Trust & Estate attorneys advising wealthy families and their businesses are frequently asked by our clients what are the indelible characteristics to help it navigate tumultuous events, stay true to its family’s mission and thrive?
Unfortunately, many families are sometimes intoxicated with the acronyms that promise to mitigate the pain of impending estate taxes at the expense of ignoring other important family and business planning issues. Similar to television commercial advertisements that sound too good to pass up, many affluent families become consumed with tax structures like FLPs, QPRTs, GRATs, CLATs and IDGTs, just to name a few. These indeed can be valuable planning tools, but alone, they do not adequately address the myriad challenges facing multi-generational family business enterprises. Large extended families with diverse business interests are like ships at sea. When the weather is fair and the sea is calm, the structural integrity of the ship is not under stress. Vulnerabilities are not apparent and thus, are not addressed. Even if recognized, action to deal with important issues is deferred under the guise of not being imperative. Unfortunately, the weather never stays calm and every family will, sooner or later, enter a tempest. It could be unexpected and internal, such as the untimely death of a family patriarch or matriarch that provided the “glue” keeping the family together, or external business factors that materially degrade the ability of the family business to generate the cash distributions to which family members have grown accustomed. When this occurs, a governance structure that lacks transparency and accountability, and one that ignores the importance of minimizing conflicts of interest, can quickly digress into a perfect storm, endangering the fabric of the family and causing stress to its businesses.
We remain surprised at just how many families, with significant business interests, fail to take the time to understand the balance needed to perpetuate a family’s legacy. Good tax planning combined with a thorough understanding of the characteristics that enhance a family’s chances to endure and remain important within their communities may be just as valuable an asset as any of the previously referenced tax planning acronyms.
Many advisors who serve large family enterprises take note of the importance of having a strong governance structure represented by a family board of directors. While a strong governmental structure is not the sole attribute of what makes a family business endure over many years, it is nonetheless a critical component.
Wishful hoping that the family will just deal with episodic events such as family arguments and generational planning issues as they arise will likely spell disaster when these lifetime events occur. As a matter of fact, we all know that events, such as selling a family enterprise, arguments, tumultuous markets, finding the liquidity to resolve the impending payment of significant estate taxes, etc. will occur, but we simply don’t know when.
So, why are governing boards so important? Simply put, a board’s primary responsibility is to act in a fiduciary capacity to protect the interests of the stakeholders (primarily family members), and to help enhance the success of the family enterprise. Among many fiduciary duties is the age old duty of loyalty, which requires that the interests of the corporation (or family enterprise) comes first, and trumps any personal aspirations (or conflicts) that a director might have in relation to the family enterprise. Obviously, the board must understand the values, needs and goals of the family and its shareholders to properly carry out its functions. A well-functioning board of directors, with contributing independent, non-family representation, will assist the family and its enterprises in navigating a course of policy formation, in developing long-range objectives, and in monitoring the strategic plan as it is carried out.
TEN BENEFITS OF AN ACTIVE BOARD*
Who should be chosen as a board member? Business competencies are obviously important, but it has been noted that “…The most critical qualification is having the ability to hold the company accountable and the discipline to not interfere in the company operations. The board of the typical family firm should have competencies, such as communication, open dissent, understanding of business, and collaboration with management, to ensure strategic guidance of the company, effectively monitor management, and be held accountable to the company and its shareholders.”*
But contemporary family governance does not end here. Families and their boards should establish structures for dealing with intra-family disputes. These emotionally charged and financially draining events are likely to occur in all families. It is somewhat surprising to learn that according to one study, more than two-thirds of surveyed family-held companies have not adopted any procedures for resolving conflicts between family members (Pricewaterhouse Coopers Family Business Survey, 2007/2008). Considering that family-held businesses often involve conflicts, this is indeed an alarming figure. An internal conflict policy adopted by the family board, while not a guarantee of peace and tranquility in family and business affairs, does help mitigate the consequences of these lifetime events, and at least can create a predictable methodology for resolving conflicts other than through traditional legal means.
A WORD OF CAUTION
It is not unusual for the parents of large family businesses to leave their equity interests to trusts contained within their estate planning documents. However, very careful attention needs to be paid to family frictions that can be ignited when clients carelessly nominate Trustees within wills and family trusts, when these same Trustees occupy board of director positions of the family enterprises that comprise, in whole or part, the corpus of the trust. Most clients know intuitively that Trustee(s) must act solely in the interests of all trust beneficiaries. It goes without saying that a Trustee cannot transact business with trust property for any personal benefit. But in family enterprises where there may not be that many trusted advisors who are willing or able to serve as a fiduciary, it is tempting to simply default to a director who is also a family member, to serve as a Trustee. But query if this is always prudent.
Without a system of checks and balances, the appointment of a Trustee who is also a director or CEO of a trust that owns or operates a family business can easily compromise the general fiduciary duties of loyalty and impartiality that any Trustee owes to all beneficiaries. It is not hard to imagine situations arising where some minority family members might feel alienated and estranged when they cannot impact the decision making process due to the fact that they are neither an officer of the company or a Trustee of the trust that owns the family’s business interests. While it is often noted that not all conflicts are conflicts of interests preventing the interested family member or board member from serving as Trustee, diligence must remain high to carefully plan with your counsel and other professional advisors the structures of governance that remain viable and elastic over extended periods of time.
- The Loyola Guidelines for Family Business Boards of Directors, Joseph Astrachan, Andrew Keyt, Suzanne Lane and Kristi McMillan, Loyola University Chicago.