More on structuring business-owning trusts
How can business-owning families use trusts to transfer ownership between generations, without demotivating and disengaging the next generation?
Last week I attended the annual conference of Attorneys for Family Held Enterprises (“AFHE”). Friday morning brought an excellent presentation by Marion McCollom Hampton and Andrew Hier of OMBI Consulting on “The Impact on Beneficiaries When Family Business Ownership is Held in Trust”. The speakers pointed out that trusts can undermine effective and healthy ownership of family businesses by removing the decision-making authority of family members and weakening initiatives for shareholder education, and by reducing or eliminating the incentive for the family to create governance structures and decision-making processes.
At Fisher Renkert LLC, we recognize that transferring ownership of a family business in trust rather than outright can have a substantial negative impact on the business. Improperly drafted trusts can demotivate and disenfranchise next generation family members, who find themselves passive beneficiaries rather than active shareholders. Inserting a third party – the trustee – into the system can disrupt both the family and the business. However, given the potential upside to be gained from transferring ownership in trust – significant tax savings over generations, protection from creditors (including divorcing spouses), ensuring stable ownership even when the beneficiary is legally incompetent – our goal is to design trust structures for business-owning families that engage the family, promote effective family and business governance, and support business continuity.
As the OMBI team pointed out, and as I’ve emphasized in prior posts, choosing the right trustee for a family business trust is critical. But even more important than choosing the right trustee in the first instance is ensuring ongoing oversight of the trustee by granting a trusted individual the power to remove the trustee, and to replace a trustee who has resigned or been removed. The holder of this “remove/replace” power has substantial indirect power over the trustee, and through that power, the ability to influence trustee decision-making. While a family member often can’t serve as trustee for tax reasons, a family member can hold and exercise the remove/replace power without running the risk of estate or gift tax inclusion so long as the successor trustee is not “related or subordinate to” the grantor or the beneficiaries (as that phrase is defined in Section 672(c) of the Internal Revenue Code). By granting the remove/replace power to a beneficiary or other family member, power can be shifted from the trustee back to the family.
Typically, the holder of the remove/replace power is called the Protector. Traditionally, the Protector of a trust has been an individual. At Fisher Renkert LLC, we suggest that families consider appointing a committee, or sometimes better yet, an entity, to serve as Protector, particularly for dynasty trusts or trusts holding substantial interests in an operating business. With either a committee or an entity, the remove/replace power will be exercised by a group of individuals. The group can be made up entirely of beneficiaries or other family members, but just as the quality of the decision-making of a board of directors will be strengthened by including independent directors, it can be helpful to include non-family members on the protector group, selected for their knowledge of the family, skills and experience. While the primary charge of the Protector group is oversight of the trustee, ongoing education of family members regarding the purposes, structure and investments of the trust can be an important secondary charge.
The group should meet regularly – at least quarterly – with the trustee and the family, and should receive copies of all information provided to the trustee, as well as the trust’s accountings, tax filings and other formal records of trustee decision-making. The group may also liaise with the family council and the board of directors of the operating business. The issue of protector succession is also simplified by use of a group – when a member of the group ceases to act for any reason, the group itself can be charged with the task of appointing a successor in accordance with specified criteria.
Last week I attended the annual conference of Attorneys for Family Held Enterprises (“AFHE”). Friday morning brought an excellent presentation by Marion McCollom Hampton and Andrew Hier of OMBI Consulting on “The Impact on Beneficiaries When Family Business Ownership is Held in Trust”. The speakers pointed out that trusts can undermine effective and healthy ownership of family businesses by removing the decision-making authority of family members and weakening initiatives for shareholder education, and by reducing or eliminating the incentive for the family to create governance structures and decision-making processes.
At Fisher Renkert LLC, we recognize that transferring ownership of a family business in trust rather than outright can have a substantial negative impact on the business. Improperly drafted trusts can demotivate and disenfranchise next generation family members, who find themselves passive beneficiaries rather than active shareholders. Inserting a third party – the trustee – into the system can disrupt both the family and the business. However, given the potential upside to be gained from transferring ownership in trust – significant tax savings over generations, protection from creditors (including divorcing spouses), ensuring stable ownership even when the beneficiary is legally incompetent – our goal is to design trust structures for business-owning families that engage the family, promote effective family and business governance, and support business continuity.
As the OMBI team pointed out, and as I’ve emphasized in prior posts, choosing the right trustee for a family business trust is critical. But even more important than choosing the right trustee in the first instance is ensuring ongoing oversight of the trustee by granting a trusted individual the power to remove the trustee, and to replace a trustee who has resigned or been removed. The holder of this “remove/replace” power has substantial indirect power over the trustee, and through that power, the ability to influence trustee decision-making. While a family member often can’t serve as trustee for tax reasons, a family member can hold and exercise the remove/replace power without running the risk of estate or gift tax inclusion so long as the successor trustee is not “related or subordinate to” the grantor or the beneficiaries (as that phrase is defined in Section 672(c) of the Internal Revenue Code). By granting the remove/replace power to a beneficiary or other family member, power can be shifted from the trustee back to the family.
Typically, the holder of the remove/replace power is called the Protector. Traditionally, the Protector of a trust has been an individual. At Fisher Renkert LLC, we suggest that families consider appointing a committee, or sometimes better yet, an entity, to serve as Protector, particularly for dynasty trusts or trusts holding substantial interests in an operating business. With either a committee or an entity, the remove/replace power will be exercised by a group of individuals. The group can be made up entirely of beneficiaries or other family members, but just as the quality of the decision-making of a board of directors will be strengthened by including independent directors, it can be helpful to include non-family members on the protector group, selected for their knowledge of the family, skills and experience. While the primary charge of the Protector group is oversight of the trustee, ongoing education of family members regarding the purposes, structure and investments of the trust can be an important secondary charge.
The group should meet regularly – at least quarterly – with the trustee and the family, and should receive copies of all information provided to the trustee, as well as the trust’s accountings, tax filings and other formal records of trustee decision-making. The group may also liaise with the family council and the board of directors of the operating business. The issue of protector succession is also simplified by use of a group – when a member of the group ceases to act for any reason, the group itself can be charged with the task of appointing a successor in accordance with specified criteria.
posted by Amelia Renkert-Thomas at
3:46 PM
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