Governance in family offices involves the systems, processes, and policies that define the interaction between the family sphere and the business sphere, which then extends to other stakeholders, like non-family executives, employees and regulators. This structure is essential for sustaining business operations and ensuring the family’s values and vision are perpetuated across generations.

Family Offices come in many shapes and sizes. We can, roughly, group them into three functional groups:

  1. “Consolidating Family Office”: The potpourri of functions needed to manage the wealth of a family and prepare for a successful intergenerational wealth transfer. This type of Family Office is most recommended to active families (family business) who want to perpetuate their wealth. This form is more governance-driven than the other forms of Family Offices;
  2. “Asset Management Family Office”: The most common type of Family Office seen focuses on managing the family’s assets through different investment vehicles. This type of Family Office is usually led by former asset managers. Governance centers around risks and risk mitigation; and
  3. “Lifestyle Family Office”: A concierge service to cater for the personal needs of the family members. This is the rarest form of Family Office.

All Family Offices need a form of governance structure to operate effectively. In the following, we will focus on the Family Office of the type “Consolidating Family Office”.

In an upcoming article, we will discuss the distinction between the different types of Family Offices in depth.

Governance Models: From Informal to Formal

Many family offices start with informal governance practices, often discussed around the kitchen table. However, as the business expands and the headcount of the family increases, the need for formal governance structures becomes apparent1. These structures, such as a board of directors, management committees, or a set of external advisors, ensure that all parties understand their roles and responsibilities.

One of the key components of family governance is the Family Council. Serving as a buffer between family members and business operations (and non-family CEO), these councils are vital for discussing and resolving sensitive issues that may not be suitable for the boardroom. For instance, Family Councils can mediate emotionally charged business discussions, ensuring that personal differences do not hinder the business’s strategic direction.

Another critical aspect of governance in family businesses is succession planning. Effective governance structures support smooth transitions by clarifying the criteria and processes for leadership succession. This not only helps in maintaining business continuity but also in aligning the family’s long-term goals with its business strategy.

Balancing Cost and Complexity

While the benefits of governance are numerous, there is such a thing as too much governance. Overly complex systems can stifle decision-making and create inefficiencies. Therefore, family offices must strike a balance, ensuring that their governance structures are robust enough to secure the business and its assets but flexible enough to allow for efficient operation and growth. For example, requiring multiple approvals for financial transactions can safeguard assets but also add complexity and potential bureaucracy to operations.

Implementing governance structures also requires significant resources, including hiring experts in governance and compliance, training staff on internal procedures, and maintaining rigorous audit trails. These efforts, while costly, are essential for mitigating the risks associated with growing the family business.

Advancements in technology offer family offices tools to improve governance without necessarily increasing costs. For example, digital platforms can facilitate better record-keeping, streamline communications, and enhance the transparency of business operations. Technology solutions can reduce the administrative load and improve the accuracy and efficiency of governance practices. For more on this subject, explore our guide to “Reinventing Family Office IT Infrastructure for the Modern Era”.

Building Trust to Reduce Agency Cost

Family businesses uniquely integrate socioemotional wealth (SEW) within their operational and governance frameworks. SEW encompasses the non-financial aspects of the family business that members highly value, such as identity, family continuity, and the ability to exert personal influence over their business decisions. While SEW significantly contributes to the unity and longevity of the family business, it also introduces governance complexities that can conflict with principles of professionalism and efficiency.

SEW’s influence on governance is a double-edged sword. The emotional and relational investments that come with SEW can enhance engagement and innovation among family members and advisors in their roles within the family office2. This emotional investment often leads to lower agency costs as the interests of family members align more closely with those of the business, fostering a natural stewardship that reduces the need for stringent controls.

However, SEW can also conflict with the need for professional governance structures as these governance structures run against information asymmetries that a family may want to uphold to protect their SEW. Family members may prioritize emotional outcomes over financial gains, potentially leading to decisions that do not maximize business value. Problems arise, if there is a split between family branches and each family branch develops its own set of – worst-case – conflicting SEW priorities. For example, a family member might retain a leadership role despite inadequate performance due to their status within the family, leading to inefficiencies and potential conflicts. You may learn more on this subject by reading our previous article “The Need for Professionalism Over Socioemotional Wealth in Family Businesses”.

Effective governance structures in family offices can mitigate agency costs by aligning the interests of managers with those of the family owners. This alignment is facilitated by shared family values and goals but must be supported by robust governance frameworks. One way to strengthen governance in such challenging environments is through enhanced transparency. Family offices can adopt open communication practices, regularly sharing financial reports, business updates, and strategic decisions with all family members involved in the business. This practice helps to build trust and ensures that all stakeholders are informed and aligned with the business’s goals and practices. If you would like to explore the connection between misalignment and agency costs, read our piece on “Aligning Mindsets: The Invisible Costs of Information Asymmetry in Family Office Advisory”.

The Unique Challenges of Governance in Family Offices within Emerging Markets

Emerging markets present a unique set of challenges for the governance of family offices, primarily due to less robust legal and regulatory frameworks.3 In these environments, the lack of a well-established legal system can mean that the mechanisms typically used to enforce governance structures in more developed markets are weak or absent. This situation necessitates a greater reliance on internal governance mechanisms to protect business interests and manage risks, often leading to higher operational costs: the family will spend more time and money monitoring internal and external agents in lieu of an incomplete legal structure protecting their rights. A solution to this challenge is to create a self-regulating organization where governance standards are maintained through family agreements and internal oversight rather than external legal pressures.

Family offices in emerging markets must also be adaptable, tailoring their governance structures to the local socio-economic context. This might involve integrating local business practices and cultural norms into the governance model to ensure relevance and effectiveness. For instance, a family office might emphasize respect for elder family members in decision-making processes, aligning with cultural norms that value seniority and experience.

Final Thoughts

Effective governance in family offices is about creating a framework that supports the business’s operational needs while respecting the family’s values and dynamics. By strategically implementing and adjusting these structures, family offices can enhance decision-making, improve communication, and ultimately, secure their legacy for future generations.

References:

  1. Stanley, L.J. et al. (2019) ‘A Typology of Family Firms: An Investigation of Entrepreneurial Orientation and Performance’, Family Business Review, 32(2), pp. 174–194. Available at: https://journals.sagepub.com/doi/abs/10.1177/0894486519838120.
  2. Kosmidou, V. and Ahuja, M.K. (2019) ‘A Configurational Approach to Family Firm Innovation’, Family Business Review, 32(2), pp. 154–173. Available at: https://doi.org/10.1177/0894486519827738.
  3. Young, M.N. et al. (2008) ‘Corporate Governance in Emerging Economies: A Review of the Principal-Principal Perspective: Corporate Governance in Emerging Economies’, Journal of Management Studies, 45(1), pp. 196–220. Available at: https://doi.org/10.1111/j.1467-6486.2007.00752.x.