What is the Family Bank
A family bank is a targeted estate planning strategy that removes assets from your taxable estate, protects them from liabilities, and preserves them across generations, with the specific intent of being an opportunity fund for heirs to launch or expand a business venture that will later produce income. Though not a formal legal term, a family bank represents managing assets for the benefit of family members with the purpose of seeding a new business opportunity.
Families that have considered offering such capital are generally pleased with the message it conveys to the family in terms of opportunity and in continuing what, for many, has been a successful venture into the free enterprise system for generations past and present. Ultra-High-New-Worth (UHNW) families often take charge of own private equity, venture capital and angel investments, driven by the fact that they trust their collective family morals, values and judgments more than they do those of some outsiders.
A family bank can be created as part of a larger trust fund that can be used for the beneficiary’s health, education, maintenance, and other traditional purposes. Given economic uncertainties and changing tax laws, individuals use this approach to safeguard their assets while providing venture capital, or “seed” money, to family members who are in business for themselves or who are contemplating taking part in the American dream of entrepreneurship.
These assets can be used for insurance, collateral, loans, business ventures, or real estate. The goal is to minimize estate tax, provide asset protection, and ensure preservation and growth of an opportunity fund to be utilized by future generations through a lens of entrepreneurial spirit.
Your Family’s Venture Capital Bank
Unlike a traditional trust fund for heirs, this arrangement is designed in mind to support their entrepreneurial inclination and passions. The family bank helps heirs acquire, start, expand, or maintain their own business or career. By formalizing the structure using a trust, a family bank ensures fundamental goals and initiatives will remain in place long after founders are no longer here to make those decisions themselves.
It can encourage not only entrepreneurship, but also education goals around learning business principles, for instance how to read and understand financial statements, credit, budgeting, negotiating, and investing. A family bank can also help to foster important life skills around fiscal competency, risk management, leadership, collaborative decision-making, effective verbal and written communication and conflict resolution; as well as how to work with professionals in the fields of finance, business, law, and accounting.
A family bank is not intended to provide for every career choice or lifestyle of future generations; some in a family tree will become teachers or craftsmen, physicians or scientists, devoting their time to philanthropy, the arts, nature conservancy or raising children. To provide for the nonbusiness activities of descendants, resources may be provided in other trust vehicles, like supporting education or health goals that not every member of a family may need or want to utilize.
How much founders choose to leave to children, for what purposes and under what conditions, are amongst the most difficult family wealth issues we see our clients likely to face.
But by setting aside a fund for entrepreneurship, which accepts a higher level of risk and is willing to support the future business success of children and grandchildren, our clients can provide some assurance, and clarity, that should any future members of their family choose to follow a path of entrepreneurship, risk, and wealth creation, that the resources will be there to help them do so.
How Does a Family Bank Work
There are a variety of ways to design a family bank. Usually, it’s formed as an irrevocable trust, either during the wealth creator’s lifetime or at his or her death. To set up a family bank during a founder’s lifetime, a separate trust, often an Intentionally Defective Grantor Trust (IDGT), can be established with the assistance of legal and tax advisers. In an IDGT, assets are transferred to the trust, removed from the grantor’s estate for estate tax purposes but not for income tax, benefiting the beneficiaries while the grantor pays the taxes. This also helps minimize the future growth of a grantor’s estate for estate tax purposes.
Generally, the family bank will designate trustees, typically family members from different generations and/or knowledgeable outside advisers, to manage the trust and make key decisions. The trustees can act like a “board of directors” to mentor and make decisions on investments, loans, and other matters. The trust is governed by a broad document, while a detailed, amendable constitution guides the board’s decisions. The trust should include rules for loan forgiveness and handling defaults, as well as clearly laying out the process of selecting, removing, and compensating trustees in practical terms. This structure provides asset protection and flexible governance. Here is a link to our whitepaper on Navigating Family Governance – Why Family Meetings Matter.
Like many good intentions, the challenge is often in the details. When a family or family office starts developing a plan to provide venture capital, several challenging questions arise. Perhaps the foremost question is how to establish a consistent policy that ensures equal opportunity within the family’s means.
Other important questions that need to be addressed include:
- What are the criteria for approving or rejecting a venture request?
- How should expectations be set for the investments? What are realistic expectations?
- How should non-profit ventures be handled? How should expectations differ between profit-oriented and community-based non-profit ventures?
- What about accountability? What happens if the expectations are not met?
- How should the investment be administered within the family or family office? Should the function be managed outside the family with family guidance at the governance level?
- What role will the family investment vehicle play in the governance and/or management of the venture being financed?
- In the event of a failed investment, what can be done to ensure the unsuccessful entrepreneur remains a welcome contributor to the family?
Benefits of a Family Bank
One benefit of creating the family bank during a wealth creator’s lifetime is being able to enjoy helping younger generations build their own “something” such as wealth, a new brand, a tech platform, a philanthropy, a mission, and so on. Typically, our clients have exceptional expertise, and experience, and want to help not only relay the wisdom, but to also learn from the next generation. Collaborating with “next-gen” individuals through the formalized structure of a family bank, helping younger family members contribute to their family’s wealth replenishment, while finding self-actualization and possibly noble purpose for their work, can spark deep joy in our families – a joy that many UHNW clients may not have ever felt before.
Family banks offers several unique benefits:
- Long-Term Perspective: Family investors often have a longer investment horizon compared to traditional venture capitalists, allowing for more patient capital that can support ventures through extended development periods.
- Flexibility: Families can be more flexible in their investment criteria and terms, adapting to the specific needs and circumstances of the ventures they support.
- Aligned Interests: Family venture capital can create opportunities for family members to work together towards common goals, fostering unity and a sense of shared purpose.
- Network and Resources: Families often have extensive networks and resources that can be leveraged to support the growth and success of their investments, including industry connections, business expertise, and strategic guidance.
- Values-Based Investing: Family investors can align their investments with their personal values and philanthropic goals, supporting ventures that contribute to social good and community development.
- Personalized Support: Family offices can provide personalized mentorship and hands-on support to entrepreneurs, helping them navigate challenges and capitalize on opportunities.
- Preservation of Wealth: Investing in innovative ventures can help preserve and grow family wealth over generations, creating a sustainable financial legacy.
- Learning Opportunities: Engaging in venture capital provides family members, especially younger generations, with valuable learning experiences in business, finance, and entrepreneurship.
- Enhanced Reputation: Successful investments can enhance the family’s reputation and standing in the business community, opening doors to new opportunities and partnerships.
- Diversification: Family venture capital can diversify the family’s investment portfolio, reducing risk and increasing the potential for high returns.
Challenges of a Family Bank
While family banks offer several benefits, such as asset protection, tax planning, and centralized financial management, there are also disadvantages and challenges associated with them:
- Costs and Complexity: Establishing and maintaining a family bank involves legal, accounting, and administrative work, often requiring the assistance of professional advisors.
- Family Conflicts: Disagreements can arise over investment decisions, distributions, and financial direction, leading to tension and conflict.
- Regulatory and Compliance Risks: Family banks must comply with various legal and regulatory requirements, which can be complex and vary by jurisdiction. Failure to comply can result in penalties, legal disputes, and damage to the family’s reputation.
- Taxation and Legal Risks: Changes in tax laws or incorrect tax planning can lead to unexpected liabilities. Additionally, legal challenges, such as disputes over the validity of trusts or wills, can arise.
- Illiquidity: Family banks may invest in assets that are not easily convertible to cash, such as private equity or real estate. This can lead to liquidity issues, especially if family members require cash for personal needs or unexpected expenses.
In conclusion, a family bank provides families with greater control, flexibility, and privacy over their financial matters compared to traditional financial institutions. It also helps reinforce the family’s mission, vision, and values.
It supports investments aligned with family values and fosters unity, communication, and collaboration. Family banks are invaluable for teaching financial literacy, encouraging teamwork, and providing a secure space for taking risks and learning from mistakes.
With customizable financial services, wealth preservation benefits, and the potential to enhance the family’s overall well-being, family banks present an attractive option for those seeking a personalized and flexible approach to create purpose-drive wealth for their family, and for future generations.
A well-managed “venture capital-type fund” within the family can be a most rewarding addition to an already rich legacy in entrepreneurship and participation in the free enterprise system. It can also be a major contributor to the family’s efforts in active philanthropy that may offer numerous family members a path to realize their dreams of active involvement in making a difference in their communities.
Disclaimer:
The information provided is for informational purposes only and should not be considered investment advice. There is a risk of loss from investments in securities, including the risk of loss of principal. The information contained herein reflects Callan Capital’s views as of the date of distribution. Such views are subject to change at any time without notice due to changes in market or economic conditions and may not necessarily come to pass. Callan Capital does not provide tax or legal advice. To the extent that any material herein concerns tax or legal matters, such information is not intended to be solely relied upon nor used for the purpose of making tax and/or legal decisions without first seeking independent advice from a tax and/or legal professional. Any forward-looking statements or forecasts are based on assumptions and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. Callan Capital is not responsible for the consequences of any decisions or actions taken as a result of the information provided in this presentation and does not warrant or guarantee the accuracy or completeness of this information. No part of this material may be (i) copied, photocopied, or duplicated in any form, by any means, or (ii) redistributed without the prior written consent of Callan Capital. For detailed information about our services and fees, please read our Form ADV Part 2A, and our Form CRS, which can be found at https://www.advisorinfo.sec.gov, or you can call us and request a copy at (866) 912-4888.