Catriona Syed, a partner in the private client team at law firm Charles Russell, discusses how wealthy families can avoid the all-too-common slide back to normality which can occur over just a couple of generations.

Catriona Syed, a partner in the private client team at law firm Charles Russell, discusses how wealthy families can avoid the all-too-common slide back to normality which can occur over just a couple of generations. As always, this publication does not necessarily agree with all the comments expressed here, but is pleased to share these insights.

It is so common as to be almost customary to begin articles discussing preserving family wealth by referencing the proverb “shirtsleeves to shirtsleeves in three generations”.  Whilst something of a cliché, available evidence does suggest that this is a real problem for wealthy families, and the issue has rarely felt so acute as in the current economic climate. Wealth is usually created by one member of a family, and often, during their lifetime, decisions about the distribution and holding of wealth will be made by this person alone. This may be appropriate but, as the family’s interests begin to diverge (usually on their death), a different decision-making process becomes necessary. Feelings can run high, as it is often the case that some, but not all, the family are working in the business, there may be a widow who is not the mother of all the children, at least one of the children may have been divorced, etc and everyone will have his or her ideas about how the assets should be divided – which can sometimes result in unhelpful litigation and adverse publicity.

There are numerous strategies and structures to try and avoid this outcome (it is not within the scope of this article to discuss holding structures, although these can be very effective), but a determined family can easily lose even a large fortune by falling out with each other. Whether a patriarch or matriarch can be persuaded to encourage their family to adopt a system of governance is of course an entirely different issue.  However, successful families (in terms of wealth preservation) will have a good family communication network and all parties will have realistic expectations of what their roles are within the family, its businesses and its philanthropic or other activities. 

Managing expectations

The decision-making process regulating the family itself and the family’s business is what we refer to as “family governance”; it is as individual as the family concerned and it does not usually depend on the level of wealth concerned.  Broadly speaking, methods of family governance run from the more to the less formal, usually becoming more formal the more people have a stake in the wealth, particularly if the wealth is principally tied up in a single stock line which cannot easily be realised at its true potential in the short term. To be effective, the governance process needs to allow the family as a whole to formulate their long-term strategy and act as a forum for discussion for questions such as “should the family business be sold?” or “is there money available to fund a family member’s divorce?”.  Particular difficulties can arise when different people are looking for different things from their inheritance.   Some may be happy to have their wealth tied up for several years, because they may not require a return from it (for example, because they are working elsewhere), whereas for others it may be their principal source of income.  A good system of governance should be able to cope with conflicting demands, and should manage expectations so all parties know what they can reasonably expect from the family’s wealth.

Family governance methodologies

The least formal systems, generally appropriate when the family is small, can simply involve discussing important decisions. A slightly more formal arrangement might deal with some aspects of family wealth, e.g. it may provide that capital must be preserved for future generations and can only be passed to direct descendants, whereas income can be spent freely, or it could provide that all family members must have pre-nuptial agreements. 

More formal systems can incorporate:

·                   a written constitution, or a family charter, setting out the family’s values and goals, and how they are to be upheld, including provision for conflict resolution;

·                   a strategy for the family business – either for its retention or disposal or to enable some family members to buy out others (insurance may be helpful in this regard);

·                   a strategy for family charitable activities, which can sometimes be as important to them as the business;

·                   an internal communication policy;

·                   formal annual or biannual family assemblies;

·                   a dividend policy and a salary structure for family members based on their contributions to the family’s common interests;

·                   a policy for dealing with external communications – both for damage limitation if a family member receives adverse publicity, and generally for managing the family’s brand;

·                   treatment of non-family employees to ensure they are properly incentivised;

·                   a family council to act as a “steering committee” to manage day-to-day matters and liaise with senior management in the family’s business; and

·                   a family office, generally staffed by non-family members, to provide administrative support and (in some cases) financial advice to the family.

Not all of these will be appropriate in all situations, but unless primogeniture is to be adopted (and it remains an effective method of keeping wealth in a family, but generally at a cost) effective family governance gives most wealthy families an enhanced probability of wealth preservation through successive generations.

This article was produced jointly by Syed and associate Jos Style.