Written By: Jon J. Gallo and Stefanie J. Lipson
Los Angeles, California
In high-net-worth estate planning, trusts are commonly used to transfer wealth from generation to generation. The rationale for using trusts is often tax savings, coupled with protection from creditors and claims of a divorcing spouse. However, this rationale ignores an extremely important — but underused — function that trusts can play in an estate plan: educating the next generation to manage their inheritance responsibly.
Affluent families we work with are often concerned that their children and grandchildren lack the knowledge and skill to manage their inheritance responsibly on their own. Most clients decide that the better approach is to leave the inheritance in a trust, under which a third-party trustee manages the property until the beneficiary is ready to responsibly manage it on his or her own. Frequently, the arrangement provides for the beneficiary to serve as a co-trustee for a number of years, essentially an apprenticeship before becoming sole trustee. This educational component of a trust becomes that much more crucial when passing an interest in a family business to the next generation.
THE BUSINESS SKILLS TRUST
When an interest in the family business passes to the next generation, the ability of the business to grow and thrive can be threatened — less than one-third of family businesses survive the transition from the first generation to the second and only 13 percent survive the transition to the third. The likelihood that the family business will survive these transitions is greatly enhanced if a trustee with proper qualifications manages the interest in the family business until the beneficiary has both the desire and the skills to become trustee. Properly drafted and administered, a Business Skills Trust (BST) can minimize the risks of family business failure when transitioned to the next generation by reducing the likelihood of disputes and preparing the younger generation to succeed when they ascend to ownership rights in the family business.
The BST recognizes that there is a minimum requisite knowledge that an “owner” of a business should possess in order to properly evaluate business decisions that arise; because the trust owns the business, the trustee is charged with exercising the rights and responsibilities of an owner and should possess this minimum level of business knowledge. In addition, the trustee of a BST has the responsibility of educating beneficiaries who wish to become trustees. Rather than conditioning access to the trusteeship on, for example, attaining a certain age or graduation from college, each of which has no necessary correlation with the ability to properly exercise the Trustee’s powers as an owner of a family business, a BST conditions ascension to the trusteeship with acquiring the requisite knowledge and skills to properly manage the trust’s interest in the family business.
BUSINESS SKILLS CURRICULUM
Using a curriculum we developed in conjunction with the UCLA Anderson School of Management, we work closely with the trust creator — the settlor — to specifically identify the concrete skills that the beneficiary should demonstrate in order to assume the trusteeship. Examples of skills typically identified in a BST include (i) knowledge about the business’s organizational structure, including the differences in the roles of owners, board members, officers and managers and key personnel, distinctions in classes of ownership and any rights of minority and non-voting owners; (ii) dividend or distribution policies compared with reinvestment models; (iii) the business’s purpose, objectives and strategic plan in the context of its industry, size, geographic location and other marketplace conditions; and (iv) an ability to read and understand the business’s financials, including P&L statements, cash flows and assets and liabilities. We refer to this bundle of knowledge as “business skills.” While each skill has broad application to any business, as a current owner of the business, the settlor is in a unique position to define the skills in the context of the particular family business.
An additional key consideration in creating a BST is who will assume the trusteeship and exercise rights in the family business while the beneficiary acquires these business skills — is this role entrusted to another family member involved in the business or a non-family member advisor and do the governing documents of the business limit who may exercise such rights? Finally, in any trust arrangement, we believe a key component to minimizing disputes is to educate the beneficiaries and the trustee on the terms of the trust and the roles and responsibilities each plays in carrying out the terms of the trust surprisingly, we have found that many beneficiaries and trustees have never even read their trusts!
Because of the specialized skills, it is desirable for a trustee of a BST to possess, we often provide that non-family business assets are allocated to a separate trust, in which the criteria for trusteeship do not correlate with business skills but could instead correspond with whether the beneficiary who wishes to serve as trustee demonstrates an ability to manage wealth responsibly. In addition, where a trust’s ownership interest in a business is a minority interest or a non-voting economic interest, the business skills are adjusted to reflect this difference, recognizing that the trust could subsequently acquire a majority interest or acquire voting interests, making the traditional business skills more desirable.
In utilizing a BST, the next generation of family business owners can be provided the time and curriculum to learn crucial skills for understanding and exercising ownership rights in a family business and reduce the frequency of disputes among co- owners that arises from lack of understanding and which disrupts (and often destroys) the business.
ABOUT THE AUTHORS
Jon J. Gallo has earned a national reputation for developing intergenerational wealth transfer strategies.
He and Stefanie J. Lipson are members of Greenberg Glusker’s Private Client Services Group. For more information about Greenberg Glusker, please visit www.greenbergglusker.com or the International Society of Primerus Law Firms.