The Modern Family Bank

The Family Bank model is increasingly being used for innovative financing strategies, as individuals sell their businesses and leverage new profits to lock in cheap capital.

For decades, wealthy multigenerational families have used the Family Bank concept to develop financial discipline and business acumen in younger generations. Under this concept, younger generations pitch business ideas to the broader family; if they’re successful, they receive a loan for their endeavor from the broader family rather than from a traditional commercial bank.

The idea of managing family wealth as a “Family Bank” has historically been used by parents and grandparents to support the growth of younger family members. Funds can be kept in something as simple as a bank account or investment management account, or in more formal entities such as a limited liability company, partnership or a trust. Disbursements are then made for purposes such as starting new businesses or pursuing other ventures that benefit society and teach through experience.

Today, first generation wealth creators are using the Family Bank model to start new ‘family businesses’, which are arising from a wave of business sales by private owners, as well as low interest rates. In our opinion, those who come into significant funds from selling a business can use the Family Bank concept in new ways for their own purposes. This can be before, during and after wealth transfers to younger generations.

By investing sale proceeds and pooling it with the rest of the family’s wealth, families can put their assets in a Family Bank structure and borrow against it. Credit lines secured against portfolios of liquid securities can sometimes be a family’s lowest cost source of capital. The Family Bank model provides broad and easy access to inexpensive capital, which can be used to finance further business ventures by the wealth creators/business owners themselves, many of whom are not content on transitioning to passive investors yet.

Tough Transitions

New ways of using the Family Bank model have increased in popularity as business owners rush to sell their companies before punitive wealth or corporate taxes become law. According to data firm Pitchbook,1 many business owners have pulled their succession plans forward by several years to get ahead of potential tax changes and make the most of high market valuations. The upshot, however, has been a growing number of former business owners struggling to shift their mindset from entrepreneur to early retiree.

In our view, the transition from entrepreneur to investor after selling a business can be challenging. Business owners may find themselves without a regular paycheck while lacking control over the value of a balance sheet. Their desire for income can be further complicated by thoughtfully constructed—yet often not fully understood—trust and entity ownership structures that arise from succession planning.

Treating net proceeds as a new business wrapped in a Family Bank structure is more appealing to some than living off the earnings of their investments as a retiree. We believe liquidity of this magnitude and complexity is more than just an investment portfolio; it becomes a new family business, worthy of the structure and support systems of any other operating business. In our view, the concept of the Family Bank is at the core of this new family business.

Lower Borrowing Rates

As clients create wealth and update their estate plans over time, wealth may be divided among a number of different entities. Pooling assets into a single Family Bank structure can create potential economies of scale, tax efficiencies and fee savings across the structure of the family’s wealth. It can also create a consolidated collateral pool for borrowing strategies to fund new ventures at very low costs.   

For example, if a former business owner wants to invest in a new private business venture, they can borrow against the Family Bank’s investment portfolio to secure a line of credit at very low rates. Rather than using the cash from a business sale for a new venture, individuals can invest the cash and achieve higher returns than the borrowing costs they would pay on a secured line of credit backed by the Family Bank’s assets. Furthermore, financing a new venture with loans backed by the Family Bank’s collateral can potentially be structured to generate interest income for the Family Bank.

Take the example below:

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Here the business owner borrows $25 million using an investment line of credit (ILOC) that’s backed by the Family Bank with $50 million of assets under management. That $25 million can in turn be lent to a business venture at a higher interest rate than the ILOC rate – yet likely still less expensive than what the business venture could qualify for on the open market.

In our example, the Family Bank charges the venture 3.25% over the Secured Overnight Financing Rate (SOFR), while paying SOFR + 1.25% on the ILOC.  The deal can then provide a below-market source of financing for the business, as well as a $500,000 income stream for the Family Bank.

All in the Family

Loans from the Family Bank can still be used for their original purpose: to fund business interests for children to manage. Taking the above example, one of the children (or a trust for their benefit), could contribute equity to the business venture, so they have skin in the game, while the Family Bank provides cheap access to borrowing.

Meanwhile, the interest income generated for the Family Bank can be distributed to the business owner/parent to cover lifestyle and spending needs while appreciation in the new venture can be allocated to trusts for children, or to further capitalize the Family Bank. The flexibility to tailor this model to the ever-changing circumstances of a family provides opportunities for balance sheet, tax, and investment planning to allocate income and growth to the people and entities that need it.

First generation implementation of the Family Bank model can also help smooth the transition of family investments to younger generations, especially when paired with an active plan for family governance. For instance, the Family Bank can be created and used for the business owner’s investments while the children are young; and as the children age, the management of the private investments themselves can give the new generation an opportunity to learn about finance and business. Those children can then take over the management of some of the investments, and they can ultimately take responsibility for the overall management of the Family Bank. 

Using the Family Bank model at the initial sale of a business can provide cost savings and efficiencies for business owners as they look for new ventures, while gradually bringing younger family members into the fold of Active Wealth management. By Active Wealth, we mean realizing how sudden liquidity can be utilized to its greatest, most lasting effects. It requires not just a stellar investment strategy, but also strategic borrowing, dynamic spending, shrewd tax management and mindful gifting to build a legacy of wealth for generations to come. We believe the Family Bank can be a powerful tool for documenting, structuring and putting those ideas into practice.

  • 1Pitchbook “U.S. Private Equity Middle Market Report, Q2, 2021”

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