The year 2015 has witnessed the rapid expansion of the Chinese family office industry, as indicated by the booming growth of professional institutions that provide services for Chinese families (enterprises) represented by local family offices. Various family offices’ understanding of the family, industry and approach to service have similarities but differs in many ways, too. Our team has been studying the myriad challenges facing the family (enterprise), and exploring the best approach that integrates overseas family offices’ approach with the Chinese practice.We will share our insights with readers in this article.
Challenges Faced By Contemporary Chinese Families
As the driving force behind the private economy, contemporary Chinese families and family enterprises face innumerable challenges. These challenges are inevitable for enterprises in emerging markets, in their current stage of development. From our research, we have concluded that contemporary Chinese family enterprises face the following four challenges, which are also highly consistent with the challenges faced by other family enterprises globally. We believe that we can use the success and optimal practices of foreign families and family enterprises as a reference to help sustain Chinese family enterprises in the future.
- The Challenges in Enterprise Ownership and Control
Most contemporary enterprises in China are controlled and managed by first generation entrepreneurs. These first generation entrepreneurs want to pass on their enterprises to the second generation, but they have to deal with problems such as successors’ lack of ability and aspiration, intergenerational misunderstandings, and the lack of understanding or respect for the individual differences within a family. Besides this, some enterprises face difficulties in the transformation and potential aging of business models, necessitating their upgrade and reconstruction. The appropriate configuration of ownership and controlling power, stock ownership incentives related to employees and managers, and the arrangement of business partnerships should also be taken into consideration. If the distribution of rights and liabilities is inappropriate or the roles of family members in enterprises are not fully considered, it may result in the loss of control over a family enterprise, and the outflow of outstanding professional managers.
Some entrepreneurs may choose to sell out or discontinue their involvement in family enterprises, but the timing, method, and channel for doing so may impact the ultimate value of the enterprises. Meanwhile, many aspects of the move will be challenged, including the balance of stakeholders, the conduct of new business and the management of substantial funds that stem from them leaving.
- The Challenges in Maintaining and Increasing the Value of Financial Assets
Families are also beset with difficulties in the field of financial asset investment. Firstly, families often have no specific investment plans with clear investment objectives, and have not thoroughly considered the mobility, investment period and risk preference of family members. There is also a lack of investor education and well-designed investment policies. Secondly, families have often not fully implemented diversified investment strategies. Without reasonable asset allocation and consideration of the correlations between different assets, they tend to concentrate their investment in one country or one currency and have not implemented effective re-balancing and risk-control measures. Besides this, families fail to reasonably measure their investment’s performance. Most family investors still assess investments only by looking at their return on investment, which cannot fully reflect the underlying risks of investment assets. If families don't clearly and correctly assess their investment performance, they cannot make good investment decisions.
- The Challenges of Safety and Compliance
Laws and taxes are inevitable issues for families. With regards to laws, families may face disadvantageous litigant results and may adopt inappropriate legal arrangements for the intergenerational transfer of wealth. In terms of designing the structure of a family trust, they may select an inappropriate offshore location or trust terms, and lack supervisory or legal compliance documents. In terms of taxes, they may be exposed to transnational tax risks arising from the change of nationality and identity. Besides this, they may be faced with problems like a lack of response mechanism for dealing with upcoming issues related to inheritance tax and how to standardize and optimize family enterprises’tax.
- Challenges in Family Governance and Continuation
A harmonious family guarantees prosperity. Family governance is the most critical issue that concerns family enterprises most, while the primary issue for localization of the Chinese family office is to tackle the dual governance of Chinese families and Chinese family businesses in the context of Chinese society. This is a problem apparently beyond the reach of the overseas family office. First of all, the family may lack a common vision and belief system, which may include a lack of recognition and support in the family leaders, an imbalance between individual freedom and family loyalty, an absence of clear decision-making processes, and the rareness of reasonable management structures.Secondly, there may be an intolerance for the younger generation among family members, a lack of communication and trust, ignorance about individual differences, and a lack of understanding about the family decision-making process. What’s more, the issue of family successors is also a major challenge faced by the family business. It’s possible that the family does not have a specific training plan for the family successor (including the training of necessary skills and a sense of responsibility) or clear expectations for the qualified successor.
Four Categories of Family Capital: A Concrete Embodiment of Family Wealth
What is wealth? Everyone has a different understanding. Material wealth is important, but spiritual inheritance is critical. Judging from overseas experience, family offices are the best choice for realizing such a long-cherished wish.
To summarize in a holistic way, family wealth can be divided into four kinds of capital: human capital, cultural capital, social capital, and financial capital.
- Human Capital
This consists of not only all family members, but also a family’s external consultants, tutors, offices and trustees. What really brings good fortune to a family is the experience, knowledge and abilities of such people. Their foresight and decisions will influence the future and destiny of the family, so human capital is critical.
- Cultural Capital
This encompasses family history, missions, values, family rites and ceremonies, etc. Cultural capital helps family members to better understand themselves and the family. It is helpful to answer the question of where the family comes from and where it is going. It will facilitate the family members’ recognition of family values and common visions from the bottom of their heart, ease tension and friction among them, and unite them as a group with perpetual vitality.
- Social Capital
This refers to the external social connections, resources and capabilities of a family. At present, both Chinese and foreign families attach great importance to charity. Philanthropy can bring a family social capital, including family credit, reputation, and influence. But more importantly, family philanthropy is an important force for strengthening family cohesion, family spirit, and social responsibilities.
- Financial Capital
This is the most easy to understand form of wealth, and consists of cash, stocks, bonds and other securities, family enterprise equity holdings, private equity investments, real estate, etc. For an enterprise, a sound business frame, tax structure, IT support system, human resource planning, brand management, and marketing all have positive effects and make contributions to the entire family.
Not a single one of these four types of capital can be omitted; they stimulate each other. If a family places particular emphasis on a certain type of capital but ignores others, it may cause internal friction and, ultimately, the disappearance of capital.
The Family Eco-System: A Panoramic View of the Family
What stands to be inherited is both a family’s history of wealth creation as well as the wealth itself. A sound and well-organized family eco-system is essential for maintaining and carrying forward a family’s glories. The family eco-system model advocated by Hefeng Family Office is not only a service model for family offices, but also a structural model for self-reflection and perfection of the family.
The family eco-system refers to a family enterprise’s sustainable development, including the ability to grasp opportunities and conquer challenges and build up the core of a modern family eco-system, featuring integration between different generations, cultures, emotions, and funds by strengthening the family’s common vision and values. This can be achieved through the channels of legal planning, tax planning, wealth management,and adapting one’s life to realize the balance of ownership, right of control, power of management and right of earnings.Making use of the tools of communication, education, employment, and planning are also essential.The system of governance, investment, legal affairs, tax, risk control, education, charity and the way of life itself will all be arranged around the inner core, so as to protect, manage and carry forward the human capital, cultural capital, financial capital, and social capital of the family, thus building up the outer core of the modern family eco-system.In the broader context of social, technical, economic, political, and physical environments, the inner and outer cores of the family eco-system and environment will influence and interact with each other in a process of constant evolution, and maintain a state of dynamic balance and relative stability within a certain period of time.
Only a sound family eco-system can guarantee the sustainable development, efficient management, and valid inheritance of family wealth.
Family offices: Construction of a Sound Family Eco-system
For Chinese families and family businesses, it’s a significant and far-reaching decision to select an appropriate family office.The family office industry is on the rise, but is still in a developmental stage, amidst fierce competition. Only the family office that understands the essence of the industry and revitalizes the intrinsic value of the industry can really stand for the family and shoulder the responsibility of family governance and wealth planning with a unique professional perspective, thus enabling a family’s glory to be maintained over generations.
- A Branch of Family Governance
A family’s future hinges on its specific structure and process, and development of the family eco-system is also dictated by its common vision. The family office will render support to the decision-making model, mission statement and governance structure. As a branch of family governance, it will unite and lead generations of family members in pursuing constant development.
A family’s demands are diverse and stretch over several professional fields. However, most families don't have the capability to identify and implement corresponding services and products. Besides this, families also hope to throw themselves into more interesting undertakings. Therefore, these families need organizations or institutions that fully represent them to obtain a variety of services and to satisfy demands in several other respects. International experience shows that family offices are the best choice for realizing a family’s objectives.
From my observation in the industry, the service period of a family office for a family is usually measured in decades, and lasts for generations in some cases. It is in the long-term that the family office and family develop a tight relationship, so the family office can always stand in for the family and act as a spokesperson in the family’s best interests.It is only through a long period of communication and understanding that the family offices can gain a full understanding of the family and offer a service plan that caters to the long-term interests of the family.
- Wealth Planning and an Independent Perspective
The family office will provide a family with professional, strategic and tactical planning in diverse fields, and coordinate specific areas of expertise in different fields using external service suppliers, so as to conduct worldwide cooperation across fields and industries, and eventually transform the long-term objectives of the family into reality. This not only includes wealth in a narrow sense (namely financial capital), but also includes wealth in a broader sense (namely human capital, cultural capital and social capital). One of the unparalleled strengths of the family office – this highly integrated platform –is to systemically coordinate and strategically plan wealth in various forms.
The wealth planning position of the family office transcends preservation and appreciation of its financial capital, and it seeks to highlight the value of the family as a societal benchmark, with connotations encompassing creation of wealth, feedback to the general public, social management, advocacy of virtues, and success of the family members.
In particular, financial capital is a vital component of wealth planning for preserving and increasing the family’s financial assets in the present complex economic environment and financial market. The family office will provide customized investment solutions to legal entities and individual investors of the family in an objective and independent manner based on professional knowledge, from a perspective that is separate from family and financial institutions.
Hefeng Family Office: Perpetuating the Glory of The Legendary Family
To better serve the Chinese family and the global expansion of family businesses, Hefeng has established 11 offices in key global offshore locations and financial centers, boasting global integration solutions – including localizing services by way of joint ventures, acquisitions, and self-operation – that few family offices in China are truly capable of offering. The office is rooted in the world of the Chinese, and deeply understands the strengths of Chinese culture and tradition, and will effectively wrestle with the challenges and opportunities faced by the Chinese family with local wisdom.
Hefeng Family Office is dedicated to building up a sound family eco-system for Chinese families (businesses) with the leading family eco-system theory, systematic and specialized tools, globally integrated resources, and an outstanding team. We subscribe to the following core value: “state-governing principles come from basic rules, and harmonious families contribute to society’s prosperity”. Hefeng Family Office will press forward with the family through generations in trials and hardships, passing on family responsibility and glory.
Jacky Jiang
Founding Partner of Hefeng Family Office
Managing Director of Guangzhou Hefeng Sucession and Investment Management LLC MPA, Kelley School of Business, Indiana University , USA
