The Evolution of the Family Bank and the Role of the Family Office

Posted by Dr. Kirby Rosplock on 11 February 2015

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In this week’s blog post, I discuss the evolution of the family bank, and the role of the family office in family banks.

The Evolution of the Family Bank

Family banks can range from simple to complex, and each family bank can evolve based on the needs and specifications of the family as it matures. The bank’s function is to meet the purpose and scope of funding for the needs of the next generation while considering sustainability for future generations. A simple family bank might be one with the sole mission of providing simple loans to younger family members. This entity can be easily formed with elementary governance, and loans can be made using IRS guidelines. A more complex family bank might be trans-generational with the mission of providing a wide range of sophisticated financing to family members. This can involve complex tax and estate planning, multiple trusts, multiple corporate entities and advanced independent governance systems with elaborate policies and processes. The following provides a brief overview of how the family bank can evolve throughout different stages of the family.

The family bank may have a very simple corporate and governance structure providing a small amount of funding for simple activities and personal assets. Some examples are when a parent wants to make funding available to the next generation to purchase their first car, equipment for a summer job, or a small residence during college. The simplest family bank is useful for introducing elementary business, financial and governance principles and practices to the next generation. Senior and junior family members can voluntarily fund the bank, and the next generation can obtain funding based on a request that meets predetermined criteria and terms. While this type of entity is not complex enough to require a fully professionalized governance system with independent oversight, it should focus on democratizing and harmonizing the process of providing intra-family financing by facilitating good relationships, communications, joint decision-making and accountability. The terms of financing should meet the requirements of the IRS for making intra-family loans and be well documented.

As the next generation family members become more knowledgeable about business and financial matters, and they require a larger amount of bank funding for personal assets, such as a home, the family bank’s objectives, succession planning, business plans, corporate and governance structure must evolve. At this point, the family’s financing needs are still relatively simple and can be accomplished under basic terms, policies and processes to monitor and mitigate risk. In addition to building strong relationships, communication, joint decision-making, process and accountability, governance should also provide transparency and frequent reporting.

As next generation family members become interested in entrepreneurship and want to form their own businesses, the scope of the family bank must evolve once more. If they are interested in acquiring, owning and operating properties or companies, they should receive appropriate education and have relevant business, financial and investment experience. Any proposal from a family member should be accompanied by a detailed business plan. Governance at this stage should incorporate a form of independent oversight, advice and mentoring. This oversight can be accomplished with independent members on a family bank board of directors, an investment committee or an advisory committee.

In the next stage of complexity, the family bank can be useful for providing larger amounts of capital for longer periods at higher risk. Family members may have achieved substantial business, financial and investment experience, and want to utilize a significant amount of funding from the family bank for investments in multiple new ventures, properties, investment funds or acquisitions. Depending on the family bank’s agreed purpose, other uses may also include funding to buy out a part or all of an existing family enterprise, buy out an employee stock ownership plan or purchase large family properties. It can also be used to transfer wealth and assets to the next generation.

To handle complex financing from family banks, a comprehensive and highly disciplined analysis, approach and plan is necessary. Proposals for funding should include a detailed business plan taking into account all aspects of use for the funding and long-term goals. Other considerations include, available bank capital, permissible financing criteria, the bank’s appetite for risk and the bank’s longer-term sustainability, succession planning and the next generation’s long-term interest. The monitoring, reporting and financial transactions at this level are more complex, sophisticated and challenging. Governance should be focused on building long-term, sustainable shareholder value and promoting a strong, professionalized source of funds with independent oversight, while supporting healthy family relationships.

In a more complex family bank system, family members can voluntarily participate at both the family bank level, as well as co-own or co-invest in different assets depending on the charter and other agreements. By requiring or allowing the next generation to commit some of their own funds into fixed, financial or operating assets when they are seeking additional financing from the family bank, not only shares risk, but also provides additional motivation to the family member to be accountable and successful.

The Role of the Family Office

Although the family office typically has been viewed as a defensive vehicle for wealth preservation and to mitigate principle erosion, the family office can also be proactive in supporting, facilitating and building a strategy for family entrepreneurship. Family banks are at the crossroads of family business systems, entrepreneurship, direct venture start-up and private investing, as well as family, investment, corporate governance and corporate, estate and tax planning.

Because traditional family offices are positioned at the center of the financial, legal, investment, accounting and wealth transfer needs of the family they can play a key role in supporting family banks by providing these areas of expertise to the family. They can also provide education to family members about what it means to be entrepreneurial and how to gauge opportunities.

Often, the family office may have links into new ventures and businesses through private equity investments or direct investments, as well as involvement with one or more family business. These resources can provide access to entrepreneurs and exposure to how businesses are formed, operated and grown. Some family offices with direct venture investment or family business experience can be instrumental in supporting family members as they develop a business case and plan for the venture they are considering. Ideally, the family office can assist with the selection, coordination and oversight of independent expert advisors, such as lawyers, tax advisors and others. In cases when the family office does not offer these resources, either in-house or through strategic partners, the family may need to look elsewhere for the appropriate resources and partners.