their services to one family only, whereas multi-family offices support a number of families. The term ‘virtual family office’ is used for when these services are outsourced.
More than a third of local family businesses are unaware of the family office structure (Farrugia, 2016 and Sant, 2015). This could be explained by the poor consideration given to formal governance mechanisms and wealth management in family businesses. Additionally, most local family businesses are still entering their third generation (Borg Cardona, 2014) and earlier generations tend to be more interested in building wealth rather than maintaining it.
A family office can help a family business by:
- centralising specialised and tailor-made services addressed towards the needs of the business,
- increasing transparency,
- giving family members more time to focus on issues relating to the business operations,
- enhancing communication amongst family members and managing different expectations,
- educating family members.
How Can Dependency and Lack of Initiative From Upcoming Generations Be Avoided?
Successful business transfer and the preservation of family wealth take place when “the skills and desire to be in business” are transferred across generations (Shrapnel, 2014, p. 7). The lack of dedication and drive towards preserving family legacy is one of the factors which hinder the succession process (Casha, 2015). This can be avoided in the following ways:
- educating children to take responsibility for the preservation of family wealth,
- involving young generations in business decisions and exposing them to current practice,
- developing governance structures to regulate the family members’ involvement in the business,
- preparing a succession plan which gives clear instructions as to the roles that family members should take up after the founder’s resignation,
- setting up a protective trust to regulate the way in which family wealth is to be used.
Governance structures such as a family charter can regulate family members’ involvement in the business by setting out a number of conditions which need to be satisfied by individuals who wish to work in the business. These conditions could include obtaining specific qualifications and acquiring work experience outside the family business.
The Accountant’s Role in Family Wealth Management
Accountants and auditors have a trusted role within the local business scenario, particularly with respect to the management of wealth generated by business activities and investments held by the business (Farrugia, 2016). Being entrusted with the responsibility of trusted advisor, we must ensure that we are aware of the characteristics of family businesses as well as the issues they are faced with if we wish to offer our clients a valuable and relevant service. Furthermore, the implementation of the Family Business Act is expected to give rise to more formal discussions on the subject, presenting us professionals with an opportunity to specialise in this field.
A list of references is available from the editor and will be provided upon request.