Thoughts on multi-generational planning - Part 3: Avoiding unnecessary complexity

Over the years, I have seen clients become almost mesmerized by the intricate features of complex planning structures – multiple trusts, holding companies, interlocking entities, tiered partnerships, freeze or preferred return structures. They focus on the detail but lose sight of the big picture, which is transferring family wealth in ways that will maximize the family’s long-term benefit. For families, I think that complexity can be a bit like Novocain, at least at the outset – focusing on high-tech techniques numbs nerves that are twinged by the prospect of transferring wealth, power and control. The family leader thinks, “Since I’ve hired the best minds and put in place the most sophisticated planning, then how can my plan possibly fail?”

In families’ defense, it is easy to get swept up in the benefits of complex techniques, and hard to envision exactly how the structure will operate – and what resources will be required to maintain it – in the future. Complexity brings with it potential cost in many forms:
• First, the more complex the structure, the more moving parts it will have, and the more moving parts, the more opportunities for unforeseen glitches, conflicts and issues that will require attention (at a price) in the future. For example, just moving cash through an investment holding structure to fund a new investment or make a distribution for taxes can create tax and legal issues, particularly if the cash is needed quickly and is in the “wrong” entity.
• Second, a complex structure is more expensive to administer, and will require greater and more sophisticated resources on an ongoing basis. Administrative staff, accountants, investment advisors, bookkeepers, other legal counsel, insurance advisors – all will need to understand the structure and its purpose, and work cooperatively to keep it operating smoothly. Families are often distressed when they see bills arising from conversations among advisors (sometimes without any family participation), yet such conversations are often essential to running a complex structure.
• Third, even if all parties understand the structure and its purposes at inception, memories fade, advisors come and go, circumstances and laws change, and the structure that once was a perfect example of form following function can come to seem more like a Rube Goldberg creation. Family members who don’t understand the purpose and operation of a planning structure are more likely to challenge its validity in the future.

So, is the answer to throw out complex, sophisticated planning? No. The answer is to recognize that the extra return derived from the complexity – in terms of increased financial return, additional control, greater flexibility, tax savings, etc. – needs to be great enough to overcome the drag of increased administrative cost and time, and the risk of future obsolescence. Families need to think carefully about their wealth transfer goals – and the resources they are willing to commit to achieve those goals – long before they instruct lawyers to draw up documents. They should talk with families who have implemented similar planning about their experiences, and to their team of trusted advisors about the long-term ramifications of the planning. The point is to utilize complexity when it adds value, but with eyes wide open.

Next week: Part 4: Strategies for protecting key family assets

Thoughts on multi-generational planning - Part 2: Choosing the right fiduciaries

Who owns the assets in a trust? Most families who create a trust assume that “the family” or perhaps “the beneficiaries” own the assets, but in fact the trustee is the legal owner under common law. A trust can be an extremely effective planning tool, offering tax savings, asset protection benefits, and professional management of complex assets. But choosing the wrong trustee – putting the wrong person or group in charge of the assets - can put all those benefits at risk.

First, what does a trustee do? A trustee is responsible for investing trust property, administering the trust, and making distributions, all in accordance with the terms of the trust. A good trustee understands the scope and responsibilities of the role and takes those responsibilities seriously. A good trustee
• understands the grantor’s intent in creating the trust,
• knows the beneficiaries and monitors their needs, their other assets and sources of income,
• if not an investment expert, has the knowledge and experience to monitor investment professionals (and/or, in the case of business-owning trusts, business managers) effectively
• has the administrative capability (whether in-house or outsourced) to manage trust accounting, reporting and compliance.

Trustee candidates come in many forms – from individual family members to corporate trust companies formed by major international money-center banks, to private trust companies formed by families to serve as trustees of their trusts.
• Individuals often provide more personalized service than corporate trustees. A knowledgeable family friend or advisor often can bring a better understanding of the grantor’s intent and the beneficiaries’ needs, but may lack comprehensive investment knowledge or have limited access to investment and administrative resources. Individual trustees may charge lower fees than corporate trustees, but families should keep in mind that an individual trustee will need to engage investment and administrative service providers, and so the total cost for an individual trustee may be similar to (or even greater than) the cost for a corporate trustee.
• Corporate trustees typically offer a full package of services; many have served wealthy families for multiple generations and have developed strong teams. However, corporate reshuffling, promotions and career transitions often mean that team members may change frequently. Families should be aware that some corporate trustees will not serve as trustee of a trust holding interests in an operating business or other non-liquid assets.
• Private trust companies offer a family the opportunity to create their own custom-designed corporate trustee, which may be of significant value when trust assets include a substantial operating business or other unusual and nonliquid assets, but families should be forewarned that a PTC requires a substantial and ongoing investment in legal, accounting and administrative structures and systems and so should not be undertaken without substantial due diligence and planning.

Separate trustees can be appointed to handle certain specified trustee responsibilities, thereby enabling the grantor to custom-design the fiduciary team (at least on paper). Conceivably, a trust might have a directed trustee in Delaware, an independent trustee to handle distributions, a family trustee to share investment decision-making, provide oversight and ensure that the beneficiaries’ interests and needs are met, an investment trustee to oversee management of the trust’s portfolio, and a special trustee to manage particular assets (such as an interest in a startup venture). When dividing fiduciary responsibilities among a group of the trustees, the potential to achieve a custom-tailored structure needs to be weighed against the risk of creating an overlap between trustee roles, or worse, a gap.

Families often invest large amounts of time choosing a trustee, without giving much thought to successor trustees. Often, the issue of successors arises many years after the trust’s creation. How can a family ensure that the successor will be qualified and capable? And what provisions can be included to protect against an incompetent, ineffective or downright dishonest trustee? Probably the least effective option is to name successor trustees in the document, because the successor may not be alive or capable of serving effectively when the time comes. Almost as ineffective is to give the trustee the right to name his, her or its successor, a practice which can perpetuate poor trustees. Giving the beneficiaries of the trust the power to name the trustee can work in the case of capable, adult beneficiaries, but will not be so effective if the beneficiary(ies) are young (or otherwise legally incompetent), disinterested or otherwise incapable of exercising the power effectively.

A better option for solving the problem of trustee succession may be to name a protector for the trust. A protector may be granted a number of powers under the trust, but the most common is the power to remove and replace the trustee. With this power, the protector serves as monitor and overseer of the trustee, providing an important check-and-balance to the trustee’s power. The protector is typically a knowledgeable individual who knows the family well and brings applicable professional expertise to the role. For larger trusts, or trusts holding complex assets such as interests in one or more closely-held businesses, appointing a committee or an entity to the role of protector can be especially powerful; while an individual protector might become incapacitated or otherwise inattentive, a committee or entity, properly constituted, should be able to exercise its responsibilities seamlessly for the duration of the trust. The committee or entity serving as protector would have its own set of rules and procedures specifying its composition, responsibilities, decision-making procedures, and succession provisions.

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Next week’s post: Thoughts on multi-generational planning – avoiding unnecessary complexity

Thoughts on multi-generational planning

For the next few posts I’m going to shift the focus away from business succession planning and toward the more general topic of multi-generational planning. These issues and challenges apply not just to business-owning families but to any family with a multi-generational intention – the desire to pass the family’s legacy forward. There’s quite a bit of information about planning techniques out there – FLPs, GRATs, IDGTs, ILITs, QTIPs, QPRTs and all the other acronyms estate planners use with mind-numbing frequency – but less on more fundamental planning considerations that families need to keep in mind. Topics on the agenda:

• The denominator problem: thinking ahead 50 - 75 – 100 years and beyond
• Choosing the right fiduciaries
• Avoiding unnecessary complexity
• Strategies for protecting key family assets
• Do inheritances infantilize?

The denominator problem

For a family just embarking on multi-generational wealth planning, questions usually center on how best to pass wealth to children. When a family has amassed significant wealth - enough to provide at least a financial cushion for two or more generations – families begin to think about how to benefit descendants farther down the line. Following are two obvious points, with less obvious ramifications.

The first obvious point: there almost certainly will be MORE individuals in each successive generation, so that the family wealth will be divided into successively smaller portions. It is the rare family that has only one descendant – more typically, each child has multiple children, creating new branches to the family tree at each generation. Assuming a classic intergenerational distribution – parent’s assets are divided equally among parent’s children – each member of the next generation is going to inherit a fraction of the assets his or her parent inherited. This, of course, is not new news. The problem is that the next generation’s sense of appropriate lifestyle and spending level is learned, in many ways subconsciously, at the knee of someone who has significantly greater wealth than the next generation member will possess, and few younger generation family members are really prepared, psychologically and practically, to downsize their visions. The key, then, is for the senior generation to be open and realistic with younger generations, to help them understand what their financial situations will look like, what they will and won’t be able to achieve if they rely on inherited wealth to fund their lifestyles, and then to encourage them to get the educations and build the skills necessary to create their own wealth.

The second obvious point: as numbers rise within each generation, so does heterogeneity. When the senior generation begins to plan, the children – their personalities, skills, talents, baggage, fears – generally are known. The grandchildren are all about possibility, and the great-grandchildren are often just gleams in the family’s collective eye. For a family undertaking multi-generational planning, it’s worth keeping in mind that successive generations won’t look much like their predecessor.

First, every succeeding generation will be more widely dispersed than the prior generation – in terms of age, capabilities, geographic location, marital status, number of children. I once helped a client who had created a fortune in his lifetime envision who might be the beneficiaries of that wealth 50 years hence. The client had four children between the ages of 20 and 30. We made some assumptions, then extrapolated the family tree. Fifty years in the future, four generations would be alive – G2 through G5, representing four branches. G3 would range in age from 28 to 48; G4 would range in age from 1 year old to 26 (with more members still to come). The smallest of the four branches – the unmarried child – consisted of one person. The largest branch consisted of four generations and16 people, ages 76 to 1 year old. This analysis led us to make some statements about the consequences of the denominator problem:
• Sooner or later, the beneficiary group will grow faster than the family wealth.
• Separate branches will grow at very different rates.
• Individual family members will inherit wealth at very different ages.
• Diversity of ages and viewpoints will increase with each successive generation.
• With each generation, those who manage or oversee the family wealth will become a smaller minority, and will have to deal with a louder and more demanding group.

We also posited some actions which could minimize the effects of the denominator problem:
• Wealth holding structures must be robust but flexible.
• Transparency and flow of information will be essential to fostering effective collective decision-making.
• Education and training for family members is a must.
• The family must develop clear and accepted processes for decision-making and conflict resolution.

Daughters working for dads

Last summer, Jennifer East, founder of ONIDA, a Toronto-based family business consulting and coaching firm, asked me to participate in a panel discussion at the September FFI conference about daughters working for their fathers in family businesses. I worked for my dad from 1991 through 1993, during the early part of my tenure at our family business, and he served as a director (sometimes, it seemed, THE director) throughout my years there. Participating on the FFI panel was an honor and also great fun – it gave me a chance to revisit those years with my dad, and gave me an opportunity to hear other young women talk about their experiences working for their fathers.

Our responses to Jennifer’s questions were similar: Was it challenging to work for our fathers? Yes. Did we enjoy it? Often. Would we do it again? Yes.

When it comes to management succession in family businesses, I think that daughters have a significant advantage over sons – a daughter’s active presence doesn’t trigger her father’s competitive feelings the way that a son’s presence can. Fathers tend to feel proud of daughters’ success, not dethroned by it. One of the panelists pointed out that a daughter may also be better at getting her father to change his mind on an issue without resorting to direct confrontation – a particularly useful skill when the father remains on the management team.

It seems to me that gender alone doesn’t explain daughters’ success, however. To my mind, a prerequisite to taking on the job at our family business was a successful track record at school and at other jobs. My father respected my academic performance and accepted my law degree as evidence that I could think critically and speak and write persuasively. Frankly, my education helped me, too – doing well at law school made me confident that I could learn the skills necessary to run the business by keeping my eyes and ears open, studying hard, asking questions and working with experienced professionals with complementary strengths. Prior work experience at a large and entrepreneurial National Public Radio affiliate and a well-regarded private client law firm had taught me the basics of working with others and managing complex technical projects. Perhaps part of the reason for the relative scarcity of daughters in family business executive suites is that daughters, even more than sons, are realists – they recognize that you can’t do the job without adequate preparation and support.

Another essential factor in my father’s and my relationship was professionalism. While I didn’t go so far as to never refer to my father as “dad” once I crossed the office threshold, he and I were careful not to bring our personal issues to work. (We weren’t always so careful not to bring work home, to the annoyance of the rest of the family.) Whether or not I agreed with my father, I respected his opinion, and he and I learned to persevere through arguments, keeping the tone professional, often finding out that our disagreement was over semantics, not core issues. I also give my dad enormous credit for letting me make some dumb mistakes all by myself, neither pulling me back safely from the edge, nor rubbing it in when I realized the error. He recognized that sometimes, the only way to learn is to experience something for yourself.