Happy Business Families
Over the years, a multitude of articles have been written by trust practitioners on the topic of trustees holding the shares of family businesses. The majority of these articles have been technically robust, and generally focused on the information a trustee should request, review and, if required, react to. They have suggested when a trustee should be directly or indirectly involved with a family business’ management, and discussed what should be expected in relation to the ongoing management of the family business.
All of this is, of course, essential and, one could argue, the very basics of what should be expected from a trustee when holding assets of this nature. The poor administration of these assets can not only be detrimental to a business’ reputation, but also to its ability to continue. Case law is littered with examples of what a trustee should not do, and, thankfully, legislation has evolved to ensure greater flexibility and surety for trustees holding such assets. There are, however, other considerations that are rarely discussed in the literature, but that are equally important in relation to the effective management of a fiduciary relationship with a family.
Most trustees will acknowledge that, when family-business shares are held in a trust structure, the beneficiaries will have a greater emotional attachment to the asset than if a trust were merely holding a portfolio of marketable investments, or some other form of direct investment. The authors’ own experience has demonstrated this and highlighted the need for a far more proactive approach, and greater care in relation to a family’s values, internal dynamics, culture and the assumed rights regarding what is often the principal trust asset. A trustee who is unaware of these factors can complicate their role when interacting with the beneficiaries and administering the structure. It is not suggested that a beneficiary’s rights are in any way reduced or lesser if a different class of asset is held – merely that the deep emotional connection to a family business will require a trustee to be more aware and proactive when managing the ongoing relationship with the beneficial class.
Managing A Trust Structure
It can be argued that the trust industry has evolved at a greater pace in recent years than at any other period. This has resulted in a number of changes, with trustees now focusing much more of their resources on emerging markets. At the same time, on account of the perceived fiduciary, business and reputational risk, there has been a significant reduction in the number of trustees willing to accept family business shares into trust. These two developments are quite ironic, as, with a greater focus on emerging markets, there is an even greater demand for settlors to place family business shares into trust. In emerging markets, the family business is seen as an extension of personal wealth and the need to place the shares into trust is often greater than in developed markets.
When managing a structure holding such a complex asset, it is important to properly understand the settlor’s rationale for establishing the trust. Settlors often tend to settle assets of this nature into trust for succession-planning reasons (seeking to ensure the business is not broken up on their death); to maintain and ensure confidentiality and security; for taxplanning purposes (in instances where it is not necessarily fiscally punitive to settle shares into trust); and to provide a degree of asset protection from political and economic volatility (although the degree of protection provided if the assets remain in the family’s home jurisdiction, unless there is specific treaty planning, is debatable).
If a family’s wealth has been earned relatively recently, certain challenges arise when settling the business shares into trust. Such challenges can, at a basic level, be split into three groups. The first two are relevant during the settlor’s lifetime and the third will be relevant after the settlor’s death.
Ensure The Structure Is Correctly Established
The initial challenge is to make sure the structure is correctly established. The most effective way of doing this is to engage a properly qualified legal professional to work alongside the family, and an experienced trustee to draft the relevant trust documentation. The deeds should be drafted to take into account the high risk and challenging nature of the asset, and the family’s emotional and dynastic connection to it. The deeds may, if appropriate, contain reserved-powers provisions in respect of the family business. Depending on the family’s wealth and its level of comfort with gifting away its assets to a professional trustee, a private trust company may be a suitable structure to hold the family business shares.
Establishing The Settlor’s Boundaries
The second group of challenges involves working with the settlor and advisors to establish the boundaries of what the settlor can and can no longer do with an asset they previously owned and had absolute control over. A trustee must also work to ensure that, where possible, there is ongoing and constructive access to the second and maybe even third generation of beneficiaries. A trustee needs to manage the beneficiaries’ aspirations, as some may wish to be involved in the family business and some may have their own entrepreneurial ideas.
Implementing A Family Constitution
In addition to the family members, there will be other stakeholders in the business with expectations in relation to its long-term stability, ongoing management and future success. These will include the management team, the employees, financial institutions and outside shareholders. Managing these stakeholders’ interests and expectations as regards the business is important in order to avoid potential future conflicts.
Where possible, a family constitution should be implemented. This provides the framework upon which the family’s a! airs, including its business, will be governed. It is, in effect, a statement of agreed values, aims and relationships. It is best if the family constitution is agreed during the patriarch or matriarch’s lifetime, with the input of younger generations. Although not legally binding, it can set out how often family branches meet, what should be discussed,
how members of the family will react to various situations, how benefit should be taken from the business, mechanisms by
which conflict can be successfully managed and resolved, and the authority of individuals involved with the business.
Communication is key, and it is vitally important for a trustee to have frequent and meaningful contact with the family. This will mean regular interaction with both the family and its advisors in order to understand the family’s dynamics, the importance it places on certain values and its investment strategy and philosophy. A trustee needs to meet the younger family members to establish an enduring relationship with them and to remind the family of the trustee’s role and responsibilities in holding the family business. The ethos of the family and strategy around the family business should be agreed, to avert future conflict.
Without doubt, the third group of challenges will be compounded if the first and second are not duly considered and properly tackled. All too frequently, the death of a patriarch or matriarch will result in conflict among the younger generation of the family. It is almost an impossible task for family members to agree on any matter if they are in conflict and often the only uniting factor may be a new-found dislike for the trustee (further emphasising, from the incumbent trustee’s perspective, the need to agree matters when the settlor is alive and the family is operating harmoniously).
The Next Generation
When venturing into emerging markets, trustees are increasingly finding that the second and third generations of families wish to deviate from the path set out for them by the first generation. There is a growing desire to either spend family wealth (sometimes with seemingly little regard to earning additional wealth) or to be a success in their own right. Increased globalisation and international migration have resulted in a greater number of families being exposed to western culture, which may be the catalyst for younger family members feeling empowered to challenge what would have previously been accepted. Often without just cause and at great emotional and financial cost to the family, these beneficiaries have attacked family structures that have been established with the very specific purpose of leaving an enduring family legacy.
Before accepting such a complex asset into trust, and despite all the changes in legislation, regulation and case law, a trustee must remember that its underlying fiduciary responsibility has not changed, and neither has the business and reputational risk of incorrectly administering a specific asset or structure. Over time, the number of variables that can weaken a structure have increased and, with this in mind, trustees should have evolved to compensate for these changes. Trustees should now be positioned to mitigate many of the risks associated with holding family business shares as trust assets. The risks that cannot be mitigated should be carefully managed not only through processes and controls but also through education, careful planning and strong communication and relationship management. Ideally, multiple generations of a family will work together with their advisor and trustee to ensure ongoing family harmony and the continuation of a dynastic structure holding a family legacy.
STEP, Februrary 2015