Across Australia, family offices and privately owned businesses are entering a period of unprecedented change. Trillions of dollars in assets are expected to pass between generations by 2050 and around seventy per cent of privately owned companies are forecast to change owners as principal shareholders move past retirement age. Yet fewer than twenty per cent of family businesses have a documented succession plan and only about one third reach the second generation.
The foundations of a family office
For family offices and privately owned businesses, three building blocks underpin most structuring decisions.
1 Discretionary family trusts
Discretionary trusts can be flexible and tax effective in distributing income across the family group and are protective by design. Their effectiveness depends heavily on control. The trustee and appointor effectively determine outcomes and the trust, in most jurisdictions, has a finite life. The vesting date, at which the trust must end or change form, needs to be understood and planned for well in advance.
2 Family investment companies
Companies offer perpetual existence, familiar corporate governance and a flat corporate tax rate for retained earnings. Share classes can be used to separate control from economics, for example by giving some shareholders voting rights without economic rights or vice versa, depending on the desired outcome.
3 Combination structures
Many family offices choose a combination structure. A common model is a family investment company owned by one or more trusts. This can deliver the protection and flexibility of trusts alongside the permanence and governance advantages of a company.
In any scenario, the structure is not the goal. It is the instrument used to achieve the control, protection and succession pattern the family wants for the future generations.
Why default company rules are rarely enough
Running a family investment company under the default replaceable rules in the Corporations Act is rarely adequate for a family vehicle. Those rules do not provide tailored share classes, pre-emptive rights on exit, clear deadlock resolution or succession mechanics that reflect real family dynamics.
A family company typically needs a bespoke constitution and a shareholders’ agreement that deliberately addresses:
- how ownership and control are separated or combined;
- how new family members or external investors can enter or exit;
- how deadlocks are resolved; and
- how control passes when a director, shareholder or key family member retires, loses capacity or dies.
Ownership and control are different questions
Ownership describes who enjoys the economic interest in assets, whereas control describes who actually makes the decisions. Control covers who directs investments, who decides when and to whom distributions are made and who has the power to change the people in those roles.
Separating ownership and control allows the next generation to benefit economically without immediately taking on the burden of operations and management of governance. It also enhances asset protection, and in many structures, the people who enjoy the benefits of family wealth do not legally own the assets that would otherwise be exposed to business risk, creditors or relationship breakdown.
In practice, control tends to sit in a small number of levers:
- the trustee in a trust, who decides what happens to trust income and capital
- the appointor, who can hire and fire the trustee and therefore ultimately control the trust
- share classes in companies, which can separate voting rights from economic rights with real precision
- the company constitution and shareholders’ agreement, which set out reserved matters, veto rights, pre‑emptive rights, good and bad leaver provisions and mechanisms to address deadlock matters.
A useful starting point for any family office is to ask who controls the principal structure today and who will control it when the current leader retires, loses capacity or dies.
Asset protection: you cannot lose what you do not own
Asset protection is central to family office structuring, and discretionary trusts are commonly used for this reason. Where assets are held by a discretionary trust and family members are potential beneficiaries with no fixed entitlement, there is generally no specific, ownable interest for a creditor to claim. That protective design comes with a trade-off where beneficiaries cannot point to a guaranteed entitlement, which means that the identity and powers of the trustee and appointor become critical.
The main threats to family wealth tend to fall into three categories:
- business and personal creditors, particularly where family members act as directors or guarantors or work in high liability professions;
- relationship breakdown, which is common and often under planned for; and
- internal disputes within the family, especially in blended families or where expectations have not been documented.
To manage these risks, some suggestions include:
- building protective structures early and for their own sake, rather than reacting to an emerging problem;
- ring fence risk by ensuring trading businesses, the family home and investment portfolios are not held in the same entity;
- using corporate trustees rather than individuals, to limit exposure to personal assets of trustees; and
- being realistic about the limits of late restructuring. There are claw back rules for transfers made to defeat creditors, family law provisions have broad reach and there is a real risk that reactive changes will fail or create further problems.
For tailored advice on family office structuring or asset protection, contact our McR Private team.