Like all businesses, family ones have to deal with a diverse range of challenges that typically include reacting to market turmoil, cash flow pressures, retaining the best management talent and driving international growth. Without doubt, though, the most critical challenge involves generational change.
In the trust world, there are countless stories of families who create wealth through an entrepreneurial individual and lose it again within three generations. Often the wealth creator can directly influence the second generation – their children – to be frugal. However, while the children may be careful, they may not always be as expert at creating wealth as their parent. Often, the children will manage to maintain the status quo, and keep the family wealth static. But, given inflation and the increasing cost of living every year, maintaining the status quo can often mean that the family are gently eroding their wealth in real terms.
Good governance is an integral part of wealth structuring
When grandchildren arrive, they may be born into wealth and may not have the same discipline that was instilled into their parents. If few family controls are in place, this can sow the seeds of disaster, as some might feel it is acceptable to spend the family fortune with largesse. Under these circumstances, it really is only a matter of time before the majority of the wealth is eroded.
Making a success of succession is not, by any means, impossible and there are large numbers of high-profile families who not only protect their family wealth, but manage to actively grow it from one generation to the next. So the questions are: what distinguishes the family who diminish their wealth from the family who actively grow their asset base, and how can the trust industry contribute to the key area of succession planning?
Effective family decision-making
Family governance is a well-understood concept in larger families. Many trustees work closely with families and their advisors to ensure the creation and implementation of a detailed and recorded family governance process. Where good governance is created for families covering the way they operate their businesses, it can impose similar disciplines to those under the statutory corporate governance required for a PLC.
Governance helps determine how, when and by whom decisions are to be made. It helps resolve disputes within the family and between the family and the trustee, all of which can affect the preservation and growth of the wealth. So good governance is an integral part of wealth structuring.
Education is an investment
Family members’ education should not be restricted to school and university. Rather, business-oriented families need to establish their own values and be clear about what those values are, if they are to be handed down. For the entrepreneur thinking about future generations, it can be useful to see basic principles written down in the context of the running of the family business. Typically, this may include:
- Establishing codes of behaviour about how family members talk and inter-relate to each other. An environment needs to be created where family members feel free to express their opinions frankly, thereby avoiding divisive and, ultimately, destructive conduct.
- Developing a similar open forum about how family members can both earn and spend money. In the more successful family dynasties, there is a direct correlation between effort (in the family business) and reward.
- Establishing a process for looking after all family members, especially those incapable of looking after themselves, such as children or aged relatives.
- Developing a process for resolving disputes and aiding decision-making in the best interests of the family.
- Establishing rules about what education and experience is useful for family members to bring to bear on the family business. For instance, many families who run their own office prefer relatives to have worked for a significant period in, for example, the investment industry prior to entering the family business.
- Developing an approach to philanthropy. While it is not essential that families give to charitable causes, philanthropy is a proven way of engaging family members who are not core in the business, and provides a worthwhile outlet for their energies. Philanthropy also has the added advantage of improving the profile of the family.
Secrets can cause problems
While establishing open channels of communication in the family can help eliminate divisive behaviour, the same can be said of communication between trustees and individual beneficiaries. One of the perennial problems that trustees face is how much information they should pass to beneficiaries.
Two cases highlight some of the issues trustees face regarding the flow of information. In Re Rabaiotti 1989 Settlement  JLR 173, it was established that the beneficiaries of a trust could inspect the trust accounts if it was in the best interests of all the beneficiaries. In addition, a letter of wishes could be disclosed to the beneficiaries if the court felt that there was good reason to do so.
In Schmidt v Rosewood Trust Limited  UKPC 26, the Court saw little difference between being a beneficiary of a trust and being an object of a dispositive power when it came to being given trust information by the trustee. As long as the object of the power has a genuine and legitimate expectation of benefiting under the trust, no distinction should be made between beneficiaries under discretionary trusts and objects of discretionary fiduciary powers when it comes to the disclosure of information.
On a practical basis, it perhaps makes sense for trustees to engage with beneficiaries as early as possible. This allows the younger beneficiary to understand over a period of time why and how decisions are made. In addition, they can develop a better understanding of how investments work and what the family’s investment strategy is. Generally, this dialogue builds a greater appreciation of the role that the trustee actually plays on their behalf.
Where beneficiaries are suddenly exposed to trustees, having had a lifetime of isolation, the trustee often faces a much harder task in explaining their role and accounting for their decision-making. Often the settlor’s best intentions of protecting the beneficiaries are seen as manipulative and the trustee is the one held to blame.
In such circumstances, the choice of trustee and an agreed communication protocol are critical, as it can be a fine line between a settlor’s intentions and the best interests of a beneficiary.
Using appropriate structures
With changing tax laws, an evolving beneficial class, and greater fluidity around where beneficiaries live and what taxes they pay, it is often easy for a structure to become obsolete. The ongoing assessment and resulting adaptation of the structure can often help maintain tax viability, provide control over the current trust assets and actually build a better relationship between beneficiaries and the trustee. By way of example, the following structures could be implemented to ensure that change is planned and effective:
- Trusts. While it is common for a close family friend or a non-beneficiary family member to be appointed to steer the trustees in the best interests of the beneficiaries, the notion of a professional corporate protector is gaining increasing recognition for the improved unity it brings to relationships between trustees and multi-generation jurisdictional beneficiaries.
It makes sense for trustees to engage with beneficiaries as early as possible
- Foundations. These can offer greater flexibility whereby family members can make up the majority of the council members. The foundation’s council is the body that administers the foundation’s assets. In Jersey, foundations are required to have an enforcer role, which is akin to that of a protector, and that too can be occupied by either a family friend, family member or professional corporate enforcer. The guardian’s role is to ensure that the council carries out its functions in relation to the charter and the beneficiaries.
- Private trust companies. These have been established in offshore jurisdictions to provide families with the ultimate level of control, and the family can provide the majority of the board of directors required to run the trusts underlying the private trust company, alongside advisors and fiduciaries.
- Shari’a structures. For Islamic families, having a Shari’a-compliant structure is essential. Many Middle Eastern families use a combination of waqfs (endowments) and Shari’a-compliant trusts that their family’s scholar approves. Waqfs and trusts are very similar and many academics consider the waqf to be the precursor to the trust.
Filling the gaps
Gaps in succession, when family members have no aptitude or inclination for the business, are often easily filled by external professionals. If family members can’t agree on the best candidates, it is often the guardian or protector who decides. They will need to take a fiduciary position in this process and decide for the best interests of all beneficiaries.
Where there is no inclination for family members to become involved in the family business, conflict can arise. In some structures, it can be normal to reward family members who work in the business more favourably. Alternatively, it is also common to recognise the value that family members make by undertaking highly productive but low-paid work and compensate them with extra funds to recognise the wider contribution that they are making to society.
Family members who have no aptitude for the business represent a slightly larger problem, but if they have their own business ideas, these can be supported by the trustee as long as the ideas are well thought through and the trust deed allows it.
If the family member chooses to have no employment at all, philanthropy can provide a positive outlet. This is particularly true where philanthropic decisions must be made about which charitable sectors the family wishes to support and those charities that represent a reasonable investment. Ensuring family members conduct their own due diligence about the daily operation of a charity, how they help at grass-roots level, and how effectively the money is spent are essential exercises that can be overlooked, unless a process is established.
Assets and Investments
Ultimately, to increase a family’s assets, some investment risk must be taken to ensure the return from the assets beats inflation. The current volatile state of the markets illustrates how hard this can be. An investment strategy reflecting the family’s appetite for risk that is acceptable to all beneficiaries and allows for financial performance that grows the asset base in real terms is needed.
The process can also be structured to allow trustees to consider other asset classes, such as property and alternatives, alongside traditional funds and equities. While some of these assets and investments may have a higher risk profile, that risk can be managed by the trustee in the context of the rules of the structure chosen. Planning, education (in its broadest sense), and the use of appropriate structures and investment strategies can combine to create an environment in which a family can keep and create wealth. But care and attention to detail are essential if the family is to flourish. Good governance, both within the family and between the family and trustees, lies at the core of an effective succession strategy.
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