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Wealth Transfer Challenges for Family Businesses

Shaping Your Legacy - Mistakes to Avoid

Introduction

Amongst the wealth transfer challenges for family business are the questions: “Who will receive your estate when you die?” and “Will your estate pass in accordance with your wishes?”

The estate planning needs of high-net-worth individuals (HNWI’s) require sophisticated and complex estate planning arrangements. Surprisingly, a high proportion of people fail to properly plan for the passing of their wealth to the next generation. Inadequate attention to proper estate planning can often result in unintended consequences and poor outcomes for beneficiaries. The following examples illustrate this.

1. Not having a valid Will

You should have a Will which you review regularly to ensure it still accurately reflects your existing circumstances and estate planning goals. This is particularly important when your family situation changes. Both marriage and divorce revoke a Will or provisions within the Will, unless your Will has been made in contemplation of such changing circumstances.

Example: Frank failed to make a new Will following his marriage (his second) to Valerie. Therefore, when Frank died, he did so “intestate” and his estate was distributed according to the relevant laws of the jurisdictions in which he owned his wealth.

Frank was survived by his second wife, Valerie, and their child Frank Jr. He was also survived by his three older children from his former marriage. Frank had made a property settlement with his ex-wife Geraldine, and had intended by that settlement to provide for his older children. Frank’s wife Julie received a little more than one third of his estate with the remainder shared between his four children.*

*This is one possible outcome. As noted, the distribution of an intestate estate differs from jurisdiction to jurisdiction.

2. Failing to consider circumstances of intended beneficiaries

A valid Will should ensure that the intended beneficiary receives the gift at the appropriate time and in the appropriate circumstances. The use of trusts within a Will can protect assets for vulnerable beneficiaries.

Example: Robert’s Will gifted his estate equally among his three adult children. Robert’s son, James, was the director of a trading company. James’s company failed and James became bankrupt. James’s share of Roberts’s estate passed to the Trustee in Bankruptcy. 

With proper estate planning, Robert could have created a structure where James’s inheritance was protected from creditors.

Vulnerable beneficiaries may also include those with health issues, especially mental health issues. Failure to accommodate their needs in the estate planning process could also stand to jeopardise their financial and overall health well-being.

3. Failing to include a Testamentary Trust

One of the most significantly powerful tools in the estate planning armoury is a testamentary trust – a trust created within a Will. Where the beneficiary has children, the gift of an inheritance via a testamentary trust can provide asset protection as well as significant tax advantages.   

Example: Allen and Robin were a professional couple with four young children. Allen passed away suddenly with his Will gifting his entire estate to Robin. Notably, all assets were held in his name only. Included in Allen’s estate were the proceeds of a large life insurance policy.

When Allen’s assets were distributed to his wife, she invested the proceeds of the insurance policy in a diversified portfolio of investment assets which generated an annual income of $90,000. Because of her other income, Robin paid income tax on the earnings of the investment portfolio at the top marginal rate. Consequently, this left an after-tax income of approx. $49,500, which she used to part-pay the school fees for the children. Had Allen’s Will contained provisions for the establishment of a discretionary testamentary trust, Robin could have reduced the tax on investment earnings from $40,500 to approximately $3,000, leaving nearly $87,000 to apply for the children’s education expense.**

**These are approximate numbers assuming the taxpayer is on the highest tax rate.

4. Not talking to your family members about your decisions

Having a family discussion about the contents of your Will and wealth succession plans can be difficult. The benefit of including your family in these conversations from an early stage, however, can help to ensure that your wishes are carried through.

Example: Christine had established a charitable foundation and was concerned that upon her death the legacy that she had established would be forgotten and come to an end. By having a conversation with her children, she was relieved to discover that two of her daughters shared her philanthropic passion.

Arrangements were then made to bring the children into the management of the foundation. If you want your children to be involved in the ongoing management of your philanthropic donations, it is prudent to ensure they are aware of your goals and intentions so that they can carry on your legacy as intended.

5. Only looking at some of the picture

An estate plan is not limited to merely having a valid Will. Estate planning includes making appropriate arrangements for the passing of all your wealth, including non-estate wealth such as life insurance and superannuation. 

Example: Ann-Marie was a single parent who wanted her three children to benefit equally from her estate. She made a simple Will to this effect.

When Ann-Marie died suddenly, aside from the residence, her main asset was superannuation, including a life insurance held within the superannuation account. Mary did not have a death benefit nomination in place. One of her children was a financially independent adult working as an accountant, while the other two were school aged children living at home.

The trustee of the super fund decided to pay the death benefits to Ann-Marie’s deceased estate. Her Will contained no provisions relating to the treatment of superannuation proceeds. This resulted in a portion of her superannuation death benefit being subject to tax, thereby reducing the value of her estate. Also unfortunately, Ann-Marie’s Will also didn’t address the greater financial needs of her school-aged children. This increased the risk of a challenge to her Will by the guardians of her minor children. Moreover, the minor children would receive their full entitlement upon attaining 18 years of age, which may not have been appropriate for vulnerable children affected by the premature loss of their sole parent.

A Brief Guide to Passing on a Family Business

Transparency

One requirement in handing a business to children is transparency. 

One of the most common questions related to family businesses is, “how can a successful business be passed on to the next generation?”. After all, the preservation of wealth and family legacy is paramount to those who have dedicated their lives to ensuring the success of their business.

It is for these reasons that many owners of family businesses begin planning the succession while the next generation are still very young.

Succession is a lengthy process. It can generate feelings of great anxiety and insecurity for both the older and younger generations. Hence, it is essential that it is well thought out and meticulously planned.

In practice, it is advisable to prepare for an active succession period lasting between five and 10 years in order for it to be a comprehensive and thorough transition.

Important things to consider in a succession process

  1. Communication

Family business owners and executives sometimes comment that the younger generation lacks drive. This is often a misinterpretation: younger family members are usually keen to become involved in the business, but are often waiting for a sign from their elders. In the best cases of succession, the process is an ongoing partnership between the two generations, rather than a one-off transfer of power. Open communication is crucial to this partnership as it enables everyone to express themselves freely, thereby creating a solid foundation for trust and transparency.

  1. Good planning

In order to avoid family disputes, family wealth and executive power within the family business should be distributed fairly – accounting for the competence of each individual. This should always be in a process fully explained to the younger generation. Good planning, alongside sound communication, will help all members of the family understand why certain decisions are being made and allow them to readily accept the outcome of the distribution.

  1. A fair process

When important decisions are made in regards to the distribution of family wealth and executive influence within the family business, each family member will inevitably interpret them differently. What may be fair for some may appear unjust to others. The succession process should therefore incorporate clear and transparent rules, and these ought to be applied to everyone – without exception.

  1. Family agreement or constitution

A family Constitution is a document that sets out the rules for relations between the family and the business. No two Constitutions are alike. It is extremely important that family business stakeholders take sufficient time and consideration to draft this defining document so that all its rules and regulations are clear and fair. By having each family member participate in the discussion process that defines the Constitution, the family can reach a collective understanding and implement it effectively.

  1. Role of the parents

It is the role of the parents to transmit a healthy business and instil their children with strong values and business acumen. However, the outgoing generation often has a difficult time relinquishing their hold on the business they’ve loved and built over such a long time. Parents must find the courage and resolve to bequeath the family business to their children and to let go.

  1. Role of the incoming generation

It is the responsibility of the incoming generation to show motivation and commitment to the business as well as to the family values. Once they take over the family business, they should dedicate themselves to nurturing and protecting the institution their family has built.

Credit: Denise H. Kenyon-Rouvinez, Wild Group Professor of Family Business at International Institute for Management Development Business School and Director of IMD Global Family Business Centre, in Lausanne.

Summary

The wealth transfer challenges for family businesses, as you can hopefully see, should never be under-estimated.

As such, we trust that by now, you have a much better understanding of these challenges and why it’s so important for them to be recognised and addressed – the right way. If you’re still having trouble making sense of all the information we’ve given you here, we encourage you to talk with an experienced estate planning adviser about how they can help you achieve your succession planning objectives.

 

How FBA Can Help You With Your Estate Planning Challenges

At Family Business Advisory (FBA), our purpose is to help family businesses succeed on a sustainable basis. As such, we provide you with access to specialist family, business and technical services with a goal being to generate opportunities for families in business.

In order to complement our own particular specialised skills, over the past several decades, we have developed a network of trusted, professional advisers in such areas as:

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Moreover, we work at all times to give you peace of mind and proactive support to help navigate any changes in the market brought about by legislative changes, geopolitical events and general market conditions – all to maximise your personal wealth and security.

These services are provided by FBA, in association with the Wealth IQ Group.

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