Family governance

Spanning the generations

Among high net worth families and family offices, the topic of governance often comes up. While the concept of
governance, and the issues associated with it, is widely understood in a business setting, its significance can be more
difficult to envision for a high net worth family and its various enterprises and holdings.

Governance — whether in a business or family setting — provides the

framework in which roles, policies, processes, and controls needed to
guide decisions can be established, monitored, and modified to attain
organizational goals and objectives.

It’s a given to say that governance is a necessary component in a well-run

business. And virtually all high net worth families in this country acquired
their wealth through one or more business ventures. Yet, for many of
these families, the lessons learned from the development and operation of
the family business haven’t been transferred to address the strategic and
operational needs associated with running their personal wealth. Although
many of these families are generations removed from the business that
originally generated their wealth, their current holdings — in whatever
form they take — represent a business enterprise in their own right. This is
true whether the high net worth family has adopted a passive investment
strategy or it has been more actively deploying its assets. The issues that the
high net worth family faces are similar to those that prompt a business and
its stakeholders to value governance.

On the following pages, we explore a number of questions about

governance that high net worth families often pose: Why is governance
important? How do families go about establishing governance processes
that align with their unique goals, values, and culture? How do families
know when they have a good governance structure in place?

While our answers to these and other questions are not exhaustive,
we hope you will find the discussion helpful as you consider your own
governance needs.

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Family governance
Q. What is family governance, and why is it
important?
A. For the high net worth family, the need to focus
on governance (or, perhaps, the implications if there
isn’t such a focus) tends to emerge as the family’s
holdings become more complex and diversified among
a multitude of passive and active investments. Although
family members may have less day-to-day involvement
in the business that helped generate their wealth, they
may still need to regard their holdings collectively as an
enterprise. Operating this enterprise requires the same
discipline and principles that are applied in a business
context in order to preserve and grow the family’s
sources of wealth from generation to generation.
Like any business, this enterprise needs to have a vision,
a plan, a set of controls, and experts — including
independent board members, trustees and other
advisors — to help guide it.
As a family’s wealth diversifies, decisions must be
made concerning what kinds of assets to invest in,
for what purpose, and for whose benefit. Also, the
financial, employment, and participation needs of
family members — the family stakeholders — must be
addressed, as well as the vision of groups within the
family for how they want assets to be deployed.
Sound business practices should include a robust system
of governance that is dynamic, affords protections,
fosters communication and input, and supports
effective business operations. In addition, governance
should help address significant family questions. What
does our family represent, and how do we define
ourselves? Is our duty simply to maximize the value
of assets, or do we have commitments to our family,
our employees, and our communities? Whatever the
answers, governance can create a roadmap for the
family to achieve its goals and objectives.
Governance is more than hiring a chief investment
officer to oversee the family’s investments. Instead, it
addresses a range of issues and stakeholders. Where
family members are trust beneficiaries, do they have a
voice? What about outside executives that may be in
the employ of the family? Will outsiders have stakes
in the family businesses? Is there discipline in defining
roles and hiring? Is every family member put on the
payroll, or does each have to earn his or her way in?
These issues require a structure and forum for strategic
decision making and a thoughtful exchange of ideas.
Q. Broadly speaking, how can governance
benefit a high net worth family?
A. Some families can address governance issues
informally. They have a collegiality that allows them
to make decisions at the dinner table because they
communicate, have common views, and have a unified
vision.
As families become more diverse in geography, financial
interests, and points of view — while growing in
number with spouses, children, in-laws, and others
— it’s typically not feasible to make decisions around
a dinner table. A governance structure can provide a
forum to address issues, particularly those that, frankly,
some people would prefer to avoid or have difficulty
broaching.
Governance can also promote accountability among
family members, helping them to become more
responsive to others’ needs and questions. A family
member who plays a lead role in planning the family’s
investments and welfare may be less inclined to act
unilaterally when a governance structure is in place that
requires a formal discussion of investment strategy.
Governance also can help family members regard one
another as peers or colleagues, not only as brother,
sister, mother, or father. With that professionalism can
come a heightened sensitivity to other family members
and their stake in maintaining and growing the family’s
wealth. In addition, it can open the lines of two-way
communication.
Having a governance structure in place can be especially
critical when hard times set in. In such times, tough
questions can arise. Were adequate controls in place?
How were these investments picked? What was the
level of family involvement? What were the structures
through which decisions were made? Without a
governance structure, even a basic one, answering
these and other questions to the satisfaction of family
members can be difficult.
Further, a governance structure can provide a much-
needed forum for airing and resolving disputes, in
addition to helping prevent family members from having
to resort to the courts. But governance is certainly not a
panacea. While some matters can be addressed through
governance structures, others cannot. It is important to
understand the limitations of governance in addressing
family issues; for each family, these limitations will
be different. Governance, though, can reduce the
likelihood that a family disagreement will become
destructive, not only to the family’s relationships but
to its wealth, which is critical to the family’s long-term
financial security.

 Family governance

Q. What specific issues can governance address?
A. The issues that a governance structure can
address depend on the individual family, its particular
circumstances, and its stakeholders. The issues can run
the gamut: Planning for the succession of the family
or business leader. Setting limitations of authority, or
length of tenure, for family members on committees
or boards. Establishing operating agreements for
partnerships. Identifying and selecting board members
or trustees, as well as planning for their succession.
Determining the family’s legacy goals — do members
want to leave a legacy to the family alone or to
particular charities and/or communities? Addressing and
monitoring stakeholder concerns. Managing/mitigating
existing liabilities — and being cognizant of potential
ones. And setting controls over who has authority to
make, change, or sell an investment on behalf of the
other family members.
With the right experience and skill sets, a governance
structure should be able to help a family address these
matters.
Q. What are the challenges to developing and
implementing a governance structure?
A. The biggest challenge, and the easiest to address,
is acknowledging the need for a governance structure
before a crisis arises. It’s hard to go backward in the
process.
ability to make the capital investments needed to
grow wealth in a way that will support the family in
the future. The opposite is also true: families that are
“wealthy” on paper may not appreciate the fact that
they have no funds for maintaining their lifestyles.
Q. What are the components of a governance
structure?
A. Governance requires a structure, with clearly
defined roles, responsibilities, goals, and accountability.
Ultimately, the structure may include an independent
board, a group of trustees, and possibly other advisors.
Each group has certain responsibilities and obligations,
and each requires different skill sets. A trustee is not
necessarily going to provide the independent counsel
that a board member may give, nor will a board
member necessarily be able to offer advice about a
particular investment strategy.
The responsibilities of each will vary depending
on the operational activities undertaken and the
investments that are in place. For example, if the family
enterprise comprises a series of partnerships, the
operating agreements for those partnerships may need
modification to incorporate a decision-making process
and the authorities granted to partnership managers or
general partners.
Some families may have one or more of these structures
in place, or they may need to augment or modify what
they have to obtain the benefit of a well-rounded team.

From there, however, family dynamics are often the

biggest impediment. A family member may not want to
take the reins for fear of being perceived as a usurper
or power monger. Other family members may not be
comfortable putting issues on the table, preferring to let
“sleeping dogs lie.”

Trying to develop a governance structure alone, without

the help of an independent board or set of advisors,
can represent another roadblock. Generational issues
also can influence a family’s receptivity to governance.
The eldest generation often does not see a need for
governance — they govern, and there’s no problem.
Second- and third-generation family members typically
do perceive a need, even more so as they marry and
build families of their own.

Focusing too much on individual family members and

their goals, rather than on the shared need to grow the
portfolio of investments that will sustain all of them, can
also present a barrier. Families sometimes lose sight of
the fact that their decisions to redeploy assets from the
original business can have an impact for generations.
For example, they need to understand that drawing
dividends from a company can impair the company’s


Family governance
Q. What’s the purpose of an outside board?
A. One key component to effective governance is
establishment of an outside board. In corporations,
outside boards provide many forms of value — cross-
pollination of ideas, best practices, and a fresh set of
eyes.
The same holds true in the business context of a family.
A family should consider an outside board at any point
along the continuum ranging from wealth primarily
generated by a closely held business to holdings in a
highly diversified portfolio of investments. An outside
board can identify matters that need to be addressed,
issues that should (and should not) be acted on right
away, and the resources with which to address them.
A board with outside members can take on strategic
challenges, such as investment policy, controls, and
succession. Such issues can be addressed either through
direct involvement of outside directors who bring their
skills to the table or through contractual arrangements
with third parties. Board subcommittees can be created
to make decisions regarding specific projects or the
hiring of consultants to meet particular needs.
An essential starting point is attaining family buy-in
to recognizing the need for a board — its potential
benefit to the family in the long term. Typically, the
board will have representatives from both within and
outside the family. The board structure must be sensitive
to family issues, some of which may be longstanding.
One approach is to put in place a rotating structure in
which each family member has a board position for a
set period of time.
A key question is who will make decisions about outside
board members. The various constituencies within the
family need to be heard in deciding whether to bring
in outsiders, developing the criteria for selecting them,
and making the selections.
Q. What’s the role of a trustee, and how does it
differ from that of a board?
A. Individuals create trusts to hold property for their
beneficiaries. Trustees hold and manage the property
on behalf of the trust beneficiaries. Trustees are legally
bound to do so in accordance with a trust agreement
and applicable laws.
But many family trusts were created decades ago.
At the time, the people establishing them may not
have accurately anticipated the needs of the current
beneficiaries, let alone the level of wealth and its
inherent complexities. This may have an impact on
trustee selection and succession.
Because trustees are often close to a family, the
outside board should be separate and distinct from the
trustees. Loyalty to the family is an important attribute
and should be valued, but not at the expense of
competencies.
It’s also important to maintain a distinction between
who is working for the family, versus for the business.
While the same skill sets may be required for certain
functions, the interests of the family and business may
differ at times so it’s ideal not to have the same people
performing the same functions for both. Trustees should
be responsible for the general direction of investments,
rather than the active investment of assets or other
matters related to the family as a whole. They should
focus on issues related specifically to trust beneficiaries,
such as determining whether and when to make
distributions, or creating vehicles to focus investment
strategies on appropriate classes of beneficiaries
(providing cash flow to older family members, capital
appreciation to younger family members, etc.).
Trustee-related issues also can arise. Trustees are subject
to a high level of fiduciary responsibility. A disgruntled
family member may question a trustee’s decisions, feel
he or she isn’t getting a fair share of assets, or believe
that assets are not being adequately protected.
Trustees often are not sufficiently aware of their
fiduciary duties and the legal constraints on their
ability to make investments. Establishing a governance
structure with formal investment policies and a
framework for making, adhering to, and monitoring
investment decisions can go a long way toward limiting
trustee liability. Further, having a structure in place that
protects the trustee can help attract and retain trustees.
In some instances, families may choose to establish a
private trust company in lieu of a traditional trustee
structure. A private trust company can provide a more
customized approach to trustee functions and help
avoid issues related to changes in the family-trustee
relationship, a trustee’s death, or a trustee’s personal
liability.

 Family governance

Q. Can a family office handle governance Q. How do you know when you have a good
matters? governance structure in place?

A. Not necessarily. Typically, a family office is put
in place long before the governance issues are
acknowledged and addressed. It starts often as an
offshoot of a finance or accounting department of
an operating business and morphs into a much more
robust type of enterprise. The skill sets required to
operate a family office — such as finance, accounting,
legal, and investments — are not the same as those
required for governance.
Creating a family office is a logical step for a family
when a major transaction occurs that monetizes its
assets. Creating a governance structure, however, goes
much further. It addresses the family’s issues holistically
and requires more attention to structuring and skill sets.
If a family office is structured improperly, there may
be tax or financial consequences of getting it wrong.
If governance matters are not addressed, the risk is
destruction of the family fabric.
A. Good governance is reflected in behavior; it’s not
a set of rules in a binder that sits on a shelf. Good
governance focuses on meeting a particular set of goals
in the interest of both the family and the sources of
wealth that are maintaining it, not just one or the other.
A good governance structure gives all stakeholders, not
just select individuals, a voice in the rules that guide
decisions. You know you have a good governance
structure in place when you are making decisions about
all the sources of wealth with an outlook toward how
that wealth will sustain current and future generations,
not simply maintain current lifestyles. And, a good
governance structure has some fluidity because it
embodies the family’s evolving philosophy toward
the type of legacy it wants to leave for future family
members and communities.

This is not to say that a family office is not critical. The

family office is extremely valuable. However, it may not
provide a forum for addressing or processing decisions
about succession, terms of trusts, or terms of directors,
nor how and why decisions affecting the family’s wealth
were made in the first place.

Q. How does a family start the process of

building governance?
Stakeholders in family governance

A. A governance structure is as much about having a
decision-making process as making the actual decisions
themselves. Establishing stakeholder roles, authorities,
and obligations, as well as a process for when and how
to interact with various family groups and trusts, can go
a long way toward avoiding problems and conflicts.
But where to begin? The complexity of family
relationships (let alone holdings) can make creating a
governance structure seem overwhelming.
But governance can begin with small steps. Consider
starting with a discrete investment or pool of funds.
Identify an amount of money that will be bifurcated
from other investments. Then, subject it to a somewhat
different investment philosophy, or seek input from
different family members and advisors.
Finally, governance can begin by simply inviting people
to the table. As difficult as it may be, it is empowering
to ask people to participate in developing a forum for
constructive, nonconfrontational discourse about the
family’s goals and objectives.
Proper attention to governance can benefit family members and other
stakeholders in the family’s well-being and success. Good governance helps
create an environment in which stakeholders feel their interests are being
met and they have a voice in matters related to their roles. Stakeholders can
include:
The people running the family’s businesses — Financial professionals who
oversee securities, real estate, private equity, and other investments on behalf
of the family. Their compensation can be tied to investment performance.
The family office — The management team that oversees family operations
and makes sure various investments fit cohesively in the family portfolio. Their
success can be difficult to quantify.
Active family members — Family members directly involved in the family
business as directors and managers. Along with having a financial interest,
they invest their time and energy in family matters.
Passive family members — Family members (and their relatives) not actively
involved in the family business but highly interested in the family’s financial
condition and performance.
Fiduciaries — People called upon by the family to serve as trustees, board
members, or otherwise who assume a fiduciary interest in the family’s welfare.


Family governance

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