Melanie Stern is section editor of Families in Business magazine.
More and more families are getting into organised philanthropy, both to marshal wealth and to contribute to society. Melanie Stern discovers some key issues to consider if your family wants to set up a foundation
Just about everyone thinks they know the solution to the world's ills. But precious few have the tools to make real and lasting change. At the end of the day, the problems we are bombarded with every day – famine, disease, poverty – need massive investments of time and money over an infinite period to even begin tackling them. It is fortunate, then, that there are more and more super-wealthy individuals on the planet whose consciences drive them to become philanthropists.
But simply throwing money at a problem doesn't make it go away, which is why increasing numbers of wealthy families across Europe run their own philanthropic foundations. Being empowered by generations of wealth, families in particular can do so much more to help change some of societies problems than handing out arbitrary cheques.
This is particularly so in Germany. There are some 80,000 companies in the country – mostly mittelstand, or mid-sized companies that are usually family-run – that face a succession transfer without having access to a suitable or willing successor, and as a result most sell out between the first and third generation. Upon realising their wealth, many families in Germany and beyond seek to put the money to philanthropic use through a foundation. Alternatively, families set up their foundation and gift a portion of the shares in their business to it, so the dividends fund the philanthropic mandate, while being concurrently protected from the results of succession or exit. It is worth noting that in Germany – unlike the UK, for example – the term 'family foundation' pertains to a tool established to protect family assets, much like a trust, and does not necessarily have charitable intentions. However, there are presently an estimated 12-15,000 charitable family foundations in Germany.
There are signs that the European philanthropy market is moving into a new phase of maturity. Until recently, a family would commonly set up a foundation in the name of their patriarch (or matriarch) after their death – but now, increasingly, foundations are being created before the death of the patron, and before the sale of their business. Observers believe families are learning to use foundations as another way around inheritance tax on estates when passed in a succession or death, while concurrently doing something positive and lasting with the assets, creating a solid family legacy.
"One of the reasons business families use charitable foundations is that inheritance tax is the most significant burden on them – an inheritance of more than €25m in Germany will be taxed at 30%," explains Andreas Richter, a lawyer specialising in advising wealthy families on foundation and charity law for leading German private equity/M&A boutique, Pollath & Partner. "If part of your business is owned by a charitable foundation – and another part owned by the family – then there is a smaller transfer of assets on death or succession, so there is less inheritance tax to pay." Additionally, a German family business that carries large silent reserves of cash will face income tax payments on it at sale of the business, so gifting those reserves to establish a family foundation prior to a sale is a means to reduce tax exposure.
Preparing a mandate
There is a lot of critical shoptalk that will require getting a lawyer with tax and charity law knowledge involved when setting up a foundation, but market experts concur families all too frequently forget that this is futile without a mandate to work to first. "We see many families set up the foundation first and then consult their lawyer second, without even knowing really what they want to do," says Felicitas von Peter of Germany's Bertelsmann Foundation – one of the world's largest philanthropic foundations, founded by media mogul Reinhard Mohn and family in 1977. "It is not enough to consult your lawyer when setting up a foundation," says Felicitas. "It is also important to know what you want to achieve, and what problems you want to solve through your foundation."
While Bertelsmann's mandate is to "encourage social change and to contribute to society's long-term viability", Felicitas runs international workshops for families seeking to set up their own foundation, or who want to review their giving strategy. "A foundation will only work if it can encompass the passion of the donor," Felicitas adds. "Once you have defined the matter you want to address, think about how you will set realistic, measurable goals."
Felicitas recommends families commission research into their desired philanthropic field and initiatives already there, as a base for their foundation's mandate; "Ask your prospective audience what it is they need, because often the solution to a problem has already been identified and actioned elsewhere, and you want to prevent reinventing the wheel."
Choosing a structure
There is a range of structures foundations can take on, depending on what the mandate is. For example, an operating foundation conceives, runs and funds its own projects, and will have the necessary staff to do so. Far more common is the grant-making foundation, whereby a foundation has a bunch of causes it wants to put money into – say, education and the arts – and makes grants in response to applications made by charities operating in these fields. This model can be run on a much smaller staff and budget. Additionally, the family can choose to either operate the foundation totally separate to the business (for instance, to sustain the foundation with the dividends from their shares or other personal wealth), as well as having the choice to link it to the business.
Philanthropy experts advise families to consider the goals of their foundation beyond theirs and the next generation, and to set up the structure with enough flexibility to allow for future change. For instance, if a family wants to set up a foundation to house their business holdings, rather than gift the majority to the foundation, the family should gift an amount such as 30%, and then draw up contracts facilitating other family members to donate as individuals on an annual basis. This gives future generations a reason to stay interested in the foundation and to keep a seat on the board, and over time these generations may want to shape the mandate of the foundation to new causes as they see fit.
The issue of family involvement in foundations is, oddly, a good place to take examples of strong and professional governance for their businesses. These days most foundations, whatever size, are not exclusively run by a family. Boards and trustee groups are usually non-family candidates who sit on a number of other foundations, operate as executives within the family business, and generally bring a wealth of philanthropic and corporate knowledge – not to mention contacts and influence – to the table. "Non-family trustees play an important role in helping the family broaden its perspectives and networks," Claire Costello, head of philanthropic advisory services at Citigroup Private Bank, tells Families In Business. "However, family foundation boards have an advantage over other types of boards because of the common ancestry families share and that binds them together. However, it is important to evaluate all board members with respect to their individual contribution and their commitment to the collective mission at the foundation." While involvement in the foundation can be tied to a family member's financial contribution, money no longer buys a seat on the board for someone who has nothing to contribute. Bertelsmann's von Peter is suitably impressed by what she has seen of her clients' approach to professional boards: "One family I know only allows family members to join the board once they have spent a summer as an intern at the family foundation, and then you must put forward your ideas as a proper proposal to the rest of the board, who decides whether to award the grant," von Peter explains. "This is a very sophisticated way of doing it."
Most philanthropy advisers also support the idea of rotating boards – for instance, a cousin takes a seat for three years, and then his brother takes that seat for the next three years – but they always strongly suggest that a family ensures there are people on the board who have board experience with other foundations, to guide the family if they are just starting out.
The most common issue for those advising families on philanthropy is that their clients can have a blinkered view of what it means to start and manage a charitable foundation. Having to consider the raison d'etre, the market's needs and who might already serve them, where funds will come from, who will be on the board – one might assume it would all sound very familiar to an entrepreneurial family. Surprisingly, many families do not see that setting up a foundation is much like setting up a new business. "Why should perpetuating a family foundation be any different than perpetuating a family business? Some families believe that business success is more difficult as the competitive pressures of business force more efficiency and competence from family members," IMD family business professor John Ward told Families In Business last summer, "but don't foundations deserve as much efficiency and competence?"
Pollath & Partners' Richter concurs. "When families approach me to set up a foundation, I almost try to discourage them because it isn't for everyone. Families sometimes underestimate the amount of work involved and I have seen family members quickly become disappointed when they find that it is much like working for a company; somehow they think that all they need to do is set up the entity and it will magically run itself. Families usually over-emphasise the legal and tax side of setting the foundation up in the first instance, when really they should be aware that it is a management job. I recommend that families consider setting up a five-year giving contract to another foundation and use this as a trial run, before setting up on their own."