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By Serge Ejzenberg
Posted Jul. 27, 2005

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In a previous article we showed that France, during 2004, has confirmed its position as one of the leading destinations in Europe for Private Equity thanks to several legislative and regulatory changes which contributes to the development of the French Private Equity Sector.

Let’s focus on the French Small and Medium Enterprise (PME – Petite et Moyenne Entreprise).
Several studies (MEDEF, Chambers Of Commerce, etc.) agree that roughly between 500 000 and 750 000 PME will be confronted over the next 10 to some major ownership changes.
These changes will not happen over night, different steps will have to be accomplished and the role of the traditional Private Equity will also have to take into consideration these emerging new markets that have already been scrutinized by the traditional corporate banks and with some “consultants” seeing there an opportunity to expand their activities and attracting new customers.
Of course this trend can be found in other European Countries.
It’s important to keep in mind that roughly these companies represents 80% of the contribution to the world economy.

What are the factors contributing to these changes?

Several explanations can be found, from the pure markets situation till some “psychological consideration” and the ageing population issued from the Baby Boom

The last one is certainly a major initiator for a management change, a well planned succession process passing the reins is crucial for the continuation of the company’s activities.

A more difficult situation is when the company has not considered taking it’s competitive environment.
Competition has always been perceived as the “black sheet” amongst enterprises; but these days there is a new factor which is in the family itself: the younger generation is not fully prepared or willing to take the reins.
Several explanations can be underlined such as the pursuit of other interests or just the willingness to step out of the business and enjoy a rich and quiet life…
As a matter of fact, the destiny of some these companies will be either to disappear or to die under the pressure of their competitors.

How to define a “Family”

There is of course the traditional family definition which is linked to a group of persons related by blood or marriage.
This was a “conservative” definition.
In our modern days the definition can be extended to individuals who are joined through important relationships that do not fit with the conservative definition.
The new current psycho-social environment has to be taken into account for the definition.

Today a family includes individuals who are joined through important relationships that do not fit the stereotypical nuclear model.
For example, divorce may divide the traditional family tree, and many families now expand their tree to include couples, same sew or otherwise.

In a governance system, “family” can also include close friends or professional advisors who have developed intricate and intimate relationships with family members.

What is Family Governance?

Every family of significant wealth lives within a family governance system that works across generations.

Studies have shown that even the most successful estate planning, tax minimization, and investment returns do not necessarily ensure wealth preservation.

The subject can be easily viewed from different aspects ranging from ethics to philosophy.

Our view will be to set the family governance principles as practical tools to be implemented and controls reviews which will make this governance working.

Some theories…

It’s not my intend to elaborate a full cursus on the definition of Governance and the implication in the family model.
Nevertheless some review of the basics are often appreciated.

We all know that public governance impacts our behavior: especially law and policy.

A former dean of George Washington Law School has defined the law “as regulating human behavior through language”.

So when family members create legal structures for various purposes (business, wills, trusts, and other legal documents,…) they set out governing rules that direct and control the behavior of others; but with a major difference between laws voted by policies makers: there is not authority to control and eventually set penalties…

Rarely there is a form of “civic education” to ensure that the family members are properly prepared to run the system.

It may be unpleasant to consider that a family has created something similar to a government or that its members are empowered to control, to guide another’s behavior.
Let illustrate this by a simple example: a father can establish a trust for his son and appoint his brother, the son’s uncle, as a trustee. Depending on the terms on how is defined the trust, the uncle may have a discretionary power on the distribution of incomes or dividends to his nephew.
The nephew may also be impacted on how the terms of the trust are written.
This can lead to uncomfortable position for both the uncle and the nephew and create a huge disturbance into the family relationships at a later stage.

A perfect family governance should enables who seeks to preserve wealth across generation must also support the family’s human, intellectual, and financial capital through this governance.

To some extend some authors would recommends to establish some form of “representative government tailored to the needs of the family”.

A view of Family Governance Framework

Several consultants, or family advisors have their own visions and theories about the subject.

Any theory, which take into account its finality: to serve the family, can be valid if:

  1. Its clearly stated
  2. Everybody has approved it
  3. The mechanisms in place offer some flexibility within defined limits
  4. Can be easily changed without jeopardizing the family.

A framework like this one can be easily adapted to most of the situations:

The human being needs to set a vision or a set of unifying beliefs.
Traditional financial advisors have too often offset this fundamental. They set short terms investment schemes with a different angle: to maximize profit and reduce costs. This is not a criticisms they are doing their job.
For a family to preserve wealth and ethic over the age, it must start at the top with some sense of the principles/visions that will guide the family’s interactions for their joint affairs.
The family should share a common “DREAM”.
Often most of the families and their advisors have not thought about these issues in this way before.
Here are some hints to be considered and openly discussed:

  1. Do we have some shared beliefs?
  2. How do we distinguish ourselves from other families?
  3. What is our common vision?

This may sounds as an academics perspective; in fact there are many useful tools to help families in this process: simple family meeting where all the members agree on certain topics and subjects.
Some external advisors (or persons, members from different family) can bring their specific view from “outside” the inner circle of the family – they are able to avoid taboo or subjects that irritate (sometimes nobody remember the reason …)
The vision statement should not be too complicated or long to express: “We will seek to use our financial resources, contacts,… to ensure the well being of each member of the family. Our family will engage its resources to promote positive contributions to the communities in which we live…”

Of course this vision statement, even if it easy to write (more easy when I can dream of such a statement…) would sometimes require several sessions and require some heavy brainstorming.

It sounds odds but the final wording of the vision should not necessarily takes into account assets and financials targets.
The debate remains opened; in any case they can not replace memories and healthy family relationships.
A successful vision will enable each member to respect the difference amongst themselves while focusing on overlapping principles.

Behind any vision or common objectives there are Policies which translate the agreed vision into guidelines that will apply to specific aspects of the family’s activities.
Ideally they should be written or if not, simple enough that all the family members can remember and agree on them.

  1. Rules for communication: which method will be used for making family decisions? How to conduct family meetings?
  2. Rules for involvement in family business: What is the skill-set requires for a family member to work in a family business? Will equity ownership be related to management involvement? What are the rights of family members who choose not to work in the business?
  3. Joint affairs: how it will be decided to grant to a family member to act into another company/family or to have specific unrelated engagement?
  4. Role of spouses: How are spouses generally treated in family trusts, foundations, entities? How much of information should be shared with them?
  5. Usages of family funds: Are the family members expected to be economically self-sufficient? Are their live style in accordance with the Vision?
  6. Investments: What is the vision of the family about it’s investments? How does the family takes into account some specific requirement?
  7. Education: What is the level of education required by each member of the family in order to engage the family in specific action?

Several other examples can be shown, the underlining purpose should always remain the same: ensure that all the family members have a correct understanding of the Policies

3. Practices:

Any good theory or recommendation will not produces the expected results if the Practice
is not in line with those.
Practices cover a broad spectrum of activities, some of them are basics (such as drafting a business plan, or writing wills and trusts) others may be more complexes a require third party assistance and training (creation of vehicle to reduce tax exposure…).
The Practice side is a very odd and complex process; it position each member of family accordingly its own interest and with the respect of considering the global interest of the family.
Often at this stage a “Family Advisor” or a “Multi Family Consultant” can bring some valuable advices and ensure that all the framework (Principles, Policies and Practices) will allow the family to reach its goals.
The assessment of the results can only validated over a long period of time.

The phases in the implementation of a family governance system:

a. Chaos:

A parallel can be seen between the theory of Marketing (applied to goods) and the implementation of a family governance system.

In the marketing theory we are referring to “early adaptors” which are scrutinized by the company to seek if the product will have a viable market; it creates “chaos” inside the company.

A famous mathematician Henri Poincaré has described in “Chaos Theory”: “Situations that from the outside appear to be the result of random or unpredictable acts, but in reality have an underlying order that can be discerned over time”.

For a majority of families “chaos” may describe their situation with respect to family governance. This does not mean that the family members are chaotic.

They focus on living their live on day-to-day issues rather than long-term wealth planning.

Usually during that period, estate and financial planning will generally respond to immediate need and be uncoordinated.
We can illustrated this with several example:

  1. A young couple will write their wills after their first child is born or before they take their first family vacation.
  2. Entrepreneurs establish and fund a private foundation as part of the sale of a business, set a funds, even though they may not have time to do long-term planning.

In most of the situation, family members do not focus on administrative needs or long-term planning. Often the older generation keeps controls of most of the family wealth issues.
The family members are not unhappy about this, but the façade of stability belies underlying chaos.

However there are some critical action steps that must be taken during that phase.
The first step would to cover basic estate planning to insure potential emergencies so that they can “sleep well at night”.
This will include some basic tax and estate planning.

Too many individuals delay this initial process and risk leaving their families in disarray.

After this first initial planning and establish some structures, the next step is to take a full inventory of financial and non-financial health of the family members as a group or individually.

The chaos phase is successfully passed when the family has reviewed some basics such as:

  1. What structures have been created to hold and transfer wealth?
  2. Who are the family advisors and are they appropriate to family needs?

As each family member reviews what he or she has created, they should focus on the intended and unintended consequences that might result from what is already in place.

They must ask:

  1. Have we created any trusts?
  2. How well do we know our family?
  3. Have we created new positions of authority for family members? (e.g. directorships,…)

The family needs to review the skills and interest of each member involved and make sure that they are matched to the rights, duties, and responsibilities given to them.

b. Coordination:

Within the family, a family member or group might take initiative to create formal ways for the family to work together.

This is a crucial phase, as it represents the transition from ad hoc planning to a more cohesive approach to long-term family affairs. There are some essential actions that must be taken by the family during this phase for the transition to be successful. Usually, there is a need for an initial family meeting or a series of meetings, which may start with specific issues that need immediate resolution.
These meetings present an opportunity to expand beyond the specific task at hand to work on core governing principles and policies. Ideally, it is during this phase that a cohesive team of advisors is formed and a primary coordinator is chosen. Through these interactions, family members will need to learn how to diffuse the intense emotional issues
that bind families and, for their long-term welfare, develop healthy methods of communicating together. Some of the actions that family members must take include: defining and clarifying Family goals, intergenerational tax planning, and ensuring that proper education is available and used by Family members. The family must understand the roles that they play and how to distinguish them from each other.

It is also during this phase that the primary Family wealth holder (if still alive) will need to understand that open communication with the family members who will inherit horn him/her is essential to ensure the healthy transfer and use of inter-generational wealth. Just as a business must focus on succession planning, so too must the family openly address succession issues. While the actual dollar amounts and minute details are not necessary, it is crucial for family members to understand some basics about the legal structures, advisors, and education that

c. Cohesion:

A minority of Cm1ilies reaches the final phase, cohesion, which can last for years, decades, and sometimes across generations.
The overriding-and ongoing-goals for this stage are: integration of family member as appropriate into the governance system, clarity between individual and joint needs/wants, and long-term sustain ability.
The most important test of success is the individual happiness and heath of family members-both financially and emotionally.

During this phase, the family must continually develop and apply an integrated system for handling its commonly held assets and intertwined affairs.

Family members must separate emotional issues from the practical issues to be managed and decided.
They must work as a team with their advisors but ultimately be in charge.
One or more family members might take the lead and serve as point person for their generation or for the Family as a whole.
Most importantly, the Family must understand when they must work together and when it is appropriate to function separately.
The Family will need to prepare, choose, and from time to time replace family leader(s) and advisors.
The Family might choose to create a Family Council other governing body. It
is important that the family maintain regular meetings, either through a Family Assembly or otherwise.
It should be noted that the infrastructure of the family governance system derives in part from legal structures, but more importantly from the emotional and personal relationships among family members.

Each family has its own way of functioning, regardless of the structures that they create and the entities that they manage. This Family "glue" must be recognized and taken into account in creating managing the system.

Phases in the Development of a Family Governance System

Chaos - Uncoordinated
- Short-term focus
- Respond to immediate needs
- Independent actions by family members
- Older generation may dominate
- Create basic estate plans
- Select advisors
- "Sleep at night"
- Cover emergencies
- Minimize transfer taxes
Coordination - Family members begin to see big picture
- Need for family meetings
- One or more leaders enlarge
- Define/clarify family goals
- Identify and begin intergenerational tax planning
- Begin education program
- Work with advisors
- Convene family meetings for specific issue
- Create coordinated system
- Choose leader(s)
- Begin succession planning
Action viewed per long-term goals Choose family leader Sustainability
Cohesion - Open and regular communication
- Leaders change over time
- Choose lead advisor(s)
- Create family office (or equivalent to manage affaires
- Establish and keep regular meetings
- Integration of family members
- Clarity between joint and individual needs/wants

Conclusion: A proper Environment

Experts agree that families must foster an environment with the following characteristics for Family governance to be successful:

a. Open communication. The lines of communication must be open, both among Family members and between the Family and their advisors. The Family must strive to overcome the challenge of communication across distances.

b. Respect for the uniqueness of each family member:
The family must understand that members of different generations-and even the same generation-will view the world and their lives very differently.

c. Sense of community:

As a corollary to respecting each individual, there must be a sense of community among family members for their joint endeavours to succeed.
Focusing on commonly held goals (such as co investing or grant making) can help foster community within the Family.

d. Clear distinction between group and individuals needs/ wants:
Individuals and groups both need to be accommodated. For example, it is inevitable that members of different generations will have different needs and views on how the family foundation should be set.

e. Respect for rules.
The media has been increasingly focusing on families who have used their businesses and charitable funds for their own purposes. It is essential that familly members understand and live with the guidelines that are created externally (e.g., public laws) and through their own internal process.

One can easily ask: can a family actually be "governed"? Certainly, it could be argued that it cannot or should not. However, this response misinterprets family governance and fails to recognize the potential gains that some form of governance can provide. Some of the wealthiest families around the world have used family governance, knowingly or not, to their benefit for generations. More and more families today are finding it helpful.
These families understand that the system takes years to develop and must constantly adapt to the changing needs and circumstances of the family.
They also understand how to distinguish between those areas that must be governed (e.g., trusts, family business) and those that do not (e.g., personal lifestyle choices).

History shows us what happens when traditional estate and financial planning are used without the benefit of family governance.
Families are yearning for something yearning for something mote. The new framework proposed in this article may help provide a useful perspective for families even if they do not fully apply Family governance to their affairs.

For others, Family governance may just be the crucial component that increases the family's chances for successful preservation of its human, intellectual, and financial wealth across generations.
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