Some families focus on passing wealth onto the immediate next generation. Others would prefer their wealth to last longer. Nurturing entrepreneurship in the family can be one way of expanding the family´s legacy and setting the foundations for new generations to thrive and have a positive impact.
The question is: How can you leverage your family wealth to nudge your descendants into embarking on new ventures?
In this episode of Life & Legacy, Claudia Caffuzzi, Head of the International Wealth Advisory Practice for J.P. Morgan Private Bank, and Karen Tan, Wealth Advisor, discuss how families can work together to nurture the entrepreneurial spirit, and mechanisms that have proven to be more effective.
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Claudia: Welcome to our Wealth Advisory series, where we discuss issues relating to Life and Legacy.
Many people think of the typical Private Bank client as a family who has owned a business for four or five generations, and the family members have to grapple with complex issues around the transition of ownership - and management - as the family business is transferred from one generation to the next, in an ever-changing environment.
Today, however, we are going to discuss entrepreneurs – clients who seek out, build, or invest in ventures that may – or may not – become part of the family legacy. Encouraging and nurturing this drive or spirit of pursuit– this is the real legacy that families hope to see their future generations embrace - the spirit of entrepreneurialism.
I’m Claudia Caffuzzi, Head of the International Wealth Advisory Practice for J.P. Morgan Private Bank…
Karen: … and I am Karen Tan, a wealth advisor based in Singapore. I am delighted to join you, Claudia to discuss how families can create an enduring legacy by encouraging entrepreneurship across generations.
Claudia: Karen, I know you have had a lot of experience in this area. What are some of the hallmarks of our entrepreneurial clients?
Karen: I have observed that these are clients who, through their own creativity, shrewd insights, hard work and some good luck, build successful businesses – in many cases again and again! Many began with limited resources under difficult circumstances, but they kept going, seeing the tremendous satisfaction of seeing their risk-taking and hard work pay off!
Claudia: And when we speak with these clients about their patrimonial planning, we discover that it is not just the substantial wealth that they want to pass to the next generations.
Karen: That’s right! They want to pass on the same spirit of starting something new, the thrill of developing something from nothing. That spark that made them successful in the first place!
Claudia: So, the legacy is the opportunity to build something of their own…
Karen: Yes – that is intangible legacy that they speak of!
Claudia: So, Karen, what can parents do to encourage entrepreneurship?
Karen: One easy way to get started is to consider offering their children something tangible, say making outright gifts to them to invest in new businesses, with no strings attached.
Claudia: Yes, many clients take this straightforward approach. The risk of it, however, was illustrated in one family that we work with. Several children took up the offer of this unconditional gift – but over time, the parents noticed that after investing in the business opportunity, some of the children did not remain engaged in the project and sometimes never recouped their investment.
Karen: Often times, a gift with no strings attached can feel like “easy money”. The children may not be as deeply committed in the business venture when there is no skin in the game.
Claudia: Exactly – finally, the parents realized that they needed to set some ground rules for children to access the funding such continued engagement, and the consequences of failure to the child – and how it may impact the potential access for the other children.
Karen: Some of these factors you pointed out, Claudia, were thoroughly considered by an Asian family I worked with when they designed their family venture fund, with the help of our family governance team. Basically, their fund:
(a) invests in start-ups and incubators,
(b) is open to bloodline family members, their partners and spouses, and approved by the family council;
(c) allows up to USD500,000 per venture, AND
(d) requires that half-yearly check-in reports must be furnished.
There is no penalty if the venture does not take off or fail. I like their approach, as there is structure and yet room for flexibility. Family members can re-apply up to 3 times for 3 different businesses in their lifetime. They are allowed to fail, get back and try again!
Claudia: That seems like a family that really thought these issues through in a great way, Karen. I guess one downside to this approach is that the child may not develop a sense of independence and ownership, and would always have the whole family to answer to. That can be a lot of pressure!
Karen: Well, yes the pressure is on, of course. After all, the family will be funding the venture. But if you had a solid business plan and strong convictions --you would want the family to invest into it!
Claudia: OK, that is fair. But what about borrowing from the family or a family fund or trust?
Karen: This is an approach that may work for some families. In that case, I would recommend laying out the ground rules on (a) time frame for repayment, (b) interest payment terms, and (c) possible exceptions. Otherwise, it could get …. complicated.
Claudia: I can see that this could be a very hairy situation! One family resolved this with a twist on the family loan. A child of one of our clients wanted to redevelop a shopping center. Instead of borrowing from the family, the child borrowed from the bank, in an arms-length business transaction – with the family providing the collateral. Because the child had a true third-party loan with standard terms, the child was obligated to take fiscal responsibility for this investment.
Karen: I like the twist in your example, Claudia. It reinforces the need to be fully committed to the venture! I also notice that a common factor across the various approaches – whether it is an outright gift, loan or co- investment – IS clarity on who decides – and for what projects.
Claudia: This is so important! In one family I worked with, children and their spouses were encouraged to make proposals for family-facilitated investments. One person made several proposals, but none were ever accepted. Since the family did not give any guidance about what types of projects they would support, the repeated denials led to unintended misunderstandings.
Karen: Yes, I can see some concerns in your example. Who can approve or reject, and the whys for the approval or rejection – those must not be left unaddressed?
Some families have shifted decision-making away from the parents – and created an independent board – with non-family members i.e. trusted executives, legal counsels, or independent directors. I have seen that work fairly well.
Claudia: It is very good idea. Karen, what are the criteria these boards consider?
Karen: Sure – in our collective experience, families should review 5 key aspects:
· the types of entrepreneurship they want to encourage – in line with their shared values of the family’s wealth.
· the approach which includes quantum, investment terms, and eligibility criteria.
· Expectations on investment returns (or not).
· Accountability by the family member in his or her venture.
· And last but not least, the fairness and transparency in the decision-making and enforcement of the agreed rules.
Claudia: That is a helpful list. As with so many things, intra-family communication is super important –clarity on the rules of the road can help avoid potential misunderstandings between family members.
Karen: I can’t agree with you more Claudia! After all, a family flourishes when individuals within the family flourish. And encouraging the spirit of entrepreneurship in the family is one way of making individuals feel their dreams are respected and fostered.
Claudia: Indeed! Keeping the dynamic sense of adventure alive in families across the generations is one way to ensure that the family continues thriving. That is it for our session today. Thank you for joining us in this Wealth Advisory series, where we discuss topics relating to Life and Legacy. Please reach out to your J.P. Morgan advisor if you would like to explore ways to encourage entrepreneurship in your family.