Archives: Our Ethos

Family Enterprise Risk Management

Here is a typical wealth manager approach to business families – “Tell us what you can about your wealth but give us a pot of cash to invest”. The reality faced by most families is rather different. Usually their material wealth consists of a core business interest, direct investments with high growth prospects (some related to the core business), direct real estate investments, and residual liquid assets (often cash). This is the investment reality for the family – but there are many more dimensions to the family enterprise than that.

What “Family” and “Wealth” Really Mean

Firstly, it is important to understand what a family means by the term “Family”. The default reaction is to talk in terms of blood relations and kinship. Seeing the Family in terms of blood relations or the male line only is not unusual and neither right nor wrong. Defining the Family in broader terms so as to encompass female as well as male members, non-blood relations such as long-serving loyal employees, trusted advisers, those who enter through marriage and adoption is not as rare as you might expect either.

The business model favoured by wealth managers and estate planning professionals requires them to focus on the Family’s financial, or more broadly speaking, material assets – its “Financial” Wealth. Some Families are content to adopt this definition of their Wealth, but for many others it is not enough. For them, Wealth also extends to such notions such as the length of time the material Wealth has existed, the number, ages and geographic dispersion of the individuals that constitute the Family – the “Human” Wealth, and the diversity of competences, interests, beliefs and norms the Family members recognise – the “Intellectual” Wealth, as well as of course the formative experiences and character of the creator(s) of the first fortune.

Wealth also extends to such notions such as the length of time the material Wealth has existed, the number, ages and geographic dispersion of the individuals that constitute the Family – the “Human” Wealth

As we have seen, the ideas of Family, and its Wealth, are both complex and dynamic. This means that real effort has to be put in by the Family to dealing with such critical issues as:

  • What the Wealth is for
  • The need to agree on a fair, robust and durable decision-making process about the Wealth
  • Setting out the way in which ownership and management of the Wealth should pass between generations
  • Understanding how social, technological and geopolitical factors might affect Family members and their stewardship of the Wealth

External Factors Affecting the Family and its Wealth

And then there are all the many external factors affecting the Family and its Wealth that are not directly related to its portfolio of investments. Family businesses are subject to the intricate and ever-changing taxation and regulatory regimes where they operate. These factors are further complicated by the fact that many families and their business interests cross national boundaries. Many Families are concerned to ensure their businesses operate in a way that respects environmental and social standards, not least because of the increasing legislation that applies in these areas.

Family businesses are subject to the intricate and ever-changing taxation and regulatory regimes where they operate. These factors are further complicated by the fact that many families and their business interests cross national boundaries

Then there are the many issues that arise from the technology platforms that the Family chooses to support its activities. These include availability (software defects, natural disaster, backup and recovery), performance (speed and network resilience) and business process (clarity of business objectives, technology requirements definition, accountability and responsibility). Security is also of critical importance, not just in terms of individuals and tangible assets like buildings, but also cybersecurity, which covers password integrity, data loss, spoofing, malware and identifying careless or uninformed or even disloyal employees.

Our Unique Approach - Family Enterprise Risk Management

For us, the Family Enterprise is a complicated and dynamic entity that can be thought of in three different ways: the Family itself, the Operational environment that affects it and the Investments that it makes and manages. We add value for Families by helping them, not just to look at their Enterprises from these perspectives, but to do so by breaking each down into a spectrum of risk factors that continually influence them. We call this approach Family Enterprise Risk Management, and the risk-based methodology we refer to as Termes.Risk.Focus.

The power of this approach is that, by helping clients evaluate Family dynamics, the Operational set up and the Investment portfolio objectively, we help them build a truly personal sense of conviction as to the most appropriate management focus and deployment of assets. A picture paints a thousand words, so we came up with the following diagram to demonstrate the different components of Family Enterprise Risk and show how Termes Risk Focus is used to identify and evaluate them:

 

Using the Approach to Promote Success in the Family Business

In the example above, our approach has identified high risks for the Family Enterprise in relation to its technology platform as well as country and management risks for some of its investments. In this case the Family is operating outdated software which is vulnerable to cyberattack, and Family members are using portable electronic devices without the benefit of any policy that minimises the risk of personal compromise and critical data loss. It is doing business in a country where the lack of modern road and port infrastructures represent significant risks to its ability to transport key components to the site of a new multi-million dollar asset it is developing, threating the timely completion and profitability of the project. It has an investment in a technology start-up which has failed to generate any profits since it was funded due to an over-concentration on the technological features of a large suite of products rather than focusing on those capable of generating rapid sales growth.

Our approach deals with the reality of the Family Enterprise, and has a proven track record of helping Families who face hard-to-solve problems. We think that our approach helps them get an effective grip on these challenges. Termes.Risk.Focus is a sound, tried and tested method that can help all members of any business Family, no matter how sophisticated or otherwise, to understand how the land lies.

Investment Risk

Can wealth managers give wealthy business families the focussed advice they really need? We think that the answer is a resounding “no”. We think that their focus on liquid assets means they miss the big picture. We certainly don’t want to denigrate wealth managers – after all, it is what we used to do – we just want to point out that the tools at their disposal are not designed to give business families what they really need.

And before you ask – yes, we think there is an effective way to do just that. We think that what wealthy families need is a thoughtful approach to wealth that assesses all the risks of their assets, and gives them power – the power to understand where the risks actually lie, which in turns gives them the real conviction they need to make informed strategic decisions about all of their wealth. We call this strategy Termes Risk Focus.

Before we go into the strategy in more detail, it’s important to say where we are coming from. Before we set up The Termes Partnership in 2002 we were the CEO and CIO of a private bank and wealth management company. Between us, we have worked in the wealth management industry for 80 years.

We know what wealth managers can and can’t do. Although they often ask a lot of questions about a client’s assets - and even the right questions - at the end of the day they expect to be given a pot of cash

So we know what wealth managers can and can’t do. Although they often ask a lot of questions about a client’s assets – and even the right questions – at the end of the day they expect to be given a pot of cash to invest. But the fact is that liquid assets are usually a relatively small part of the overall assets of wealthy entrepreneurial families.

It is true that you sometimes come across a family which has had a liquidity event, and therefore cash to invest. But in most cases the clients we deal with (who have from $100m, up into the billions) are faced with a much more complicated situation.

Usually they run a business or a network of businesses, which can involve several generations of the family. Added to that, they will very often have made direct investments in other businesses. Typically they also have real estate holdings – retail, industrial or office space connected with their businesses, and also they will normally need residences in each of the countries where they live or operate or invest.

Generally speaking their liquid assets are residual, so any discussion about those assets is only a part of the more critical or real questions they have to ask themselves.

These real questions start with this one: how do I evaluate my assets? You quickly see that this is a complex question, because it means asking other questions like: how do I compare a 30-year US Treasury bond with a 50% stake in a Japanese cloud computing start-up, or an office building in London? How on earth do I decide which of my investments and asset classes are performing as expected, and which are not?

We decided we needed to develop a systematic approach that would help families understand the relative opportunities and risks they face. We realised that it boils down to this: what risk is attached to each of a family’s assets?

We might see a situation where somebody invested heavily in real estate at a time when you could get 85% leverage, and they have breached all the covenants. Or they invested in a technology that has since been superseded. These are the kinds of real-world problems that our sorts of families face.

It was while we were working with one family who had exactly these sorts of challenges that we decided we needed to develop a systematic approach that would help them understand the relative opportunities and risks they face. We started to ask ourselves: what would such an approach look like? We realised that it boils down to this: what risk is attached to each of a family’s assets?

Now, we recognise that when the wealth management industry talks about risk it talks about volatility, Sharpe ratios, information ratios and so on. We are by no means denigrating that approach. But those things are truly relevant to liquid assets and so they are not too helpful for understanding the uncertainties in a wealthy family’s complex and varied portfolio.

However elegant and intellectually satisfying these mathematical models of risk are, they do not address the needs of a wealthy family. They miss the point. What affects families’ assets are the day-to-day things in the real world – the forces that drive taxation or regulation, or free-trade agreements, or executive management effectiveness. If 80% of your wealth is tied up in a brewing business, then understanding Sharpe ratios is not going to get you too far in getting to grips with the risks to your wealth.

And so we took a different approach. We decided to concentrate on things like political, growth, valuation, management, competition and technical risk. Then we asked how we could consistently represent each such risk element visually, and we came up with this scale:

And for each asset class, we applied a value to each risk type. So, for example here is a diagram showing the risk profile of a family’s real estate assets:

And here is their direct investment risk:

And this is how we assessed their equities portfolio:

We then place these next to each other, with each octagon given a size that corresponds to the amount of money in that asset class:

What you have is an easily accessible representation that allows a family to quickly assess its wealth at this moment in time. That is the first step towards evaluating all the risks that are attached to all their assets, which helps them build a real sense of conviction about whether they are happy with what they have, and what to do next.

We don’t pretend that this is a silver bullet. We think of the visualisation as a diagnostic tool. It doesn’t tell you what to do next. That depends on the family’s values and their perception of what the wealth is for.

And we aren’t saying that once you have seen this visualisation you can immediately start shifting assets so that you are happier with your risk profile. To an extent, a family’s asset allocation is – what it is. It might have come about by accident, or through decisions that looked good a long time ago. Some might tell you otherwise, but the reality of family wealth is that changing the allocations is not easy, and it can’t be done overnight.

That might not be immediately reassuring, but it is the reality for very wealthy families who face hard-to-solve problems when it comes to asset allocation. We think that our model helps them get an effective grip on these challenges. Termes Risk Focus is a sound, tried and tested method that can help all members of any business family, no matter how sophisticated or otherwise, to understand how the land lies.

And that in turn is the first step towards effective wealth preservation. Which is all that anyone can really offer.

Behavioural Risk

One of the most important questions for a wealthy family, but one that is all too rarely confronted, is: “What is the wealth for?”

Discussions with the principal and some of the next generation can quickly lead to the realisation that this question has never been addressed specifically – or that family members have tried to find an answer, and they all have fairly different answers.

But just because the answer is hard to find, doesn’t mean families should give up trying to find one. We believe that a clear answer provides a sound basis for family cooperation, and families risk building a house on sand in the absence of one.

The question can seem daunting, but there are several reasonable responses:

  • The family is primarily concerned with achieving harmony among family members and they structure their activities to reach that goal.
  • The wealth is for developing the next business project. This is typical among tech entrepreneurs, and a good example is Elon Musk, who after selling his stake in Paypal set up electric cars firm Tesla and renewable spacecraft venture SpaceX.
  • Many more families are focused on managing their wealth to reach a set of arguably generic aims; financial objectives, for instance to preserve its value in real terms, or to achieve a certain real or nominal return.
  • Like Bill Gates, they want to dedicate all the money in their own lifetime on philanthropic activities.
Bill Gates discussed how he is deploying his wealth and said he is happy that he and his wife have done as much as they can to ensure their children are functioning, self-supporting members of society

These are just four examples, and of course, they don’t have to be mutually exclusive. In a recent interview for BBC Radio, Bill Gates discussed how he is deploying his wealth and said he is happy that he and his wife have done as much as they can to ensure their children are functioning, self-supporting members of society. Once that was achieved, the rest is for good causes.

Similarly, we recently spoke to a 50-year-old business owner who said that he had also provided enough for his children and now wanted to spend the rest of the money he had earned to enjoy his life and pursue business objectives.

Neither man is interested in transferring the wealth to the next generation. But both have realised that the magnitude of the wealth has a bearing on what their wealth is for. If there is a lot, it doesn’t have to be managed as a monolithic quantum of wealth.

Some can be for lifestyle, some for new businesses, some for philanthropy and so on. Each part can be dealt with in a different way, setting appropriate strategies for managing liquidity, generating income, ensuring diversification and so on.

Multigenerational

Tacit acceptance of the business head’s interpretation of the wealth’s purpose can produce children and other family members who want for nothing but have no goals

Most of what we have said so far typically applies to the older generation who often head the family business. The situation can be very different when the needs and aspirations of the wider family are considered, particularly those of the younger generation.

The question of what the wealth is for doesn’t go away, although it can become something inherently more flexible to take into account the views of all the family members. However hard it is, the risk of not dealing with the issue is greater, as in the absence of a coming together and an open discussion the current business head tends to concentrate on what is important to him or her.

This is often centrally controlling the wealth, or starting new businesses – and it may be to the detriment of younger members of the family – often profoundly so.

Tacit acceptance of the business head’s interpretation of the wealth’s purpose can produce children and other family members who want for nothing but have no goals. They can develop very low self-esteem and become very vulnerable.

Families sometimes feel that they have to employ dedicated people to help family members affected in this way – sadly, often with the opposite effect. This is one reason why the discussion about the purpose of the wealth is so important – it can minimise these problems.

Unless the discussion is an inclusive exercise, not only the wealth, but the mental and even the physical well-being of family members can be put at risk.

Interdependence

Another thing to bear in mind is that the wealth’s purpose is linked with and often drives the resolution of other important issues. Discussions about wealth are tied up with questions about governance and whether the next generation want to be owners of a business or to be involved in the management – indeed, whether they are really capable of taking an active management role.

It involves discussions about the next generation’s role, and asking them what they want. This can present some real challenges. The discussion can be catalysed by the need to pass on ownership or management, which seems to involve fairly anodyne questions about process or whose name is on which asset. But very quickly families find the debate leads them beyond these concerns to the real issue – what is the wealth for?

Whilst the discussion can be difficult, it can lead to a very positive process of discovery. For example it may reveal the fact that the parents didn’t want to involve the children in the business because they thought they weren’t interested. But the effect is that the children become engaged and start to see how they could make a real contribution, rather than feeling excluded.

A conversation about what the wealth is for can help to reveal underlying conflicts between family members and open the way to constructive discussions, helping to build mutual trust and more effective cooperation.

The answers don’t have to be complicated or controversial. Just getting family members to agree a few key principles, for example something like – “the family should accommodate the different interests and aspirations of its members, while ensuring that those who lead and own the business work as a team” – can open the door to a meaningful discussion about what the wealth is for. This particular principle acknowledges that family members have different aims, but that the wealth should support them all.

Another principle is that “the family should ensure the next generation is actively involved in the business”. As we have seen, someone like Bill Gates does not sign up to this. Agreeing on this point is a profound step, and taking it will start the family on the road to finding a strategy that suits them.

Answering the question “What is the wealth for?” provides a sound foundation for family cooperation and drives many key decisions that a family has to make about its wealth. Putting off asking it might be uncomfortable, but ignoring it will not make it go away.

A conversation about what the wealth is for can help to reveal underlying conflicts between family members and open the way to constructive discussions, helping to build mutual trust and more effective cooperation

Operational Risk

We have a proven track record in designing, implementing and supporting complex IT systems for Family enterprises, but it is Family Enterprise Risk Management that sets us apart.

We begin by gaining a thorough understanding of a Family’s business activities and practices through a process of discovery. Successful technology risk management comes through focussing on users, business processes and systems. This discovery phase is an opportunity for the client to share their vision and objectives with us and for us to understand how the people and technology currently serve the needs of the business. Only when it helps the family to gauge whether the objectives are shared and understood between all members is our work worthwhile. This is critical to achieve and maintain profitability.

We determine whether the vision and objectives have been successfully translated into technical solutions and whether they are fit for purpose and future proof.

We help to ascertain whether the people have the necessary skill and will to use the technology to serve the business’s needs. In our experience skill and will gaps relative to what is required is one of the largest risks a business can face. We also review business process to identify risks, such as for example non-conformity to industry best practice, untested backup processes, unverified business continuity plans.

We determine whether the vision and objectives have been successfully translated into technical solutions and whether they are fit for purpose and future proof. The results of this discovery process serve the family with a clear picture of the risks they face. This understanding allows them to confidently take decisions to mitigate them.

Following the discovery phase we can define, design and deliver vendor agnostic IT systems that serve the business needs and the family’s vision. We stay engaged through the crucial stages of testing, training and deployment.


Discovery

  • Business process and rules
  • Systems and Application Inventory
  • Risk review - classifying the risks
  • Architecture review and validation

Design

  • Matching Business objectives with Technology solutions
  • Bespoke, client focussed architecture design
  • Vendor agnostic, business benefit driven design


Implementation

  • Vendor certified technical expertise
  • Multisite global implementation capabilities
  • Coordination and management of 3rd parties

Support

  • Full lifecycle Project Management
  • Direct user support and 3rd party support contract management
  • Continual platform update cycle
  • Regular review ensuring alignment of business goals and technology capability