Deciding what should happen to your wealth after your death is never easy.
Every wealth creator has options when planning the future of their accumulated wealth:
- Live a lifestyle whereby every penny earned is spent.
- Create an estate plan whereby the next generation inherits all the wealth.
- Create a succession plan whereby future generations (third generation and onwards) will be able to enjoy and add to the wealth of the family.
- Create a pure philanthropic plan where the fruit of the wealth creator’s hard work is spent on worthy causes.
- A combination of the last two options.
All the above options are driven by a single question: What is the purpose of the wealth?
Donella Meadows (American environmental scientist, writer, and educator) said: “Growth is one of the stupidest purposes ever invented by any culture.” In response to the constant call for more growth, she argued, we should always ask: “growth of what, and why, and for whom, and who pays the cost, and how long can it last, and what’s the cost to the planet, and how much is enough?”. [1] Donella argued against growth at all costs as a sole purpose and encourages the increase in value as a purpose.
Growth requires a cost. The wealth creator should consider the cost, or impact, of “growth at any cost” as opposed to creating value that is of benefit to future generations. The value of wealth creation is not purely financial. It includes socioemotional wealth and non-financial rewards. Socioemotional wealth can be described as the combined value of having great family relationships, contributions to the family’s purpose and the “feel good” actions of the family, which helps the environment and social groupings the family functions in. It is the socioemotional wealth that is the value element in wealth succession. Socioemotional wealth refers to the non-financial aspects (sometimes called non-financial capital) that is derived from financial capital such as property, or business that has been passed down throughout generations. Thus, holding a form of sentimental value.
The moment that we consider a wealth succession plan that extends beyond the third generation, the sustainability of the wealth transfer becomes an essential consideration. The wealth creator should consider what the capital preservation requirements are to generate sufficient income for the family to survive off. A balance is struck between income generation and building value through socioemotional endeavours.
A sustainable wealth succession plan, from the family’s perspective, ensures the effective transfer of financial capital to future generations. Further generating sufficient income to support the lifestyles of family members and enhancing socioemotional wealth to foster lasting value.
A family lacking a clear purpose is likely to see its socioemotional wealth drift without direction. For this reason, its capital depletes to finance their lifestyle rather than constructively contributing to its purpose.
For the rest of the article, we will focus on those families that are wishing to transfer wealth to and beyond the third generation.
It is important to note that governance is central to the sustainability of wealth succession. There are two types of governance systems we will explore, namely Family Governance and Corporate Governance. Although two separate systems, they do interlink, and it is those links that create a solid basis for a successful transfer.
The family governance system embodies how the family makes decisions and how they govern themselves. A simple family governance structure is where the family assembly (a formal gathering of all the family members) elects a family council to be itself. The family council will take responsibility of the day-to-day management of the family’s affairs.
The family’s fiduciary structures (such as trusts, companies, and foundations) run within corporate governance frameworks. Trustees, directors, and council members make decisions per fundamental corporate governance principles and rules.
The sustainability of the wealth succession plan depends in part on the interaction between the ‘Family Council’ (the family governance system) and the management of the fiduciary structures (corporate governance system). It is this interaction that helps decision making to be long term, focusing on capital preservation and wealth creation.
Furthermore, the family council informs the corporate governance system of the current needs and status quo of the family. The trustees, directors, and council members ensure that their support for the family aligns with the structural requirements, including honouring the original intent of the wealth creator in setting up the fiduciary structures.
The family’s biggest contribution to ensuring the sustainability of the wealth succession plan lies in the processes they adopt to formulate the family governance framework. The process being followed is more important than the result itself, as it serves to engage the family on all levels to ensure that the set framework and its functions stands for all generations within the family.
Once the next generation is engaged in the family assembly, attention can be given as to their education. Educating the next generation prepares them to be productive members of the family. They should be encouraged to develop the skills needed to manage the wealth of the family in such a manner that it provides the capital and socioemotional wealth for their next generation. [2]
Introducing the next generation to corporate governance structures provides them with the opportunity to see and develop the relationships they will rely on when they assume control of the wealth. This means they should be included in trustee meetings, attend board discussions, and feel that their input is valued. Ideally, the family should hold a planning meeting before meeting with the trustees and a debriefing session afterward.
The third step in ensuring the sustainability of wealth succession is to empower the next generation. Empowerment involves including them in decision-making at the right time, based on their skills and knowledge. Engaging the next generation early fosters their development and gives the current generation confidence in their abilities and experience.
Conclusion
Before a family can focus on sustainable investments, they should consider whether they have sufficient structures in place to ease the transfer of wealth to future generations. It is expected that an engaged, educated, and empowered generation will function well in an environment where the family ‘s governance structures interact efficiently with the corporate governance structures.
In conclusion it is encouraged that the family builds its value through socioemotional endeavours that are balanced by capital preservation that generate sufficient income for the family to live off.
[1] Meadows, D (1999) “Sustainable Systems”. A lecture at the University of Michigan, 18 March 1999, https://www.youtube.com/watch?v=HMmChiLZZHg
[2] Optimizing wealth transfer for families: A focus on Next Gen Investors; F Roebuck and M Sulser; https://www.cambridgeassociates.com/wp-content/uploads/2022/10/Optimizing-Wealth-Transfer-for-Families-A-Focus-on-Next-Gen-Investors-1.pdf