Family Wealth Report talks to Linda Bourne of Crystal & Company about the latest findings of its Family Enterprise Risk Index Study, carried out with Family Office Metrics.

Recent research by Crystal & Company and Family Office Metrics found that many family enterprises are challenged when it comes to addressing risk at an enterprise-wide level, whether an operating company, family office or holding company.

The topic of risk is one of the most complex and highly talked about areas in the sector today. According to the Deloitte Center for Financial Services’ private wealth outlook for 2015, the formalization of risk management is a major sign of how family offices are becoming more institutionalized, with “risk sensing,” which combines human analysis and technology to analyze data, cited as a “rapidly emerging trend.” The issue is also significant because, as highlighted by Crystal & Company, family businesses in the US account for 64 per cent of GDP, making the risks in this sector critical to the economy.

However, key findings from Crystal & Company and Family Office Metrics' Family Enterprise Risk Index Study – which involved 159 respondents – include that only two-thirds of respondents have taken steps toward implementing a plan to address specific risk areas. Moreover, just three in ten family enterprises have implemented a risk management review process for the enterprise that includes risks of the family itself. This is despite the fact that just over half (52 per cent) said that identifying and assessing current and future threats to the organization’s assets is a top priority, while an overwhelming 95 per cent claimed to be “well aware” of the potential risks to their family and its assets.

Family Wealth Report asked Linda Bourn, executive managing director of family enterprise services at the firm, for her insights on the findings, including her views on why this has emerged as a challenge.

1. Were the findings surprising, or in line with expectations?

The surprise was that while all firms indicated they provide family office services to their owners, only about a third indicated they had a process in place to address the risks to the family itself, not limited by branch such as senior generation only.

Regardless of the type of family enterprise (operating company, single family office, holding company or some other entity) all respondents indicated they provide family office services to owners. These include insurance buying, investment management, bookkeeping and administration, tax preparation, philanthropy and trustee services.

The respondents who were top performers in the study evaluated the extended family and were not limited by family branch such as senior generation only. Examples of a family review process would be evaluating roles (boards, trustee, partnerships), locations (residences and travel), emergency preparedness (travel evacuation, security) and unique assets such as the chartering of aviation or luxury yachts or next generation’s start up businesses. The best wealth management planning is for naught if the family hasn’t taken steps to address the impact of potential risks and addressing them.

2. Fewer than a third have a structured process for identifying risk. Quite simply, why do you think this is?

It’s because of a few challenges the majority of family enterprises face as they look to establish good risk management practices.

- No full-time risk manager. Few family enterprises, whether family business, family office or family holding company, employ a full-time risk manager who would dedicate 100 per cent of their time to focus on the process. It’s my experience that this role is usually assigned to an executive group, CFO or COO who are already busy tackling a myriad of financial, operational and regulatory issues.

- Silos. The complex structure of family holdings, comprised of multiple corporate entities, trusts and partnerships, can make it difficult to address risk across the entirety of the family enterprise. Very often we see the “siloing of risk” by exposure type (example: data security, risks to real property), by entity (example: the business, the family office or foundation), or by family branch such as senior generation only. This can make it difficult to establish an overall strategy that would identify total risk exposures or to address those with higher impact to the organization and to the family owners.

3. Succession and reputation emerged as the biggest family risk areas. To clarify, does this mean in terms of perceived risk or actual biggest threat? Why do they stand out as challenges?

It’s both.

Take reputational risk as an example. Managing reputational risk has been a long-standing focus of both prominent business owning families and high net worth families associated with a family office, so it’s not surprising to see it is still top-of -mind as a top risk concern of participants in the study.

The challenge for families has been how to develop a plan. The study highlights that few respondents have created a plan to mitigate invasion of privacy, identity theft or cyber crime at a company and family owner level. This risk area stands out as a challenge because families seem to be grappling with a plan on how information should be managed using smartphones which allow instant access to a host of apps to post personal or family information to LinkedIn, Facebook, Instagram, Snapchat and Twitter, as examples.

Succession planning was another area participants in the study ranked as an important priority in their risk planning. Family business advisors have long been addressing succession planning in operating businesses as part of business continuity planning. In speaking with survey participants, they have commented further that outside of the family business, succession planning around selection of independent director’s or trustees is a focus.

4. Which risks would you say are most hidden/overlooked?

The most overlooked or hidden risk is that family owners and senior management of family enterprises very often serve as directors, officers or trustees, and, in doing so, have a strict fiduciary duty to family members and family operating entities. Through this fiduciary standard, many people aren’t aware of the obligations and standards of care, along with exposure to legal liability for their actions, similar to their counterparts in a large corporation.

In serving as a trustee for example, many feel flattered to be asked to serve, but few fully understand the time commitment over a long period of time and what is expected of a trustee. Depending on the holdings of the trust, a trustee’s responsibilities range from addressing legal, accounting and tax administration, to management of diverse assets like business interests, personal property, mineral rights or oil and gas interests.
The most important responsibility of a trustee being their duties to beneficiaries. Communicate regularly, make income payments, distributions, and provide account statements.

Many mention they are being indemnified through contractual language of an employment contract or a trust document, which is part of the solution to limit their risk. However, the best risk management approach is to ensure indemnification is backed with sufficient resources, and to purchase insurance. Being indemnified and having insurance is the recommended practice that very often is missing.

5. Which are the toughest to tackle in the family office/enterprise environment?

The study indicates trust and fiduciary risk are the toughest, and I just highlighted in my previous answer some of the factors that make this a tough risk area to tackle.

6.Could it be argued that “siloing” risk management is more effective because it is more targeted?

The effectiveness of evaluating and addressing risk comes from understanding that family enterprises are unique because the family owns the entirety of the holdings. That’s why a holistic approach is necessary, rather than “silo” only.

The family’s net worth may be tied to the financial health of their operating company, or need to be preserved through wealth management activities of their family office or the plan around risks to the family itself. Both need to be addressed with an integrated risk and insurance management plan.