Family Governance and the Family Office

Jan 11, 2020

In most families, the idea of  “family governance” is like the “family office”—not something to which you give much thought. The family office? Mom and dad are “family office” enough. Same goes for family governance—mom, dad, or some combination of the two, who serve as the unquestioned co-leaders of the family.

But when family wealth becomes great enough to create a so-called “legacy family,” a family in which business and investment and other financial assets and decisions extend beyond the immediate family and across generations, both the family office and family governance become far too complex to be managed by mom and dad. At this point, it becomes crucially important to develop a governance structure with agreed-upon rules and roles. The structure must embrace and serve every family member who has a stake in the family wealth, business, and legacy.

What Is Family Governance?

When a family’s wealth reaches beyond the scope of the current nuclear family to deal with adequately, it is time to consider treating the business of the family as a business, an institution in need of a well-defined governance structure with strong and competent leadership capable of formulating plans, developing strategies, setting priorities and agendas, conducting meetings, being accountable, and enforcing a certain set of rules and norms.

Yet while family governance gives a nod to the model of governance in a business enterprise, families differ from businesses in obvious ways. The single most important difference is that the employees, shareholders, and leaders of a business are bound to one another chiefly by financial ties. The main objective they hold in common is conducting the business in ways that grow the bottom line. Of course, many more issues are involved in business leadership as well as in the relationship among those who have a stake in the business, but the core objective of a business is financial success, which is ultimately reflected for all stakeholders in the bottom line. Families, in contrast, are not narrowly concerned with improving the bottom line—although profitably managing family income and wealth is almost always a major objective of family governance and the family office. For families, especially legacy families with ties that extend both cross geographical space and through time, objectives are complicated by their genetic and legal bonds on the one hand and, on the other, by varying aspirations and goals that may either unite or separate family members as individuals.

Thus, family governance is inherently more complicated and certainly more delicate than corporate governance. Financial and non-financial drivers are sometimes in sync but, often, are so different that they pull in diametrically opposed directions.

The Importance of Good Family Governance

Yet the prevailing impulse in the family may well be to protest against the very idea of some formal scheme of family governance. “Blood is thicker than water! We are family! We don’t need a designated leader and corporate-style rules.”

It is true that some families are more naturally harmonious than others. Some families are blessed by an abundance of intelligent, cooperative heirs who work productively together toward common goals. But what happens when one or more family members fall down on the job or, worse yet, defy the others? True, each unit within the larger family has its own money and its own, individual interests. But it is also true of most very high- and ultra-high-net-worth families that much of the wealth is held and managed in common. Issues of managing these common funds readily become subjects of discord, the intensity of which increases when management of a family business is also involved.

Imagine the Smith family. Its members routinely consult financial advisors and tax planners, and, most of the time, most of the family is content to have routine business matters managed professionally. Besides, the family business is doing well, generating a nice income. Some time ago, ownership of the business was legally transferred to a family trust, which was led by the couple who founded the business, Ed and Nancy. For years, Ed made most of the decisions, despite Ed and Nancy both being trustees. Because the business prospered under Ed, none of the family members challenged his leadership.

Then Ed died, leaving Nancy as sole trustee. The trouble is that she had never been deeply involved in managing the business. Ed and Nancy’s adult children stepped in to help, but when Nancy announced her desire to relinquish a management role for which she was not suited, the three children turned from helping mother to disputing with one another—first  over decision making and then over who should become the new trustee. The arguing soon spread to fights over who could use the vacation house in Whistler and when they could use it. Before long, the family was at war with itself.

The Smith family was wise enough to recognize the need for some formal governance to resolve their outstanding issues, beginning with the need for strong but respectful leadership. They took the first step by simply recognizing that the trouble had begun once the family patriarch and default family leader, Ed Smith, died. Unprepared to succeed him, his widow, Nancy, proved an inadequate leader. The children stepped in, but, without formal rules to follow, fell into dispute. One thing was clear to all the Smith family members. There was no longer a “natural” leader available—no patriarch, no dad. So, the family agreed that it needed to create its own new and durable system of governance.

Role of the Family Office

Without a “natural” leader to lead governance, families like the Smiths may decide to bring in professional help, and it may well be at this point that the family establishes a single family office (SFO) or joins a multi-family office (MFO).

We have already discussed the processes of establishing or joining a family office in other posts. If, however, the family does not opt for a family office, they may still seek an independent outside advisor to help create a viable system of family governance. In this, it is most important to find an advisor with a proven track record of working with wealthy multi-generational families. A good advisor will spend time talking with family members, individually, and with special focus on the processes used to make decisions within the family. The advisor’s objective is to get a full picture of the issues and sources of friction within the family. Individual interviews may elicit issues that are not shared with other family members. The advisor must make clear to each person with whom he speaks that their conversation will be held in confidence and that nothing will be shared without permission.

After gathering information, the advisor prepares a report that describes with clear objectivity the family’s existing decision-making processes, along with an analysis of their effectiveness. Although the advisor may have uncovered individual issues and complaints in the interviews, these personal matters are generally suppressed in the report, at least for the time being. The priority is to address issues that affect the family as a whole. The report, therefore,  concerns overall processes for decision making rather than specific criticisms of named family members. After reviewing the report, the family members formulate with the advisor an agenda for a family meeting focused on establishing directions for family governance.

 From Family Meeting to Family Council

High on a governance-focused family meeting agenda should be whether to create a permanent family council as a governing body. For wealthy families in which leadership and decision making are functioning smoothly, regular family meetings may be adequate for good governance. But if a family is sufficiently concerned to call in outside advice on governance, a family council may not only be a good idea, it may prove essential.

Typically, the single most important determining factor is the size of family, including the number of its branches as well as its geographical distribution. Families with scores or even hundreds of members who are directly involved in matters of wealth and legacy almost certainly benefit from the establishment of a formal family council. This does that mean that a hundred family members must gather for a parliamentary session. The family will have to decide on how many representatives should sit on the council, and, of course, they will have to agree on the criteria for their selection. (Fortunately, not every family member will offer himself or herself for candidacy. A considerable degree of self-selection can be expected, and it is likely the candidate pool will be of a more manageable size.)

Each family needs to decide what constitutes a reasonable number of council members. The number will be determined in part by the size of the family, its structure, the role some members play in the family’s business, and geographical distribution. Another consideration is more urgently practical. A council of three members may be too small. A council of thirty, much too large. A council of five or six to represent, say, 100 family members, may be both fair and manageable. Data reported in 2014 reveals that 44 percent of family councils meeting quarterly have six members.[1]

It is helpful to think of a family council as a cross between a parliament or other legislature and a corporate board. The family office and/or outside advisors can help in laying out the details of the council’s structure, responsibilities, and powers, but one thing is always necessary. The leadership role of the family council must be set out clearly and unambiguously, and it must be fully agreed upon by the family at large. This is especially important when it comes to the council’s authority to make decisions, especially financial decisions, on behalf of the family. Moreover, the role of the family council must be defined in relation not only to the family but to the family office executives. This is where the analogy to a corporate board of directors can prove most helpful. If the family council lacks a clear role, clear authority, the full support of the family, and a viable working relationship with the family office, it will tend to recede into irrelevance.

Family councils are most effective when their efforts are directed toward achieving specific objectives and goals. If the family does not have an ongoing project or projects with a specific set of objectives, the council should query family members about what it is they want—about the desired direction and strategy for the family, its values, its projects (philanthropic and otherwise), and its enterprises.

Family councils, like the family office and like families themselves, do not fit one mold. Some have a very businesslike role in leading the family, especially in financial matters. Others have a softer focus, functioning more to foster better family communication and cohesion across large, geographically distributed branches and individuals. Some councils are deliberately designed to ensure that the rising generation is not only well represented but intimately involved in the direction of the family. Councils may be empowered to organize family gatherings, retreats, and vacations. They may work with the education initiatives of the family office, perhaps organizing courses, seminars, and workshops on investing, financial stewardship, and other aspects of financial management. They may also act as repositories of family history and heritage. Family leadership is important, but so is fostering an appreciation of the family’s collective identity through time and across geographical space.

 The Family Constitution

A family office can be invaluable for working with the family to develop its values and goals, coordinate both with its investment and business interests, and plan for the future of the family and its legacy. As developed through the family office, that plan is generally a strategic plan or its equivalent. Just as the practice of regular family meetings may evolve into the more formal, deliberate, and powerful family council, so the family may want to create more than a strategic plan. They may want a document of greater scope and durability. As the family council is analogous to a parliament or other legislature, so the family constitution is analogous to a national constitution. It is a durable document that fully sets out the rules under which family governance, decision making, problem solving, power sharing, and systems of communication are established and conducted.

A strategic plan sets out goals and intentions. A family constitution establishes principles, guidelines, and rules for implementing strategy in action—that is, for translating strategy into tactics. For a nation, a constitution is a body of foundational principles and (quite often) established precedents according to which the state is to be governed. For a family, the constitution can serve a similar purpose; but, as with the family council, it can be helpful to think of the family constitution as a hybrid blend of the state model and the model of corporate bylaws, rules that guide and control how the family conducts its business.

As with the other institutions helpful to wealthy families, a constitution becomes desirable, perhaps even mandatory, when assets, needs, wants, size, and geographical distribution exceed the practical management capacity of the family members themselves. A relatively small family probably has no need for a formal constitution, but as the family grows and develops, its network of relationships becoming increasingly large and diverse, its original wealth creators either advanced in age or deceased, and family members more geographically dispersed, a set of rules codified in a formal constitution becomes more useful, more desirable, and perhaps even more necessary. Family members are not employees. Their “contracts” with the family are essentially unbreakable, and yet the members are individuals with their own aspirations, talents, needs, and desires. As time passes and generations succeed one another, values, heritage, and goals—goals relating to finances, the family business, and others—may become obscure. A constitution is a lens capable of retaining focus. Keeping any family connected is a challenge. Keeping a large, wealthy family united in productive harmony through evolving generations and the changing needs and desires of individuals can be downright daunting.

As complex as family issues can be, when the business of the family is intertwined with the family business, the complexity increases by orders of magnitude. Clarity is at a premium, and it can be provided by a set of principles, guidelines, values, and rules thoughtfully articu­lated in a family constitution. The document not only serves to guide the family in the present, helping to resolve or even preempt disputes, it preserves rules and values for future transmission to rising generations. It is a vehicle for preserving the family legacy and transmitting down the years whole and intact.

People often mourn the passing of the “good old days,” which are perceived as a golden age in which businesspeople sealed deals with nothing more than a handshake. “There was a time when nobody needed a bunch of legal jargon. A woman’s word was her bond!”

Such is the mythology of commerce. The truth is that most deals through most of history were memorialized in written agreements. Yes, your word should be your bond—but there is no guarantee that your “word” will be understood as you intend it. Handshake agreements are fine when nothing goes wrong and everyone agrees on the meaning of what was said when the handshake took place.

 Defining terms

But what happens when something goes wrong? And what happens when the understanding or memory of the parties to the deal suddenly differ? Such occasions are the reason for a contract or a constitution. And such occasions are the rule rather than the exception. In fact, over time, “something going wrong” is not a possibility. It is a virtual certainty, as are misunderstanding and dispute.

So, a family constitution can serve, first and foremost, to define key terms relating to the family and its governance. The most important of these terms is “family member.” Just who constitutes a member of the family? No one would argue about your direct descendants. But what about the spouses of those descendants? These are in-laws, but they are also the parents of your grandchildren. What happens in the case of divorce? Should ex-spouses who retain a paren­tal role for your own descendants be defined as family members? And what of adopted children? What of common-law spouses—whose rights are typically recognized by law in most jurisdictions? What of same-sex marriage partners?

Whatever else the family constitution covers or does not cover, it must define, unambiguously, “the family” and “family members.” Moreover, to preempt legal challenge, it almost certainly must define these terms in ways that harmonize with existing statute and case law.

Beyond defining the parameters of family, the family constitution must define other key terms, especially those that set out the family’s relation to the governance of the family business, investments, philanthropies, real property, and other assets.

After setting out basic definitions, most family constitutions outline the forms of governance to be applied, which are intended to be durable through the passage of time and across generations. Who will lead and how will they lead? The constitution should establish clear rules for family leadership and decision making. It should set out needed leadership roles. If there is a family council, the constitution should promulgate the rules governing it, including rules of representation, leadership, and authority. If there is a family office, working rules governing the family’s relationship to the office and its executive(s) should be laid down.

Special attention needs to be devoted to rules for asset and wealth management:

  • How are trust funds and other aspects of assets owned by children to be managed?
  • How are profits derived from assets held in common to be divided and shared?
  • How are decisions concerning the sale of assets to be made?
  • How may commonly held assets be used as collateral for loans?
  • How may real property (such as apartment buildings or condominiums) be used by family members?
  • What are the terms by which vacation properties and amenities may be used by family members?
  • What terms govern the use of family-owned vehicles, including pleasure craft and aircraft?

These are only a few of the multitude of issues family members can be expected dispute from time to time. A well-written constitution can preempt the cause of many disputes by defining rules governing the assets or other entities at issue.

A family code of conduct

As the citizens of a nation have certain rights and responsibilities, and as the employees of a company are often subject to a code of conduct or ethics, so the family constitution is the appropriate place to set out a code of family conduct or ethics, essentially providing an outline of how family members should behave toward one another.

With consideration of the family’s values as its basis, the family constitution is a good place to trace out the contours of desirable and acceptable behaviour as well as behaviour that is not acceptable. Honesty and compassion may be highlighted as guides to behaviour between family members. The constitution should include guidelines for settling disputes amicably and constructively.

Communication

Families too often make the mistake of assuming that communication among relatives is automatic. In fact, it is all too easy to lose touch, especially as families grow large and geographically distant from one another.

The constitution may spell out general expectations for communication. It may stipulate responsibility for family members to provide one another with up-to-date contact information, which can be published in an online family directory. Beyond this, the constitution should ensure that family members who act as managers of shared family assets communicate with all family members concerning their jointly held funds and property. The constitution may include standards for such financial communications, including the use of spreadsheets, graphs, and charts. All financial and legal communication should be designed to inform and educate, not obfuscate or leave non-specialists in the dark.

An important aspect of communication includes regular family meetings and family retreats. Attendance should not be mandatory, but the events should be both regular, convenient, and enjoyable. The business of the family is consequential, to be sure, but it need not be deliberately tedious. The family constitution should lay down minimum requirements for family meetings and retreats as well as council meetings.

Finally, the emphasis on facilitating family communication should not neglect individual privacy. The constitution should define privacy and confidential information. It should carefully articulate the fam­ily’s expectation of privacy, both in terms of individual privacy and family privacy with respect to outsiders. Since many high- , very high- , and ultra-high-net-worth families are prominent in their community, the nation, or even internationally, the constitution is a good place to set out rules for communicating with the media and using social media. A good family constitution defines privacy as the collective fiduciary responsibility of the family.

 Resolving conflict

What the constitution has to say about desirable, acceptable, and unacceptable behaviour among family members is related to both avoiding and resolving conflict; however, it is important that the family constitution set out clear rules for dealing with conflicts when they do arise within the family.

No constitution—national, institutional, or family—seeks to outlaw conflict. Not only would this be futile, but it would also be counterproductive. Progress is often made through conflict. What a good constitution does is recognize the inevitability of conflict—and also its utility—but it provides mechanisms for resolving conflict fairly and productively. Conflict is normal, inevitable, and even potentially useful. Unresolved conflict, however, is a threat to any nation, enterprise, or family.

The constitution should guarantee every family member the right to be heard and respected. It should, in fact, frame the airing of concerns as a family responsibility. The constitution should prescribe procedures for expressing grievances and should set standards for making an argument and defending one’s position. It should make clear that no family member’s concerns are to be ignored, dismissed, or treated frivolously. If deemed appropriate, the constitution can include suggested techniques for effective conflict resolution and may specify the use of professional arbitration services.

 Amending the family constitution

A constitution is not holy writ, its truths eternal. It is a rule book, its truths durable but also subject to change, modification, addition, and subtraction as situations evolve. Every effective constitution contains the seeds of its own modification. An effective family constitution should provide for a process of amendment to remain flexible and adaptable to inevitable change—changing needs, changing opportunities, changing vision, values, and goals. Although each generation should receive the family legacy intact, each generation should also have the opportunity to work toward the betterment of the family, to make its own mark, and to ensure that its voice is heard. Without a mechanism by which the constitution can be amended, it will become obsolete in whole or in part.

The constitution should mandate its own periodic review, and, like other aspects of family governance, leadership, and management, it should be evaluated for its effectiveness in realizing the family’s vision, embodying its values, and working toward its goals. The family office can be of great help in such evaluation and benchmarking.

If a change is deemed appropriate, it should not be left solely in the hands of the family council—though that council should offer an opinion. An amendment should be a high-priority item on the agenda of the next family meeting. There are no hard-and-fast general rules for amending any constitution, but common sense suggests that the process should not be too easy. Major change should not lend itself to impulse. Approval of an amendment should probably require more than a simple majority of adult family members. A two-thirds or even three-quarters majority is likely more appropriate. If there is a significant dissenting minority, their objections should be carefully considered and, perhaps, accommodated in some way in the amendment as finally passed. Achieving maximum consensus is most desirable.

The Role of the Family Office in Family Governance

The issue of family governance should clearly demonstrate that leading the family is not the role of the family office. The family leads the family—through designated members, through a family council, through family meetings, and in the light of a family constitution. The role of the family office is to provide advice, legal and financial consultation, knowledge, ideas, and data, as well as to follow through in various ways with the implementation, execution, and monitoring of actions the family decides to take. In addition, the family office provides a variable variety of logistical, clerical, accounting, analytical, fiduciary, and legal services and support.

For determining the shape of family governance, the family office can provide advice on and advisors for all aspects of leadership, rule-making, the conduct of meetings, the creation of strategy, the formation of a family council, the techniques and technology to improve family communication, and the framing of a family constitution. The family office can also provide input that will ensure that the rules created by the family for its governance are in harmony with legal and regulatory requirements of all jurisdictions in which family members live and do business. In all this, the family office and the family office executives are to serve the family, not to assume a leadership role over it.

[1] Kirby Rosplock, The Complete Family Office Handbook: A Guide for Affluent Families and the Advisors Who Serve Them (Hoboken, NJ: Wiley/Bloomberg Press, 2014), 273.