The Role of the Family Bank and Four Keys to Success
In this week’s blog post, I discuss the role of the family bank, and four keys to successful implementation of this entity.
What is a Family Bank?
While there is no legal or widely accepted definition of a family bank, these special entities typically provide an organized structure and process for a funding from family members to family members. If the family bank is planned and implemented with a good governance system, it can be a powerful mechanism to put wealth to good use for the benefit and development of the family and their relationships.
Families, such as the Rothschilds and Pictets, established some of the earliest family banks in Europe. These semi-informal lending operations eventually grew to become larger commercial banking operations. A number of the larger U.S. financial institutions today are a function of families, such as the Mellons, Pews and Phipps, who developed broad commercial capabilities in addition to family enterprises. Family banks, however, are non-commercial entities that provide intra-family financing to support and inspire entrepreneurship, next-generation development, responsible stewardship, good governance and opportunities for capital creation.
Four Principles for Family Banks
There are four overall principles for families and family offices to keep in mind when they are considering forming and building a family bank: democratize, harmonize, customize and professionalize.
One of the primary ways to maintain a healthy family is to create a system of wealth management that allows each member the ability to participate in the decision-making process. By giving the next generation a voice in decision-making, the family bank empowers them while supporting their development. If they do not feel they are a part of a joint decision-making process, or a bank system that has attractive policies or terms, the next generation may be less interested and motivated to participate. Similarly, if the terms are not relevant to them, or are dictated to them, the bank may not have any next-generation participants.
Consider the example of one very well-intended, hardworking senior member of a family who invested a significant amount of time and money with his wealth management firm and advisors to develop a new trans-generational structure to provide the next generation with jointly owned assets. After careful consideration, the next generation politely declined any interest in participating in the entity or jointly owning the assets. If the next generation was involved early on and throughout the process, the outcome may have been different and the senior member’s efforts, time and money could have been used better.
Building and maintaining healthy family relationships is paramount to preserving and growing financial and human capital across generations. Without good relationships and a strong governance system, a family bank is in jeopardy of developing complex conflicts and destructive family dynamics. These negative outcomes can be prevented by promoting healthy family core values (integrity, respect, trust and openness) and a sense of responsibility, while also creating processes and policies for open communication and conflict resolution. Harmonize does not mean that everyone in the family has to get along at all times; rather, it means that family members understand how to manage conflict productively and peacefully. Some families have a consensus-driven approach, whereby they must come to a majority agreement, but no vote. Conflict and disagreement, when handled professionally, can be extraordinarily productive and healthy for establishing long-lasting harmony.
Each family is unique, and each family’s mission, vision, objectives, values, level of participation, time horizon, estate appetite for risk and resources are different. The following questions can help clarify what is most important to them:
1.) Are they mostly interested in developing a soft bank or a family bank that balances these two approaches?
2.) Does the family want to develop one family bank for all descendants or one for each branch of the family?
3.) Should the next generation be provided an option to invest in the family bank over time?
4.) What are the limits to the types and terms of loans or financing?
5.) What type of return should a family bank investor expect for their return on investment?
6.) Can spouses, stepchildren or distant relatives qualify for loans?
7.) What level of governance policy and process detail is appropriate?
A wide variety of structures, entities, agreements and policies are available to tailor a family bank to fit each family.
The professionalism of a family bank can help prevent many business, legal, financial and tax missteps. The key here is to treat the family bank as a professional, disciplined family business by taking such steps as formalizing the financing policies and process, and incorporating the independent oversight of non-family board members. The bank can also facilitate training and mentoring of next generation entrepreneurs by bringing in experienced outside advisors to provide unbiased expertise. Family banks that involve independent board, investment or loan review committee members can help eliminate any suspicion of favoritism or bias in decisions and transactions, sidestepping potentially unhealthy family dynamics.
Each of the distinct groups related to the bank) the family, the bank itself and its board/advisors) should be well defined, with professional structures, agreements and documents. And an open flow of communication between these groups enables them to make well-informed decisions that are aligned with the best interests of all involved. It is well known that an independent board of directors, board of advisors and committees can play a key role between a family and a family business entity.
But even with the formation of a board of directors or advisory board, and strong communication, families would be best served if they developed a healthy family governance system early in conceiving a family bank. A strong family governance system will provide the rules, policies and guidelines for the board. Professionalization of the family bank system and each of the subsystems is important for the family bank’s long-term sustainability.