Sara Hamilton is the founder and CEO of Family Office Exchange. Hamilton and Family Office Exchange serve as advisors to investors with assets lasting beyond one generation.

Risk management is hardly a new concept in the corporate world, but even in sophisticated family enterprises, it is far from an established practice. Family Office Exchange (FOX) recently assembled the findings of a yearlong research study on how financial families identify and assess risk. The results demonstrate that even those families that list risk management as a key concern usually limit their definition of risk to financial security or investment volatility. Adopting a comprehensive view of risk requires looking beyond traditional investment diversification and insurance coverage to examine a wider spectrum of risks, such as selection of inappropriate trustees, a lack of clear decision-making processes within the family and negative media exposure.

FOX asked 40 ultrahigh-net-worth families to identify the areas in which they have the most concern. Ten categories emerged as areas where threats to stability could lead to the most damage in terms of long-term generational wealth and family continuity. (Click image to enlarge)

Five of the 10 categories fall under Family Continuity and Governance. A closer look at each area reveals the range of risk issues covered within each category, as well as the approaches used by families to solve or lessen the impact of these threats.

1. Family Legacy
When wealth inheritance comprises one of a family’s goals, a strong family legacy can provide the emotional glue that keeps the generations motivated to work together. Many families believe in instilling this legacy even in young children, so that they grow up understanding their history and who they are.

A family in the Midwest developed a mentorship program to ensure an appreciation for family history in younger generations. Children are paired up with a relative who teaches them the family history on an ongoing basis. Adults are assigned this responsibility when a new family member is born. This is a commitment that everyone participates in. It also serves to tie the family together across generations and family branches.

2. Family Governance and Decision-Making
An effective governance system facilitates trust within the family. Clear processes and guidelines exist to detail how decisions are made, and those decisions are communicated in a timely fashion. Strong governance becomes even more critical as the family grows and wealth is shared among both siblings and cousins.

A family that recently sold its privately held business decided that they would need the same type of structure to manage their finances that they had implemented in the past to manage their firm. The governance system had to provide enough structure and discipline for managing substantial shared family assets while not stifling the flexibility and freedom of individuals or households. They developed a council made up of representatives from each branch of the family. Other members were encouraged to participate on committees that reported to the council. Educators were brought in to teach leadership, mediation and basic legal and financial skills to give all members a baseline education in wealth management.

3. Family Relationships
Managing personal relationships is perhaps the most difficult issue to address within a wealthy family. Building and maintaining good relationships are learned skills. A family that encourages open communication and demonstrates honesty and trust through its actions is likely to have fewer problems than one that frowns on emotional discussions or has a history of scorekeeping, power struggles or dishonesty.

A second-generation family consisting of two brothers acknowledged disagreements early on, as well as the history of family conflict. To avoid carrying this conflict into the next generation, the brothers determined that splitting assets and developing two separate financial operations would help reduce tension and put past conflicts to rest. Their decision did reduce the stress between them, and now their children are making greater efforts to come together via group vacations and shared philanthropic projects.

4. Investment Performance
The risks involved with poor performance are well understood, but those related to investment volatility are not as well known. Most families have advisors in place to monitor performance and make comparisons against determined benchmarks. However, they may not be adequately measuring the level of risk in the portfolio in relation to the returns being generated. A misunderstanding of the beta within a portfolio can result in misguided decision-making and losses.

One family office runs mock portfolio rebalancing exercises on an annual basis to measure the levels of volatility across family investments and build a greater awareness of where their risks might exist. These simulations also allow office executives to measure the performance of the current portfolio in order to determine where opportunities may have been overlooked. They take other measures to ensure proper diversification, such as applying equal-weighted investment strategies and moving away from utilizing cap-weighted indices that typically do not show a volatility risk until it is too late to fix a problem.

5. Family Business Leadership
Passing on the family business and ensuring family leadership presents a well-documented challenge to many American families. Entire curriculums and countless consultants devote themselves to this issue. Families that have a clear process for determining business succession plans and that effectively communicate those plans will be better able to navigate the financial and personal issues involved.

A family in the Midwest is preparing to transition leadership of a multibillion-dollar privately held business. With six members in the third generation, all in their early to mid-30s, the family has to decide not only who will move into positions of leadership, but if these members will be ready for management responsibility by the time the second generation is ready to retire. To avoid pushing the next generation too far too fast, the older generations long ago decided to include nonfamily members on both the company board and executive team. By doing so, they created a group of regents that will provide transitional leadership, freeing the second generation to plan their retirement, while allowing their children to grow into management positions at a reasonable pace.

6. Fiduciary Exposure
In a recent bulletin for clients, estate planner Roy Adams quotes professor Jacob Todres of Queens, N.Y.–based St. John’s Law School: "Trusts-and-estate litigation is number one on the hit list of litigation in general." Several recent high-profile lawsuits demonstrate the tremendous financial and emotional losses that can result from the mismanagement of trust assets in a family. All family members should clearly understand the duties and legalities of the trustee role before accepting this responsibility themselves or appointing others.

To avoid the risks that come with having a relative serve as an individual trustee, many families appoint a corporate trustee. While risks still exist with this option—sharing private family information, the potential for the corporation to be sold—it can alleviate concerns of individual liability and helps to separate business decisions from personal relationships. This decision also greatly diminishes the risk of an inexperienced person managing family trust assets and provides a permanent solution to the issue of trustee succession. A trustee serves as a gatekeeper, and removing the emotional/personal aspect of that role can help diffuse potential conflicts or lawsuits between relatives.

7. Family Dynamics in Business
Business-owning families in particular have concerns about how family dynamics affect the ability of members to work together. This can be an especially sensitive topic when some branches control ownership decisions and others do not.

A prominent family business owner described the need for "glue beyond the business," meaning that he found it necessary to have factors outside of the business that encourage strong, long-term family ties. A Northeastern family whose fourth generation now leads their private business has developed a system that allows members to opt in or out of participating in the company. They created a career support structure that provides interested family members with internships and appropriate job training within the company, while respecting the choice of members who choose careers in other industries, including funding for required graduate or professional education.

8. Family Reputation
Wealthy families often live under a microscope. Members should be trained in what information can be publicly shared and how to interact with the media in a crisis to ensure privacy. This can be especially critical for families with a well-known name; they may be particularly vulnerable to any situation appearing in the media.

A family in the Southeast that owns and operates a leading U.S. corporation requires full media and public relations training for all its members, regardless of their role in the business. Training includes simulations of a media storm to demonstrate how the actions of one member may not only jeopardize the family’s personal wealth and reputation, but also can lead to negative repercussions for employees and stakeholders. The realization of how one individual’s actions can affect the welfare of such a wide audience heightens awareness of the awesome responsibility that comes with being born or marrying into a high-profile family.

9. Personal Ownership Responsibilities
The privileges associated with being a member of a wealthy family come with personal responsibilities for ensuring the welfare and well-being of future generations. Families that take the view that they are stewards for future generations and nurture a culture that instills a sense of ownership responsibility are far more likely to communicate and accomplish long-term goals.

A family in the Southwest realized that within the second and third generations, very few members had the legal and financial education required to understand and oversee their complex investment entities. The few members who had this background made the majority of financial decisions, while other relatives abdicated that responsibility.

The active owners worked to gain agreement from the passive owners that everyone would commit time to receiving at least a basic financial education, and then participate actively at quarterly meetings to openly discuss financial decisions. This strategy worked not only to ensure that investment decisions were made with larger family input, but also to decrease the burden on the current decision-makers and prevent any suspicions as to how choices were made.

10. Legal Exposure
Wealthy families often have multiple legal concerns that must be continually managed. The complex investment structures utilized by many families require constant oversight to ensure that these entities comply with market and/or tax regulations. Changes in estate laws can dramatically affect generational estate planning techniques and structures. If family members live or hold property overseas, they also must comply with the laws of foreign countries. Finally, affluent families should maintain proper levels of insurance for things such as private businesses, household staff or corporate board membership.

A family in the Midwest has taken a multistep approach to protecting themselves from litigation. First, the family office is registered as an investment advisor with the SEC because there are more than 15 family-member investors. Second, insurance policies for all members are run through the family office so that executives can monitor and evaluate their coverage. Finally, to lessen the likelihood of future lawsuits between members, all new estate plans include a clause requiring heirs to utilize mediation to settle disputes.

Regardless of the particular problem or area of vulnerability, getting family members to come together to discuss their shared risks is easier said than done. Even when pressing risks jeopardize their future, there is a natural reluctance to disrupt the status quo or bring up sensitive family topics. However the price of inaction can be high. The cost of a family crisis is always higher than the cost of preventing the crisis in the first place. While it is impossible to prepare for all possible circumstances, a family that has a structure for identifying and addressing risks will be better prepared to handle even an unforeseen crisis. Without a structure or methodology for dealing with emergencies, a crisis often precipitates chaotic outcomes.