When you hear the word governance, you might quickly turn your mind to corporate governance. You might think about the regulations you have to deal with when doing investments and building businesses. These can be stringent and unfavorable, which causes an uncomfortable feeling as a reluctance to dive into what is perceived as a tedious task.
Yet governance is always put in place to encourage honesty, transparency, and promote fairness – something which we all aspire to in our daily work. Most likely when you think of governance, you will think of your own government. With the current status of many governments across the world not performing at the level expected by their citizens, it begs the question – is governance trustworthy? Or is it risky and dubious?
Let’s unpack governance within a family office setting. It can be defined as ‘the way we choose to communicate and interact with each other as a family and concerning the wealth we possess.’
Research has shown that investing early ineffective family governance and likely pay dividends for the family in the long term. As we know, every family is unique. However, families that have greater wealth, are defined by several generations, and reside in different jurisdictions will undoubtedly have greater complexity.
Risk is a part of everyday life for even the most ordinary of families. family. . While all families have unique characteristics, families of wealth face some very similar risks, with the number of risks being someway endless. Let’s look at the risks that a family office and a family are exposed to when investment in family governance is not made or is not made with due diligence.
1. Investment risks
If a part of the family’s wealth is placed in investments in any form or category, there is a need to fully understand the risks associated with investing. It is fundamental to outline how decisions are made in making any such investment, and what processes are in place to manage those investments effectively. Investment governance itself may demand that a family set up an investment policy statement. This statement provides the general investment goals and objectives of the family and describes the strategies that the family office should employ to meet these objectives. Having a deep understanding of what the investment goals of the family office are is critical to their success. In 2020, both long-term and short-term investments were impacted by COVID-19. Having a clear strategy and direction is imperative to ensure that the Family Office maintains or grows the family portfolio, with a clear directive on how to act in volatile periods. Developing a solid investment policy statement is not a typical exercise for most investors. It requires a lot of thought and an understanding of how the market works – as well as familiarity with investment principles and practices.
2. Business risks
Anything that threatens a company’s ability to achieve its financial goals is considered a business risk. These are those risks that a family-owned or controlled company will face in the regular course of its business and how those risks should be identified and managed. To name just a few these are economic risks, compliance risks, security risks, financial risks, reputational risks, legal risks, and strategy risks.
When a company experiences a high degree of business risk, it may impair its ability to provide investors and stakeholders with adequate returns. Several different factors influence business risk. Understanding each of these factors are reflected by your own family office is key to mitigating these risks.
3. Management risks
These risks relate to the process of appointing people to run and manage those entities as highlighted above. It is also important to consider the role individual family members play in these structures, compared to the executives who are in a professional management capacity and non-executive employees who sit in a governance capacity. Having a functional family constitution that is a working document helps govern the family and the wider family office’s relationship. It defines the roles that family members play in running the family office and puts in place the protocols that the family will have agreed on and aligned to ensure that conflict may be minimised or handled with more astuteness in judgment.
4. Family risks
These can be many including sibling rivalries, the control exercised by the wealth creator, conflicting generational aims, health matters, critical man risk, and succession issues. Family risk relates to family relationships and the family legacy. These decisions are not merely financially oriented as they often affect the livelihoods and quality of life for parents, uncles, siblings, cousins, and other family members. Family offices have historically been known to overlook or not focus on this particular risk cluster and have instead left the family to independently resolve these issues. This is a grave mistake and has often led to the family overlooking or ignoring underlying problems that have caused the loss of wealth in some cases. A thorough family governance exercise, which is inclusive of all family members, often brings these issues to light and offers an opportunity to address them. Moreover, the family governance exercise review leads to family members aligning to shared history, shared vision, and ultimately building or rebuilding trust. Governance is not the tools themselves but the process, consolidated and assisted by the tools.
5. Reputational risks
This risk may be related to the business the family owns, or if the family has a name that is well recognised in their own country, or even more importantly, a name that has global recognition. Such risks may not be necessarily fully recognised or understood but can have material social and commercial consequences. There has always been the risk that an unhappy customer, product failure, negative press, or lawsuit can adversely impact a family office’s brand reputation. Social media has amplified the speed and scope of reputational risk. Just one negative tweet, video, or bad review can decrease your customer following and cause revenue to plummet. To prepare for this risk family offices should firstly leverage strategies to regularly monitor what others say about the family and its interests online and offline. Secondly, they should be ready to respond to those comments and help address any concerns immediately. And thirdly they should keep quality top of mind to avoid lawsuits and product failures that can damage your company’s reputation.
6. Technology risks
No family or family enterprise can ignore the march of technology, which, if properly embraced, can be immensely positive. On the flip side, but if underestimated it can be commercially devastating and even harmful to a family’s reputation. Social media needs to be managed carefully by every family. Social media is a great way to promote and grow social wealth, create awareness and enhance relationships with the communities the family aligns to. That being said, if it’s not executed correctly, social media usage can damage your reputation. “Social media is the most immediate threat to your company’s reputation,” says Pete Knott, Digital Consultant at reputation management consultancy, Lansons. Because of the generation gap within most families, one generation may be online and another not. Working with family members and employees of the family office to align and be educated on the sort of information posted becomes a critical task.
7. Security risks
Families of wealth need to be particularly careful about the dangers of not having the right protections regarding their data. And families with widely recognised names are vulnerable both from the wealth that can be fraudulently stolen, blackmail, and the risk of bad publicity. In 2017, a survey conducted by CSIS and McAfee stated that close to $600 Billion are lost to cybercrimes annually. The amount is up to one percent of the Global GDP. Major firms have experienced significant losses due to cybercrimes. Family offices have to learn about various ways that new threats occur and determine how well they can shield their information and systems. Having an in-house IT specialist may be a cautious yet necessary conversation.
A framework for having a dialogue about risk is foundational to aligning family office stakeholders on risk and incorporating risk management into family governance and family office decisions. Family offices may continue to take on many faces and dimensions as the world continues to be fast-moving and exposed to technologies that make it all one global village. Having assessments with a governance expert about which risks your family and family offices are exposed to is not only prudent but necessary.