Mark Rubin is co-founder of the Metropolitan Group, LLC.
Family businesses have opportunities to use sophisticated strategies to manage financial risk. But, as Mark Rubin explains, they can also apply similar principles to manage human risk
I was sitting down with the Wall Street Journal about a month ago and read with interest an article describing a sophisticated new form of insurance available in the US. With increasingly complex tax laws and guidelines, certain insurance providers have developed tax indemnity insurance that reimburses the insured in the event that taxes are owed to the IRS.
Many thinkers on risk management consider risks to have elements that are in our control and elements that are out of our control. Tax indemnity insurance is an example of neutralising a risk that is out of our control. Indeed, the insurance industry is based on the notion of considering what is at risk (physical assets, financial security, life and health) and offering ways to protect these valuable assets.
More and more family enterprises are taking advantage of these and other sophisticated approaches to risk management. Recently, a family office client who runs a hedge fund explained the various metrics and statistical analyses that his firm employs to maximise the potential financial return on an investment, while minimising the downside risk. It is another approach to narrowing the range of what cannot be controlled.
While insurance is one means of risk management, it is not a replacement for diligent behaviour and responsibility. It would be foolhardy to leave a fire in the fireplace when leaving the house, not lock the doors to the library where the antiques are kept or skip due diligence on a private equity investment. Insurance should not make you less responsible or proactive in managing risk.
The human risks
Unfortunately, it is not possible to purchase insurance to manage the human risks that family enterprises face. Many journalists have identified the human risks in family enterprises. Alcohol and drug addictions exist at higher rates than we would like to think; some family members start at an early age relying on family enterprise subsidies; and poor governance has led to unethical behaviours and bankruptcies.
Nobody describes the root causes of these human risks better than family business author Jay Hughes. In his book Family Wealth – Keeping it in the Family, he makes the point that a significant risk to family members is that wealth and access to it can hinder the ability for families to create generations of successful, productive families. To overcome this risk, Hughes believes families must address not only the development of financial capital, but also the family's human and intellectual capital.
Let's face it, it is not the financial success that is the ultimate meaningful objective, rather it is the impact that a family enterprise's success has on everyone, including the family, others served by and working for the enterprise, and the broader community.
Managing human risks
Increasingly, family enterprises are looking for guidance concerning the impact wealth will have on their children's ability to develop meaningful relationships and careers. What family enterprises can do to address human risks is to undertake a sophisticated and proactive approach to those risks that are controllable and those that are not, and manage them systematically over time.
Some guidelines and potential resources for managing human risks follow.
Provide opportunities to fail. We all need to learn the consequences of our decisions. Being able to manage the complexities of life begins with the often painful process of learning from our mistakes. My business partner, Fredda Herz Brown, has written about how it is often hard for younger family members in successful family enterprises to be given the opportunity to take chances and risk failure. She offers the notion that it is hard for prosperous families to allow members to struggle with life's challenges on their own without accessing the family's often far reaching resources. In addition, the younger generation can feel as though they are under a microscope, or have much to lose in the face of great success.
The need to have the opportunity to fail is greater today with the vast array of choices we all face. In the Paradox of Choice, the author Barry Schwartz explains how choice – the hallmark of individual freedom and self-determination that we so cherish – has become detrimental to our psychological and emotional well-being. The dramatic explosion in choices in recent times has paradoxically become a problem rather than a solution. Understanding the process of choice and learning from their mistakes will go a long way towards the development of productive family members.
Provide feedback. Families who commit to a long-term view of managing human risks do identify and develop leaders, both from within the family ranks and from outside. Managing the human risks necessitates providing ongoing developmental feedback. Not doing so can lead to family members questioning their skills and level of power in the world, often leading to deep feelings of shame. Unfortunately, for families, the process of giving one another feedback is particularly hard, because it forces them to acknowledge differences among family members, and they fear potential conflicts that may arise.
Two things have allowed families to overcome their resistance to providing feedback. The first is that we have a natural tendency for improving ourselves. This desire makes us hungry for direct and honest feedback. Second, thanks to technology, there are now proven methods available to facilitate the collection of feedback data anonymously and confidentially.
Read, read, read. Because it is so difficult for wealthy families to remain private, they can be prone to insularity. While this might create a sense of safety, the risk is that it can create a very small world. As much as for anyone else, a lifelong commitment to reading ranks high on the risk management scale. Reading exposes the reader to new and interesting ideas, empowers them to think critically, and gives them the opportunity to share with friends and family members. One family we work with circulates reading lists and in preparation for family gatherings rotates the role of discussion leader around a book that he/she has chosen to be read by a group of family members. Many of us who grew up in the US in the 1960s and 1970s had drilled into our psyches that 'Reading is FUNdamental'. This catchy phrase was promoted by a literacy minded philanthropy which provides books to five million children annually.
Work, work, work. Whether inside or outside the family enterprise and whether for pay or for personal or community satisfaction, part of a family's management of human risks should be the development of work policies. An individual's confidence and self-image is often tied to the degree to which they have satisfying ongoing work. Family enterprises have many opportunities to engage family members in work projects, even when no operating company resides in the enterprise.
Family business expert John Ward has always promoted the notion of working outside the family business. In his new book, Perpetuating the Family Business, he says families must define and clearly communicate family employment policies to assure the family is able to attract its most competent family members for involvement in leadership functions.
Another benefit is the exposure to others who can serve as sounding boards and potentially as mentors. Early in my career I asked a senior colleague to help me think through some difficult professional dilemma and it led to a lifelong professional relationship that has helped me experience trust, and professional intimacy.
Modelling. Role modelling is probably the most important guideline. The real risk is that younger family members will not take the messages of the seniors seriously if they are not acting accordingly.
It is important to remember that human risks are certainly some of the most difficult to control, which elevates the need for family enterprises to identify and proactively manage them. Development of these guidelines should result in family enterprise members leading more productive, community oriented and meaningful lives.