Family banks pose special challenges

With the holiday season and its emphasis on family upon us, I thought it only appropriate to blog about family banks.

In the community banking sector of the financial services industry, the family bank is a true small business subset often discussed because of its unique overlay.

Family banks, by definition, are those banks and holding companies that are controlled primarily by the members of one family. Unless you have the appropriate last name—or are married to someone who has or had it—you do not get to own stock, you do not get on the board of directors, and you are not a senior officer of the bank.

The issues common to community banks, in general, are also common to family banks. Such issues include board succession, management succession, share liquidity, cash flow off the shares, return on equity, and the like.

Pretty standard stuff.

The complicating overlay for family banks, however, is “the family.” 

Ownership issues abound

Over the last 40 years I have had a multitude of experiences helping family banks figure out what to do with both the family and the bank. My roles is part financial advisor, part attorney, and part psychologist/social worker. In my experience, the shareholder base of a family bank is often much more difficult to manage than the shareholder base of a public company.

For example, think about payment of dividends, another typical issue in a community bank. The difficulties of meeting all the shareholders’ cash flow expectations is often magnified in a family bank where some of the family members are working for the bank (i.e., taking money out of the bank through compensation) and others only receive dividends.

To make matters worse, consider the implications when those who are taking out compensation determine to reduce or eliminate the dividend for those who are only shareholders.

That issue alone could make for an interesting holiday season!

Likewise, consider management succession. Is a family member set to succeed? Does the family member in the chain of succession have the capability to run the company? Does the family member have the respect of other management teams? Or does everyone else believe that individual is only in the position he or she is in through connections?

Which part of the family calls the shots?

The family overlay cannot be minimized.

Take the hypothetical situation of a community bank and holding company that is owned by five siblings. Assume the bank has been in the family for multiple generations, but the siblings are getting up in age, and have no interest in coming into the bank as senior management. The question in that situation becomes “what do we do with the bank?” 

In many cases, there will be five different opinions out of the five branches of the family.

• One family group may simply want to sell, take their money, pay their taxes, and move on.

• One may want to keep the bank in town, even if it has to no longer be a family bank (that is, bring in new investors).

• Another family group may want a resolution that would keep the family together and cordial and is not necessarily worried about the community or the bank.

• One may want some odd combination of the others.

You get the picture.

Finding equitable solutions takes a knack

The family overlay in family-owned banks requires heightened creativity. In the hypothetical set forth above, is there a way the family group that wants to sell can sell at a fair price?  Is there a way the family group that wants to keep the bank can do so without bringing in numerous new investors?  Is there a way to keep the family cordial while doing all of the above? 

My recommendation in this hypothetical would be to form an ESOP or KSOP to cash out the family that wanted to get out.

If that group had enough stock so that the ESOP or KSOP owned 30% post-transaction, then the recipients of the cash for the sale of their stock to the ESOP could, in a Section 1042 transaction, roll that cash over into qualified securities and defer the tax on the gain until those securities were sold. That would take care of the family members who wanted to sell.

The family group that wanted to stay in the bank would also get their wish because the bank would remain in the community. It would be a little more leveraged up than it was before, but otherwise, it would be owned by the family and the employees (who, in most cases, after so many years have become like family).

This solution would also likely satisfy the branch of the family that was more worried about family harmony than the bank. The hybrid sectors of the family would also need to be addressed, but this provides the big picture.

Family banks are unique. They have all the issues of a regular community bank plus the family dynamic overlay.

And they are always interesting!