Creating an integrated estate plan for a large, multigenerational enterprising family is like solving a Rubik's Cube. Just as each twist of the cube affects multiple squares simultaneously, each branch's estate planning decisions can have a ripple effect on family members in other branches. It's an intricate puzzle, and the challenge is ensuring every move contributes to the well-being of the full family. With all these complications, it is no wonder that estate planning coordination gets put on the back burner. Here is a typical story and a genogram to help keep track of the characters.
Generation 1 sibling group: Brothers John and Gary joined forces 40 years ago to start a machine shop. They were equal partners in what would become a significant supplier of machined parts to the North American aviation industry. Each had two children.
Personality-wise, John and Gary were opposites, as many siblings are. In the early years, this didn't seem to affect their partnership. John was a saver and Gary was a spender. John was a conservative Christian who did not drink. He had been married to Denise for 40 years.
Gary divorced his wife, Beth, after 20 years of marriage. Gary loved the fast lane, dated around after his divorce and had an unhealthy relationship with alcohol. He remarried at age 58 to Luciana, whose vacation home was in Colombia. She insisted that they move to her vacation home when he semi-retired in his early 60s. Gary worked two days a week remotely.
Generation 2 cousin group: Growing up, the cousins would spend many Saturday mornings hanging out at the shop, sweeping floors and often playing hide-and-seek while their dads worked. The families got together for birthdays and holidays and often spent time on weekends sleeping over at each other's homes. They met once a week to see their grandparents, and their mothers were very close friends. As young children, they would spend most of their free time together.
But as the cousins aged into young adolescents and young adults, their time together dramatically changed. Their grandmother passed, and Gary's divorce created a bitter division between the two families. John's wife was furious with Gary and stopped inviting him over to their home; this caused a break in the cousins' connections. Gary’s divorce, his new marriage and his part-time work schedule created financial challenges.Over time, the disparity in the economics of the two families caused tension and disagreements in the cousin group. Gary had another daughter with his second wife, which created additional tension in the family relationships.
John's daughter, Sally, an accountant with an MBA, eventually became the CEO of the family business; her brother, Larry, a mechanical engineer, was the head of engineering. Gary's son, Thomas, worked his way up in the business to become head of purchasing. His sister, Jennifer, had no interest in working in the business and moved to a different state.
Succession and estate planning: The brothers' differences complemented each other as they grew the business. While they managed their personal lives very differently, they harnessed their various talents to grow the business. They successfully developed the next generation and set the company up with good leadership – no small feat. They thought their succession planning was solid and would create continued success for the business and harmony among their children.
Unfortunately, it wasn't until they settled on a leadership succession plan in their late 60s that they began to get serious about reviewing estate planning matters. At this point, they realized the magnitude of the challenges. They were early in the planning process when Gary died suddenly. With paltry savings, inadequate life insurance, multiple tax jurisdictions and a second younger family, Gary's older children and John were left with very few options to complete a transfer of Gary's ownership in the company.
Gary's estate could not pay the taxes, and his 50% share of the business was acquired by John's family. The capital requirements for the buyout caused a financial strain and halted the company's growth trajectory, but the greatest loss was the destruction of family relationships.
This could have been avoided had the two brothers prioritized a coordinated approach to their estate planning earlier in their partnership. Had they done that, they could have addressed the need for regular updates in the valuation of their shares and reorganized their ownership with an appropriate structure, using specific trusts and insurance strategies to mitigate the tax implications of the death of one of the brothers.
Why coordinate estate plans?
Enterprising families must coordinate their estate and business documents to de-risk their ownership, leadership and family systems. We regularly see families whose ownership documents and estate documents were created decades earlier, when the company was a start-up and had little value. There tends to be little to no clarification of how the company's shares or units will be valued and what discounts should be applied for non-majority ownership status. In addition, the documents often include no information on how the company will fund the liquidity event. In the best-case scenario, there are “key-man” life insurance policies to assist in funding a liquidity event.
Though the process may seem daunting, coordinating your estate planning is essential for a smooth and successful transition of ownership and wealth upon the death of a leading-generation member.
Preventing future conflicts. Good planning requires productive discussions within branches and in the broader family.
If Gary and John had met with a team of advisers as they were integrating the next generation into the company, they could have avoided much of the above-described heartache. A family business adviser could have worked on aligning the “why of ownership” for the cousin group and given them a voice in becoming owners by choice, not chance. The lawyer and accountant could have created clear and concise language around valuation and payment expectations upon a liquidity event. The lawyers also could have discussed the various estate planning options available to Gary and John to reduce the impact of federal and state estate taxes.
They would help the family decide whether to pass ownership to the cousin group through inheritance or purchase, whether a generation-skipping trust would be appropriate, and what funding alternatives might be available. If Gary and John had started this conversation early enough in their lives, life insurance trusts could have become a powerful funding vehicle for family transfers. Other trusts could have played a role in addressing voting rights and wealth distribution between family branches.
Minimizing tax liability. Estate taxes can be a significant burden on a family business. Intentional early planning can provide opportunities to lock in lower valuations for estate tax purposes and to lower premiums for insurance policies, which can provide much-needed liquidity at the time of an estate event.
If John and Gary had created a family trust, they could have avoided the tax issues faced at the time of Gary's death. Some families create one voting trust and place the shares of the business into the trust to address wealth transfer issues for the next generation. Some families have multiple trusts created by the individual owners. If there are two or more trusts, the issues surrounding share ownership, voting and wealth distribution must be mirrored in each trust. The trusts must align with the provisions of the shareholder agreements and the documents that control governance. Alignment helps prevent conflict between the various roles and responsibilities of each system. It also takes into account multiple laws to avoid the risk of future litigation. Trusts can also ensure that the interests of nonoperating owners are represented.
Many family business owners who reside in the United States are advised to utilize trust structures to protect their wealth and business from estate taxes. The tool is an effective tax avoidance mechanism, but it has complications. There are two kinds of trusts, revocable and irrevocable. While families who place their wealth and operating businesses inside irrevocable trusts benefit from tax protection and legal protection, this type of trust cannot easily accommodate ownership changes.
Trusts are usually put in place for multiple generations. The complications arise in trustee and beneficiary role clarity, communication regarding the “why” of continued family ownership, liquidity of assets, and exit options. These trusts often prevent the beneficiaries from having a strong emotional connection to their interest in the assets inside of the trust, including the business. Beneficiaries complain that they do not feel like owners. These challenges can be overcome with good planning, governance within the trust, and the hard work of building relationships between the trustee(s), beneficiaries, and family enterprise leaders.
Responding to changes and committing to the future. Estate plans may need to be adjusted based on changing circumstances. For example, some members of multi-branch families may move to different jurisdictions or even different countries. Their new places of residence may have different tax laws or may provide different opportunities to reduce a tax burden. The family must understand the impact of change and integrate new planning to stay current with strategies to minimize tax liabilities. They must take care to comply with relevant laws and regulations as family members' lifestyles or circumstances evolve. They must review legacy agreements to ensure these documents are not outdated. This may lead to family policy revisions that better reflect family members' current situations. In addition to providing clarity, coordinated estate planning offers an opportunity to educate the rising generation and for all family members to renew their commitment to the family and the business.
Managing interpersonal issues
Although transparency in estate planning within a family business has many benefits, sensitive issues may arise. Here are some of the challenges that might be stirred up:
Differing expectations. Family members may have varying expectations about their roles, their responsibilities in the business and the stake they will inherit. Aligning these expectations can be challenging, especially if there are pre-existing tensions. There are many good reasons to create family employment and participation policies and updates to shareholder agreements that address generational changes. Among the advantages are engagement of the broader family across branches and the opportunity to have frank discussions about roles, ownership and entitlement.
Unequal distribution of assets. Some family members may feel entitled to a larger share of the business or its assets, leading to resentment. This calls for open and honest conversations about fairness and equality.
Fear of change. Family members may resist changes to established structures and roles within the business. Their expectations may be based on how things used to be. Emphasizing the long-term benefits of the new plan and how it will help sustain the business can help overcome resistance.
Complex family dynamics. Family relationships can be complicated, and discussions about wealth and inheritance may bring up unresolved issues. Navigating these dynamics requires empathy and active listening. Engaging a neutral third party to facilitate conversations can help.
Inadequate communication skills. Poor communication can lead to misunderstandings. Building effective communication and relationship skills and establishing a culture of open dialogue should be an ongoing priority. Families need to educate the ownership group and their spouses about the importance of joint planning. We recommend that emerging owners receive education on connected wealth issues. This will help them understand why their estate issues impact their family members, and why tax planning helps ensure the continuity of the family business.
Solving the puzzle
To help ensure transparency, it's a good idea for the whole family to use an aligned team of advisers. The advisers should have a defined organizing principle, which should center on the success of the entire family. Owners, family members, lawyers and accountants should review documents such as the valuation of the company, operating agreements, and estate plans of all owners at least every three years. Think about how the circumstances in your lives — and the laws that govern you — have changed in three years.
Creating a team of advisers who will work together to periodically review, update and amend the controlling documents that connect ownership, leadership and family systems is essential to keep abreast with changes. This review process will help to minimize disharmony and financial hardship. With repetition, the process becomes less of a burden on time, emotions and costs.
Addressing potential problems proactively and implementing strategies to facilitate communication can help an enterprising family navigate the complexities of estate planning more effectively. Building a culture of openness and collaboration is essential for the long-term success and sustainability of the business across generations.
And let us not forget the satisfaction of finally solving the Rubik's Cube – a sense of accomplishment and comprehensive planning that increases the odds that the family's business legacy will be preserved for generations to come.