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This chapter is from the book

Strategic Wealth Management of Your Family Enterprise

You can see that the classic approach equates wealth management with investing. This book focuses on a new way to structure your wealth management affairs. I call it “strategic wealth management.” Strategic wealth management is a holistic approach to wealth management that focuses on your entire family enterprise. At its heart, family enterprise is about human capital, not just money. The complete enterprise integrates your family purpose with your business, financial assets, careers, estate plans, and other aspects of your personal and family circumstances. It explores all of your strategic options and puts you in the driver’s seat while showing you how to employ your advisors to greatest effect. Your values, your skills and resources, and how you relate to your business, career, and family are at the core of the strategic wealth management approach and are key elements of what I call the “Strategic Wealth Management Framework.”

Figure 1.1 diagrams a new Strategic Wealth Management Framework, updated from the first edition of Wealth. This new framework is based on hundreds of detailed interactions I’ve had with other wealth owners since this book was first published. I’ve learned a lot from them and I’m grateful for the wisdom they’ve shared. Their insights have broadened my thinking and given me increased confidence that wealth effectively managed is proactively managed. The Strategic Wealth Management Framework is now more action oriented than its predecessor, highlighting the key value drivers for success. Effective governance of your key value drivers—family purpose, your economic engine, and your management of leakages—is the heart of the framework and the lifeblood of your family enterprise.

Figure 1.1

Figure 1.1. Use the new Strategic Wealth Management Framework to create a fully integrated plan that meets your objectives.2

Using this framework requires more time and effort to implement than the classic model. It is a more comprehensive, systematic approach designed to help you manage your wealth according to your personal and family goals, whether for your lifetime, or for multiple generations. If you work with this framework, you will spark greater focus for your family and will generate better performance from your advisors. Fortunately, there are many surprisingly simple elements of managing wealth, especially financial assets, effectively. Many are even simpler than the classic approach implies. I will highlight these simple, pragmatic, responsible solutions throughout the book. Take them to heart, especially if your core interests lie elsewhere than investing, tax, or complex estate planning.

Figure 1.1 shows that flourishing family enterprises require a clear and shared family purpose, a strong economic engine, and effective management of leakages. Sometimes these key value drivers work in harmony, but conflicts among them regularly arise and must be resolved. If your family is executing well in all three areas, you can make business decisions for the success of the business, invest financial assets prudently for long-term appreciation, and support family members to realize their individual potential while strengthening family ties. In well-managed families, success and stability in any one sphere influence and strengthen the other spheres and the whole system, creating a virtuous circle.

For the virtuous circle to prevail, effective leadership and governance are necessary, within and across the three key value drivers. Governance structures must be aligned, values and rules of engagement must be shared and understood, and leaders must be credible and empowered.

  • Family purpose. The family’s leadership, operating within the governance structure, is responsible for shaping, communicating, and advancing the family’s purpose. Family purpose is supported by three commitments:
    • Maximize the human potential of each family member. When each individual is encouraged to flourish and be productive your family benefits, regardless of the way in which each individual meets his or her potential.
    • Adapt and evolve the family’s culture and values over time. In an ever-changing context that is our world today, a stagnant family culture and value set will likely become irrelevant and be ignored.
    • Identify and invest in shared affinities. What brings family members together with purpose or fun? What builds a sense of shared identity and purpose? Invest in these affinities just like you do your economic engine.

    In catalyzing connections and common identity beyond your family’s economic ties, a shared purpose provides the platform for stronger interpersonal relationships and more effective decision making. The strength and value of shared family purpose become particularly evident during times of transition: of leadership, of generational ownership, and during the complex transition from business-owning family to financial family.

  • Economic engine. Your lifestyle is fundamentally tied to the strength of your economic engine. In the wealthiest families, this link might seem trite—but even in these families, eventually reality bites.

    The math is clear, though not widely understood. Your family’s economic engine—businesses and/or financial assets—must generate annual returns of at least 10% just to cover the combined weight of taxes, fees, inflation, (modest) distributions, and the “law of compounding children” (the growth in the number of family members from one generation to the next). Over a generation or two, only exceptional businesses and investment portfolios generate returns at this level. The strength of your family’s overall economic engine depends on the robustness of each of the following: your business, the performance of your financial assets, and your family members’ careers.

    • Your family business. Businesses are typically the primary engine of wealth creation. Most businesses start out undiversified, illiquid, and subject to powerful operational, economic, and competitive factors that can lead to wealth creation and, just as rapidly, wealth destruction. If your fledgling business survives to maturity, your family will face new challenges. Mature family enterprises control businesses that generate stable excess cash flow—although they still entail considerable risk. Families in this enviable situation face additional challenges. How do you maintain a family culture of entrepreneurship as the wealth grows? What should be your family’s continuing operational involvement in the business? How should your operational involvement affect your governance structure? How do you diversify if you don’t want to sell your business? How do the cash flow requirements of the business, financial assets, and family members relate to each other?

      Most families eventually choose to sell the core family business. For any number of reasons—perceived risk in the business, lack of family business leadership, animosity within the family, inadequate returns—a family might determine that the benefits of continuing to own the business are insufficient relative to the value achievable from selling. You want to maximize the probability that your family will control the disposition of your core asset, rather than having a decision forced upon you by externalities. For the optimal outcome, you want to evaluate the decision to hold or sell within the context of your family enterprise as a whole. What would be your net-net result, after the sale causes you to realize what might be decades or generations of deferred capital gain on your company shares? What will you do with the cash? Where will you reinvest the proceeds not earmarked for spending? Are you prepared—organizationally, culturally, and in terms of financial infrastructure—to be a financial family? The transition from a business-owning family to a financial family is a radical and risky transformation of the family enterprise. You want to be prepared.

    • Financial assets. Excess cash flow generated by your business and salary can be used to diversify into financial assets. Effective conservation and management of your financial assets is crucial to the functioning of your family enterprise, especially as they become substantial asset pools in their own right. Well-managed financial assets bring your family greater economic security by diversifying the family enterprise without having to sell the core business. They also give the family financial management experience that grows exponentially in value when there is a liquidity event. On the other hand, I’ve seen poorly managed financial assets, sometimes by just one individual, bring unanticipated liabilities to bear on entire families (for example, when a cousin uses shares in the family business to collateralize a risky loan).

      Some families distribute excess cash flow to each family member, leaving it up to individual family members to manage their capital as they see fit. Other families make a concerted effort to commingle financial assets, develop a common investment strategy, and retain highly experienced investment professionals.

      Considerable benefits come from managing financial assets with scale and focus, especially if your collective assets exceed $100 million or more. First and most important, you can attract better investment talent, specifically a chief investment officer (CIO), with a single large asset pool than with a series of much smaller, independently managed pools. A CIO is a professional investor—not a client service representative or product salesperson—responsible for delivering investment performance and integrating that effort with the strategy for the entire family enterprise. Second, your single, larger pool of capital will have access to more desirable investment opportunities, which often come with higher minimum investment requirements and lower management fees. Third, commingling assets allows your family to share the administration of estate planning and investment management, simplifying tasks and lowering administrative costs. Finally, with a commingled investment strategy, family members are mutually accountable. To make the strategy work, each family member must control his or her financial affairs within guidelines that are agreed upon through the family governance process. Although to some this all might feel constraining, the structure and discipline of pooled investing and leakage management can significantly increase your family’s economic security, including the long-term security of your core business.

    • Careers. Careers generate additional income and reduce your family’s overall economic risk profile because they diversify family members’ sources of cash flow. Careers carry a cultural benefit to your family, too. Over generations, wealthy families risk creating a culture in which family members are always valued customers but do not benefit from the discipline of having customers themselves. A culture of setting stretch goals, of prudent risk taking, of service to customers and community, and of having to make reasonable sacrifices in the pursuit of those goals is healthy. Again, we see the potential for a virtuous circle: The less each family member depends on the family’s wealth for his or her lifestyle, the more risk you can collectively afford to take, and the more likely the family enterprise will flourish for generations to come.
  • Leakage management. Think of the economic engine as having leaks—dividend or distribution payments, expenses, taxes, and inflation, to name a few. Leakages are an inevitable part of any family enterprise, and they are much more within the family’s control than the value of a business or an investment portfolio. Over years and decades, leakages profoundly affect your family’s wealth, but their importance to the long-term vitality of your family is often poorly understood. The larger and less well-managed your leakages are, the greater the risk to the family enterprise and the more likely it won’t stand the test of time.

    You can divide family leakage management into two areas. The first area is cash flow management. How much is distributed to family members and spent each year? What are family operating expenses above and beyond those of the business? How much does your family pay in taxes annually? The second area is estate planning, including governance, control, succession planning, and tax minimization. How much of your family wealth will be transferred to government coffers upon the death of family members? Are estate plans structured to help protect the family’s assets from unwanted outside interference?

    Good leakage management can mean the difference between maintaining control of your family business and leaving the fate of your family enterprise to chance, and seemingly small changes in the rate of leakage can have large consequences over ten, twenty, or fifty years.

  • Building a virtuous circle. People wonder why family enterprises don’t last. A healthy economic engine is necessary, but insufficient. For long-term vitality, you must manage your entire family enterprise as an integrated whole. Well-managed family enterprises are stable and strong with good governance, clear family purpose, diversified assets, and controlled leakages. Operating in this context, you can make prudent long-term investment decisions for your core family business, determine the most productive level of family involvement in the business, and control its destiny. Your family’s financial assets, professionally managed to realize the benefits of scale and focus, are key contributors to your family’s continuing economic vitality. Family members feel a strong positive connection to your family enterprise and are encouraged to thrive and contribute to an evolving, forward-looking family culture. When you build this virtuous circle, you are stewarding your good fortune and cultivating your family’s valuable business, human, and financial resources. In doing so, you serve the family enterprise as a whole, as well as each family member.
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