As of June 2021, China was home to five of the 10 cities in the world with the most billionaires. The investable assets held by Chinese individuals reached RMB241 trillion, the fastest growth all over the globe. And, the total investable assets are expected to reach RMB330 trillion by 2025. Currently, almost all China's High-net-worth individuals (HNWIs) and ultra high-net-worth individuals (UHNWIs) are the first generation of wealth creators. In terms of the age structure, the majority of China's UHNWIs are over 50 years old, or even over 60, showing an increasingly serious issue of aging. Benchmarking to the developed world, China's family business inheritance services are growing quickly on the supply and demand sides, yet the two sides are not linked smoothly. "To start a business is difficult, but to keep it going is more difficult," as the conventional wisdom holds it. The call for common prosperity poses even higher requirement on the professionalism of intergenerational transitions of Chinese family firms. RC has studied the family business inheritance issue from the perspective of a professional service agency in this field, and on this basis publishes the report with the hope of offering insights into how to reform and promote the inheritance and development of Chinese family firms.
【A Clear Picture of the Current Development of Chinese Family Firms】
1.Five Chinese cities were among the top 10 on the annual World’s Billionaires list of Forbes. However, the aging of Chinese family business founders (the so-called “first generation”) is becoming a greater concern.
As of June 2021, Beijing ranked the first by the number of billionaires and the second by net worth on the above-mentioned list, which included five Chinese cities among the top 10 (see Figure 1). An important goal of the first generation who has accumulated impressive wealth is to keep their family business going forever and transferring their wealth properly and safely.
Figure 1: Distribution of the World’s Billionaires by Geographical Location in 2021
Sources: Forbes, RC Family Office
Currently, almost all China’s High-net-worth individuals (HNWIs) and ultra high-net-worth individuals (UHNWIs) are the first generation of wealth creators, thanks to the country’s reform and opening up in the past 40 years. However, another reality of this achievement is that - in terms of age structure - most of China’s HNWIs are aged above 40, while the majority of the UHNWIs are over 50 years old, or even over 60. By estimates, the Chinese will pass RMB17 trillion, RMB42 trillion and RMB78 trillion of wealth to their next generations in the coming 10, 20 and 30 years, respectively. Therefore, ultra-high-net-worth families in China are facing the challenge of how to smoothly transfer their high amounts of wealth.
Figure 2: Distribution of Chinese Billionaires by Age in 2021
Sources: Forbes, RC Family Office
2.Intergenerational inheritance has become the foremost demand of the first generation
According to the survey of RC, more than 80% of the rich aged above 50 regard the transfer of their family wealth to the next generation as the foremost demand. Specifically, they are most concerned about the inheritance and succession planning of their businesses, risk isolation, family trust planning and growing successors.
Figure 3: Attitude of Chinese Billionaires over 50 toward Family Inheritance
Source: RC Family Office
Figure 4: Business Needs of Chinese Billionaires over 50 for Family Inheritance
Source: RC Family Office
In the next 10-20 years, China will experience a transfer of family firms from one generation to the next, a scale never seen before. The country’s wealth battlefield will show a dramatic scene: First, the new opportunities arising from economic transformation will continue to produce the first generation of wealth creators; second, with the massive demand for transfer, a large number of second- and third- generation successors will inherit the wealth of their previous generation, marking the start of the evolution of individual wealth to family wealth.
【Chinese family business inheritance and development face many challenges】
1.The first generation have no suitable successors
At present, about 75% of the first generation in China are aged above 50 (see Figure 2), and many of them are trying to train their children and grandchildren as successors, but very few have managed to do so mainly for the following three reasons: 1) Their decedents do not know how to manage an enterprise. For example, the former de facto controller Luo of the listed company Hisoar, a pharmaceutical company, gave up control over his family firm with a history of 40 years in just four years; 2) their descendants are not interested in business management. For example, the third-generation heir of a private company in Wujiang, Suzhou, is obsessed with cartoons and indifferent to take the helm of the company; 3) family firms do not have strategic inheritance and succession plans. Most Chinese entrepreneurs are too busy with their business operations to establish professional plans and solutions for the inheritance of their firms and management of their wealth. As a result, the firms will be all at sea on addressing business and wealth transfer. Every family firm should think carefully about and deal with the critical issue of how to develop a set of stable inheritance system to ensure that the firm could keep going stably in the event of an incompetent successor, an accident to the business owner, and the use of professional manager, etc.
2.Insufficient analysis and research of macro policies leads to ineffective inheritance of family firms
At the institutional level, changes in the government’s tax, financial and other policies can have an impact on the intergenerational inheritance of family firms. If the strategic plans and financing programs developed by a firm with a certain scale for the going-global drive of its brand, overseas investment, and upstream and downstream M&A strategy, etc. go against the nation’s strategic policies and foreign exchange administration regulation, or the firm fails to study the national policies thoroughly, the firm may destroy itself. And, with the introduction of the Common Reporting Standard (CRS) for higher tax transparency, HNWIs are finding international tax avoidance more difficult. Predictably, CRS is just the beginning of the tax law reform. In the context of realizing common prosperity, there are growing expectations for estate and gift taxes, thus posing greater challenges to the transfer of wealth from one generation to another. The lack of understanding of relevant laws and regulations and insufficient research on macro policies will be the root cause of the inability of family businesses to effectively pass on their wealth.
3.Relationships and family-oriented ideas affect inheritance: Family firms do not have a policy-making system in place that suits to their own family culture
Chaos among family members and within a family firm constitute a big obstacle to the family’s successful transition. In order to maintain good standing, many family firms do not separate family from business effectively. Consequently, family and business are intertwined, and the business ownership is unclear. These problems not only damage the firms’ decision-making and asset utilization efficiency, but in particular, make it impossible to clearly divide and ascertain the owner of wealth during intergenerational transfer. For example, the “mom-and-pop store” model has certain advantages when the scale is small because of less decision-making steps and simple coordination between different bodies within the organization. However, as the business expands gradually, the disadvantages surface: the development of the enterprise relies heavily on the ability and quality of the founding couple and the mutual affection between the husband and wife, which tends to restrict the enterprise’s further growth and is not conducive to the establishment and development of a modern enterprise system. Take Dangdang, an e-commerce site for example. Li Guoqing and Peggy Yu, the husband-and-wife co-founders of Dangdang, are going through a divorce which has been anything but cordial. Due to the equity structure design problem in the early days of Dangdang, the couple could not agree with each other on how to develop the company after Dangdang completed privatization from the United States in 2015. A series of clashes over fighting for equity interests in the company, e.g. divorce proceedings and Li storming into Dangdang’s headquarters to remove the company seals, not only led to slow management decisions and talent loss, but also caused damage to the interests of the company’s employees and suppliers, and in particular made Dangdang miss several development opportunities in the e-commerce field.
4.There are hazards in the risk awareness of family firms as the situation evolves constantly
“Risk isolation” acts as the foundation for keeping wealth within the bloodline, yet it is an issue often neglected by families in the past. Because risks might and might not happen, most families failed to pay them attention in advance.
From the perspective of being realistic, managing risks consumes time, money and energy, but it cannot generate handsome gains in near term. For this reason, family firms which focus on short-term gains often act in a near-sighted way because they think risk management is cost-ineffective and wastes lots of money. They would rather to make easy and fast money than to conduct professional, personalized planning for risk isolation. As a matter of fact, family business succession and inheritance is a lengthy process involving investment risks, life risks, “black swan” and “grey rhino” events. A bigger and longer family business will be exposed to a greater chance of risks. Therefore, the lack of risk awareness at family firms often stands in the way of family wealth transfer.
5.Many family firms do not have strategic awareness on inheritance
As a systematic project, family inheritance requires family firms not only to plan ahead for the selection of successors, but also to establish a stable governance and management system with mutual checks and balances. Such a stable system provides a stable environment for a good successor to run the business, and also ensures the smooth operation and continuation of the business in the event that the successor is not competent or the business owner has an accident. Many firms do not make prior planning for succession in their heyday and have no practical succession plans during the inheritance process. Once an accident takes place, these firms will inevitably suffer losses in various aspects such as business operation and family reputation. For instance, Yoozoo Games, an interactive entertainment provider with four business segments, including global game development and distribution, big data application, IP development and operation, and pan-entertainment industry investment, got listed on the main board of the A-share market in June 2014. Its founder, Lin Qi, passed away on December 25, 2020 after being suspected of being poisoned by a colleague in December 2020. The unexpected death of the founder left Yoozoo leaderless, which added many uncertainties to the company’s management, resulting in a lackluster of business, reduced profitability of main business and a significant decline in performance. Although Lin Qi’s ex-wife, Xu Fenfen, later became the de facto controller of Yoozoo, the company’s development is still in an infirm state.
6.With a poor understanding of how to use inheritance tools scientifically, family firms fail to make them serve their inheritance goals
Wealth transfer is family specific. A family firm can move on effectively only when it chooses the right inheritance tools and personalizes the terms, as well as seeks the help of improved legal instruments. In so doing, the wealth transfer solutions and tools can fit to the family culture, meet the real needs of family members, and make forward-looking arrangements for possible risks and risk responses. There are legal bottlenecks in the development of domestic equity and estate family trusts, which should be addressed through supplementary design using corresponding legal instruments for the purpose of realizing the basic inheritance function. In terms of a design combining both onshore and offshore inheritance structures, it is all the more necessary to take into account the legal discrepancies at home and abroad and the foreign exchange regulation and compliance. The dispute over shareholding in Lunan Pharmaceutical caused a stir online in July this year. Mr. Zhao Zhiquan, the founder of Lunan Pharmaceutical, wanted to transfer the overseas portion of the company’s shares in the trust incepted before his death to his daughter Zhao Long through the trustee Ms. Wei. However, due to the unreasonable design of the trustee’s directors and trust executor, there was a dispute over the ownership of these shares. As the disputed parties were located in two different jurisdictions, the Linyi City Intermediate People’s Court in Shandong Province and the Eastern Caribbean Supreme Court in the British Virgin Islands came up with two sharply different decisions. The ultimate ownership of the underlying shares has not so far effectively resolved.
7.The mixed qualifications of inheritance service providers make it difficult for family firms to find the right ones
In recent years, more than 2,000 family offices of various kinds have swarmed into the market, with an admixture of qualified and unqualified ones. In terms of structural composition, Chinese family offices can be broadly divided into two categories: First, family offices formed under trust companies, commercial banks and law firms, etc. They are departments of such financial institutions as commercial banks, insurers, trust companies, securities companies and third-party wealth management companies that are set up to serve private banking or ultra-high-net-worth clients. Family offices act as a supplement to existing business or a channel to acquire clients, and they can hardly perform all the duties of a family office. Second, independent family offices serving ultra-high-net-worth families only. These family offices are not affiliated with any department or enterprise and make decisions completely from the perspective of serving the needs of high net worth families. For this reason, dedicated family offices with an elite team are in a better position to meet the needs of high-net-worth families.
Family offices which have developed for a decade in China are still in their infancy. Although a handful of family offices in the market are deeply committed to their work, market players on a larger scale do not have an in-depth understanding of family offices, while quite a few financial institutions do not render services guided by the core philosophy of family offices. Instead, they, by virtue of their advantages in the traditional financial sector, are product sales-oriented and support the day-to-day operation of family office business with the commissions from sales only. Unlike traditional financial institutions, family offices, which form an emerging industry in China, suffer a relative shortage of professionals, while most of the existing service providers in the market have a profit model to make quick money and are unwilling to spend money and take time to train their own talents. At the same time, these providers lack a strict confidentiality system, making it difficult to meet the clients’ privacy demand. As a result, high-net-worth families find it quite difficult to spot suitable family offices which are capable of providing them with a full package of personalized and private professional services.
【Family inheritance under China’s national conditions needs to attach importance to such social responsibilities as “common prosperity” as well】
1.Interpretation of the “common prosperity” policy
The 14th Five-Year Plan unveiled last year proposed that China should achieve common prosperity, and the agenda was elevated to an unprecedented position at the tenth meeting of the Central Financial and Economic Affairs Commission dated August 17. The meeting also proposed to correctly deal with the relationship between efficiency and equity. The market-led primary distribution focuses on efficiency, which widens the income gulf while developing the economy efficiently. Therefore, the government-led redistribution upholds the principle of equity and regulates the income gap through taxation and social security spending. However, redistribution is not strong enough to fill up the larger income gap. The data released after the seventh national census revealed the Chinese people’s declining willingness to have children and the lack of demographic dividend, giving a further push to the drive toward common prosperity. In today’s China, there is a strong need for the tertiary distribution to play a role in further regulating and narrowing the gap between the rich and the poor through voluntary donations from individuals. The so-called “tertiary distribution” mainly refers to the morality-driven redistribution of resources and wealth by the high income earners on a voluntary basis through charitable and philanthropic means such as donations and grants. With the implementation of the policy, the wealth management industry and the inheritance service industry will also undergo some substantial changes. The development of family trusts will be further regulated, and the expectations for related supporting tax policies such as estate tax and gift tax will gradually increase. It is expected that more and more HNWIs will pay back to the society through donations, setup of charitable funds and other methods for the public good, which will promote the development of education, medical care, culture, sports and other causes in China.
2.RC’s predictions: the three distributions for common prosperity
✦The primary distribution still focuses on efficiency
To achieve the goal of primary distribution, the market must play a decisive role in distribution by optimizing the allocation of production factors, improving the production efficiency and making the cake bigger. This stage is defined by the principle of efficiency first. In the market-led primary distribution, it is expected that wealth will still gather in the hands of HNWIs. The Chinese economy will grow steadily by ensuring HNWIs’ ability to enlarge the cake.
✦Redistribution will be calibrated in terms of estate and income taxes
Redistribution will be achieved through taxation and the government’s non-tax revenues. China’s current taxation system characterized by “heavy taxation on laborers and light taxation on large asset holders” makes the rate of return on labor factors lower than that on capital factors. The resulting unfair distribution of wealth has widened the gap between the rich and the poor. It is expected that the taxation policy will be well aligned with the policy objective of realizing common prosperity. RC expects the government to proceed with estate and income taxes concerning the taxation on HNWIs.
✦The tertiary distribution places a premium on morality and social responsibility
The tertiary distribution is considered as a “gentle hand” on the basis of morality and social responsibility. It is a kind of wealth distribution by guiding high income earners and entrepreneurs to bear public good in mind, extend care to the society, raise the sense of social responsibility, and actively participate in and run projects for the public interests. Efforts will be made to explore new types of donation methods, encourage the establishment of charitable trusts, and open up channels for non-government forces to participate in charity and social assistance.
3.RC’s analysis: The influences of “common prosperity” on high-net-worth clients
✦The income of HNWIs will become more transparent
In the future, the government will strengthen the regulation and adjustment of high income by protecting legal income according to law, reasonably adjusting excessive income, cleaning up and regulating unreasonable income, rectifying the order of income distribution, and eliminating illegal income. RC expects that the due diligence review of the income sources of HNWIs will be more strict in the future, and the wealth of HNWIs will become more transparent.
✦HNWIs will become the key targets of tax monitoring
Recently, the Auditing Bureau of the State Administration of Taxation said that the taxation auditing department is inspecting individuals who conceal their high income and fail to declare tax truthfully. Taxation (especially income tax for individuals), as the main method of regulating income for redistribution, will be further improved and strengthened in the era of promoting common prosperity.
The family wealth management in the new tax era is bound to go side by side with the following three trends, including deepening of tax reform, strict tax collection and management, and individual-focused taxation auditing. Following the creation of tax identification numbers for natural persons, the introduction of anti-avoidance provisions in the updated personal income tax law for the first time and the mutual exchange of tax information under CRS, the assets placed by HNWIs with Chinese and foreign banks and their income and expenditure will become more transparent.
✦Traditional inheritance tools for HNWIs will be more strictly regulated
In respect of the future distribution of income rewarded by various production factors, China may increase the return on labor factors and adjust that on capital factors in a bid to balance the returns on different production factors. Therefore, the wealth tools frequently used by HNWIs, such as funds and wealth management products, may be more strictly regulated and included in the scope of tax collection and management.
✦There is a higher demand on the professionalism of asset planning for HNWIs. Charitable trusts and charitable foundations, among others may have great potential
In the tertiary distribution, high income earners and entrepreneurs will be actively guided and encouraged to pay back to the society and fulfill their social responsibility through donations, charities and volunteering, for the purpose of regulating social income distribution. And in this process, charitable foundations and charitable trusts as a new type of charity tools to beef up common prosperity will be promising.
Perspective of RC
For rulers of a country since ancient times, inequality rather than want is the cause of trouble. The stability of modern society actually depends on a certain level of equality, too. An extremely wide gap between the rich and the poor may make the society collapse. What’s more, the philosophy that “inequality rather than want is the cause of trouble” is also in line with the socialist idea of fairness and justice. If a “country” is compared to the human body, then individual “families” are the organs of the body. If an organ fails or becomes ill, it will definitely affect the functioning of the body; if the body fails, none of the organs will be able to stay healthy. The prosperity of each family is closely related to the prosperity of the country. As China strives to achieve common prosperity, it is advisable for families to incorporate public good pursuits directly into their overall family wealth management strategies from a more scientific perspective, shift from ethical investment to offering of support for the structures of charitable foundations and charitable trusts, design socially responsible portfolio solutions for the charitable portion of the funds, and ensure sound asset value preservation and appreciation and the most favorable tax treatment while achieving charitable goals. For example, families are recommended to establish various charitable funds by using the family trust management service of RC. This will bring about win-win outcomes, allowing these families to continuously and effectively perform their responsibility toward “common prosperity” over a long period of time for one and to constantly growth their business for two.
【The fledgling family office industry is in the blue ocean period, and is set to develop at a fast speed 】
1.The Chinese’s investable assets amounted to RMB241 trillion, and are expected to exceed RMB330 trillion by 2025
In 2020, investable assets held by Chinese individuals reached RMB241 trillion, with an annual compound growth of 13% from 2018 to 2020, returning to double-digit growth. The volume is expected to surpass RMB330 trillion by 2025, making China the world’s second largest onshore private banking market.
Figure 5: Overall Volume of Investable Assets Held by Individuals in China
Source: Bain & Company HNWI Income-Wealth Distribution Model
Figure 6: Composition of Personal Financial Assets in China
2.Family offices which started late in China boast enormous potential
As individuals grow their investable assets rapidly and the first generation of “wealth creators” get older, how to manage the families’ huge wealth and hand over family wealth stably has become a key issue for entrepreneurs to address. Driven by the increasing demand of HNWIs for wealth management and inheritance, China’s family wealth inheritance service industry with various institutions pouring in is witnessing fiercer competition. Trust companies, insurers, fund companies, brokerage firms, and third-party wealth management institutions, etc., have set up their family offices, sending the family office business to flourish. However, most domestic product-oriented family offices have such a single service channel and narrow investment perspective that they can hardly meet the needs of HNWIs for isolating risks and keeping wealth within the family forever. In the future, family offices that are oriented to clients’ personal needs and have excellent management capabilities like investment advisors will stand out in the market.
In the opinion of RC：family inheritance is not only the transfer of wealth, but particularly the continuation of family spirit and philosophy of life. It is a systematic project dealing with multiple aspects, including the cultivation of successors, planning for estate inheritance, preservation of family assets, and family fund planning for encouragement and support. These complex "family" and "business" management and inheritance needs require not only the ability to judge the operation of a single business or several investment products, but also the planning, design and practical experience across a multitude of specialized fields such as cross-market & cross-border law, tax and investment. As the omnipotent carrier of family inheritance, family offices bridge families' internal and external affairs governance. They need to effectively manage families' inheritance needs, ranging from the value preservation and appreciation of financial capital and safeguarding of family capital with prudence to planning for the inheritance of human capital, creation and maintenance of social capital, over a long term of period from a strategic perspective of coordinating the development of the whole and the part. Family offices should bring their unique role into play so as to help families better accomplish their wealth management goals and materialize family management and inheritance in a safe environment without conflict of interest, defend families' philosophy and dreams, and build a modern inheritance management system for Chinese families.
------Prepared by: expert team of RC Family Office