Much ink has been spilled in the financial press in recent years over the parlous financial state of certain Eurozone countries, and of Greece in particular. That country’s national mythology contains many interesting facts about the misadventures of its dynasties. For instance, we read that King Priam and Queen Hecuba, to whom the throne of Troy had been passed down though many generations, were warned in a prophetic dream that one of their 19 children, Paris, Prince of Troy, would one day cause the downfall of their kingdom.
The prediction came true: a few years later Paris carried off the wife of the King of Sparta. He was punished by a coalition of most of the Greek kings, who tricked their way into the city in the legendary Trojan horse after a 10-year siege. This story illustrates a problem that great families still encounter today: how to pass on wealth and preserve it down the generations. As the adage says, “the first generation sets up the business, the second expands it and the third ruins it”.
Is it possible to avoid this fate? Clearly, the answer is yes – provided that various aspects of family governance are taken into account. Let us not forget the Greek etymology in our language: the origin of the word “governance” goes back to Plato, who used kubernetike to refer to the art of the steersman. Governance implies above all a decentralisation of decision-making, with different people and different places involved in the process. It refers to the setting up of new and more efficient types of regulation, based on stewardship and on a partnership between the participants. In a nutshell, it is a system and a tool for leaving a viable family legacy, emotionally as well as financially.
In ancient Rome, as well as in Europe under the ancient regime, the word familia covered the whole household, including servants and slaves. The term “family governance” thus suggests decentralisation of decision-making on behalf of the entire household. But just try explaining to Priam and to the heads of family businesses that they are supposed to delegate their decision-making to third parties. And yet, by obeying some of the basic principles of family governance that favour this type of solution, it is nevertheless possible to transfer wealth from one generation to the next. In general, according to various studies, the failure rate is nearly 70%.
Wouldn’t a parent want to avoid that? “I need to pass my capital on to my children. What do you advise?” Many investment and family office professionals will recognise this kind of request. Some will reply by suggesting legal vehicles and/or customised asset allocation – solutions based on aspects of family governance at one level. Few advisers are interested in the family’s non-financial capital, yet this aspect is crucial if wealth is to be passed down the generations successfully. Non-financial capital can be human (talent, health), intellectual (education, experience), spiritual (faith, traditions) and social (values, philanthropy). The objective is to unite the members of the family by identifying and combining their strengths and interests. Successful transfer actually depends on the non-financial types of capital.
Typical family businesses of the kind that exist in their millions are often the brainchild of one entrepreneur. The classic scenario is that the latter runs the company business, gradually bringing in other members of the family over time. In some cases, the company increases its business activity and value substantially. This is when the family fortune is created. At this stage, some entrepreneurs imagine that financial investments offer returns similar to the profits generated by their business. However, they tend to forget that the returns on capital they can expect in their own business are often higher than those they can obtain on a financial asset. After all, large fortunes are often created by people with outstanding entrepreneurial talent. It is therefore sometimes better to reinvest one’s dividends in one’s own company to achieve the family’s objectives, even if these are not financial ones.
The usual catalyst for establishing a system of family governance is the question of who will replace the founder of the business. The latter, who sometimes has a rather dominant and forceful personality, may seek to plan down to the last detail how the wealth is to be passed on. Moreover, it often becomes challenging to manage exceptional wealth in a way that satisfies all family members equally. It then often happens that the company’s management structure, just like the structure governing the family wealth, requires a thorough (re)organisation to ensure that the wealth can be transferred smoothly and successfully.
As a general rule, the more pressing the question, the more delicate the operation of transmitting the wealth. This is because the structure of family businesses is often based on emotional decisions, particularly when it comes to promoting members of the family to key positions or roles. An independent advisory service allows the participants to consider how far decisions made on the basis of emotion match the reality. Indeed, it is sometimes necessary to protect a family from itself.
The emotional side also needs to be taken seriously when setting up governance structures for financial assets. One recent example of a breakdown in this area was when investments were suddenly and obsessively liquidated just when the financial markets hit their lowest level. A long-term consultative process is therefore required to strengthen the ramparts of a family inheritance so as to withstand attack by a modern Trojan horse. A conservative attitude coupled with careful planning of both corporate and private wealth can but be beneficial for the business and, more importantly, for a family’s welfare. While managing a family’s financial capital may appear to be the central issue, it is even more important to manage the non-financial capital that grows and develops over the decades.
The success and longevity of a dynasty depends on the family’s ability to take its various forms of non-financial capital seriously and work with them over time.