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Want to Promote Family Entrepreneurship? Consider a Family Bank

January 05, 2024

KEY TAKEAWAYS:

  • Family banks can instill financial accountability and
    intelligence in heirs as they seek to create value with
    family wealth.
  • Funding family entrepreneurial ventures is a key goal of
    many family banks.
  • Customization and flexibility are key—family banks should
    be tailored around each family’s specific needs.

A foundational objective among many single-family offices serving Super Rich families is to
enable future generations of family members to build their own wealth and create their own
entrepreneurial legacies.


With that in mind, the Super Rich are embracing ways to develop the business acumen of
inheritor family members—as well as ways to support them in forming new ventures of
their own.


One way the Super Rich are making that happen is through family banks. And increasingly,
families that aren’t as wealthy as the Super Rich are using these banks as well.


A way to generate family wealth—and family financial intelligence

A family bank is a formal legal entity a family sets up, with rules that govern how family
members can access funds to start or support business ventures as well as how those
family members are expected to pay back that money.

Family banks are designed to bring a level of structure, professionalism and accountability
when providing money to family members to fund initiatives. As such, they can help instill
financial intelligence, financial responsibility and financial values in family members—while
also helping to avoid accusations of favoritism in families with multiple children.
Certainly, family banks have one clear and overarching goal: creating new wealth. As
seen in Exhibit 5, a full 95 percent of the single-family offices that have established family banks

(as well as those that employ a defined process without a formal family bank structure) say “new wealth creation” is
a top reason for having a family bank. The concept of the modern family bank
dates back to the founder of the Rothschild dynasty, Mayer Anschel Rothschild. To
protect his heirs from the problems created by inheriting significant personal fortunes,
he decided the Rothschild fortune was to be used for the education of heirs as well
as investment—including new ventures. Rothschild inheritors were expected to grow
the family fortune by making their own way in business, backed by the family’s resources.

Today, family banks are structured and used in a few ways:


• One use of the family bank is to provide short-term loans to family members who have
experienced a personal setback. The monies are intended to help them get back on their
feet.


• Another is to loan money to family members for business ventures that can potentially
generate additional family wealth.

Fostering growth from new family businesses

Increasingly, family banks created by the Super Rich focus on promoting and supporting
entrepreneurship among family members who inherit wealth. The funds provided by a family
bank are intra-family loans, equity investments in the new entrepreneurial ventures or both.
For example, a patriarch might loan his daughter money through the bank so she can start a
consulting business. The daughter agrees to repayment terms at a preferred rate.

In a survey of 199 single-family offices, almost a third of them (62) had a formalized
process for supporting the venture activities of the second and third generations. Of
those 62 single-family offices, about half had established a family bank as a separate
legal entity to perform this function (see Exhibit 6).
Additionally, many family banks are designed to foster the creativity and capabilities
of the next and future generations—in essence, to build human capital along with
financial capital. Therefore, some family banks incorporate formal and informal
entrepreneurial education and mentoring support.

Danger: Beware of taking an informal approach. About 60 percent of these exceedingly
wealthy families are supporting the entrepreneurial activities of subsequent generations
through informal arrangements that lack legal documentation—usually gifts or intra-family

loans. Informal arrangements greatly increase the possibility of family conflict. For
example, two or more family members might, and often do, remember agreed-upon financial
arrangements differently. These situations can easily become destructive to family unity—
such as when the senior family member dies and there is no documentation concerning the
existence or terms of intra-family loans that he made.


Important: With family banks, accountability is paramount. Family banks are not just pools
of money that family members can draw on as they see fit. Obtaining funds from a family
bank is very much akin to getting funding from a venture capital firm or commercial bank:
The transaction must meet established criteria and be well-documented.


The need for customization

Family banks, like single-family offices, are not cookie-cutter entities. They need to be
customized around the often idiosyncratic nature of the particular wealthy family as well as
the family’s specific circumstances. That is why some exceptionally wealthy families with
single-family offices choose to establish and run stand-alone family banks while others run
the process through their single-family offices without setting up another entity. It is all a
matter of the particularities of the situation.


Flexibility is key. Family banks tend to evolve from being very simple to fairly complex. It’s
wise to build in plenty of flexibility from the start so they can adjust as circumstances change.

Example: Consider one single-family office started by a Super Rich multigenerational
family. What started off as a formal process for them to provide intra-family loans over time
morphed into a family-only venture capital firm able to deliver a diverse range of sophisticated
financing strategies.


Solutions for the not-so-Super Rich

All this said, family banks are not the exclusive domain of the extremely wealthy. Families with
considerably less wealth can also use a family bank as a lending and investment vehicle to
support the commercial activities of their heirs.


Whereas the exceptionally wealthy move assets around in order to fund their family banks,
those less wealthy are not always in such a financial position. Instead, they may need to build
a pool of money that family members can use.


Example: A family could use the tax-free buildup from certain types of life insurance to
amass wealth that family members can then use to fund their own entrepreneurial ventures.

Conclusion
Family banks are one tool that many wealthy families use to foster a culture of

entrepreneurship and financial responsibility among children and grandchildren—as well as create
new wealth for the family coffers. As an entrepreneur yourself, you may wish to explore
whether a formal family bank or family bank-style arrangement meets your particular goals
and family dynamics.
You can explore the topic further with your legal or financial professional to help you consider
the pros and cons of family banks or an alternative solution given your unique situation.