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Perspectives

How family offices can use family banks to encourage innovation

By Edward Marshall, Director, Global Family Office Group

January 10, 2019Posted InFamily Office

A ‘family bank’ is a mechanism that wealthy families who have family offices can use to set aside funds to encourage a more sophisticated form of financial and consulting or mentorship support for various family members’ own business ventures and investment projects. While a family bank is not literally a bank, it is nevertheless a structure specifically formed for this purpose to fulfill some of the functions of a bank.

The family bank is often discussed solely as a way to provide funds to next generation family members for investment proposals, but this is too narrow a definition. Family banks can also help family offices to increase cohesion between family generations, encourage collaboration, expand financial literacy, instill family values, prepare future generations for leadership, and encourage innovation.

The family office can marshal the resources to be a clearinghouse for fund and loan requests made to the ‘bank’ by placing itself between principals and requesting family members. It can do so by providing additional objectivity and a more dispassionate and effective way to deny requests made by family members.

How-family-offices-can-use-family-banks-to-encourage-innovation

The family bank concept tends to be an evolutionary development for family offices. It is a step typically taken as the next generation reaches adulthood and begins to engage in individual business pursuits of their own. In the process, the family office expands its areas of support to include fostering entrepreneurship.  A well-designed family bank will:

  • Follow the family’s established mission and vision
  • Have clear governance and participation processes in place
  • Involve family principals and trusted outside advisors
  • If appropriate, communicate fund distributions and results regularly to all family members
  • Show flexibility in the types of investments considered
  • Encourage calculated risk-taking and a spirit of entrepreneurship 

In general, family principals ‘seed’ a pool of cash and – in coordination with family office executives – create a systematic process whereby family members can apply to access those funds for their own projects. Although principals must support the family bank, family office executives often play a ‘quarterbacking’ and professionalizing role in running it. In coordination with principals, family office executives often help design policies and procedures, monitor and regularly report progress on funded projects, and seek ways to help fund recipients to be successful in their ventures (e.g. mentorship of family members and marking professional connections in the business community. 

Family bank distributions can take the form of direct equity in family members’ projects, commitments to support third-party bank loans, or outright loans to family members. It should be noted that philanthropic efforts, while also supported by the family office, are usually made via the family’s charitable entities instead.  Moreover, family offices should work with tax advisors to ensure that funds distributed are consistent with the family’s estate and gift plans and are compliant with tax and other applicable regulations. 

For the purposes of reviewing and approving projects to receive family bank funding, it is important that the family creates a committee. The committee or family office should also work with recipient(s) of funding to develop business plans, performance metrics, reporting protocols, and assign accountability for those projects funded. 

For a family bank to be successful, it must provide the following to the family:

  • A clear mission, so that permissible uses and projects are defined and understood
  • A diligent review and approval process that applies to all submissions
  • Clearly developed, articulated, and respected roles by the review committee 

When family banks are unsuccessful, it is because one or more of these requirements are not fulfilled.  For example, it is not uncommon for principals to exercise effective ‘veto’ power over projects despite the existence of a formalized process where a majority of the committee determines approvals.  Implicit bias can also undermine the integrity of the family bank if funding requests are repeatedly approved for some family members and not for others.  In such cases, having well-developed criteria for submissions, a formal decision-making framework, and the commitment to fund those activities that receive approval will help overcome some of these issues.

Family banks provide a strong mechanism to build family cohesion, instill values and mindsets, and help increase the sustainability of a family’s wealth.  Family offices should consider establishing these types of mechanisms to support the strategic objectives of principals around perpetuation wealth across generations, family harmony, legacy, wealth education, and entrepreneurialism.