Dispute Management

THE FAMILY TRUST:  One of the Great Misnomers of Our Time

Published: 2007 05 04 | Views: 1771

Lawyers and accountants in the estate planning field often recommend setting up a trust to their 60- or 70-something family business clients.  This is typically done for tax or creditor-proofing reasons and often in circumstances where the client does not feel comfortable leaving shares of the family business to the children or one or more of them.  From the point of view of the client, this is a happy result.  The question is how happy will it be for the children who might one day become next-generation owners of the business. 

A typical scenario goes something like this.  Father and mother go see lawyer to have a will drawn up.  Lawyer tells them that there will be no capital gains when one dies but when they are both gone and the shares of the business are passed on to children there will be tax.  In order to minimize the tax, lawyer says, we can do an estate freeze where father and mother acquire preferred shares at current fair market value.  We then set up a trust for the children which will own the common (growth)  shares and thereby defer the taxes on any increase in value over the current fair market value. 

Most family business owners today are aware of the statistics that only 30% of family businesses survive to the second generation and only 10% survive to the third generation.  These are not happy statistics for members of the senior generation whose dream has been that one day the business would be passed on to their children.  One of the biggest culprits for these poor statistics is in my view the trust structure itself.

The estate planning lawyer is hired by the entrepreneur, not by the family business and not by the next generation.  The focus of the exercise is usually on taxes,  creditor-proofing and other “hard” issues of concern to the client.  There may or may not be a discussion as to the effect of this structure on the next generation and if there is it is not meaningful particularly where the next generation is not involved in the conversation. 

If there was a full and open conversation that considered the interests of the next generation as much as the senior generation, the resulting structure or at least the terms of the trust might be very different.  What is it about the nature of a trust that is so much at odds with the interests of 30- and 40-something year old members of the next generation with senior roles in the family business?  Pretty much everything.

It is bad enough when someone owns a minority interest in a private company.  The rights of a shareholder in that case are fairly limited but at least there is entitlement to review the financial statements annually and ask questions and in the event of a sale be entitled to a share of the proceeds.  However, in the case of a typical discretionary trust, there are no rights whatsoever, not even the right to one day own the shares!  The “child” (who by now has children of his or her own)  is only entitled to something if the trustee(s) say so. 

Many aspiring children of a family business have heard for years from their father “one day this will all be yours”  and are still waiting for that day!  Or perhaps the child is too respectful or fearful of the father to even ask about ownership rights let alone insist upon them.  In either case, such a scenario does not bode well for successful next-generation ownership for the simple reason that the child does not get to experience the joys and responsibility of ownership. 

The senior generation owner is so busy protecting his or her interests in setting up the trust that he forgets a big part of what it was that made him successful in the first place.  The fear of failure often is what drives a successful businessperson yet with a trust and with a protective approach towards children that often comes with financial success the child is often unwittingly denied the opportunity to succeed.  Just as a young child must be allowed to make mistakes in order to grow, so too does the aspiring next-generation owner of a family business.

There is a movement afoot in the United States called “holistic estate planning” whereby it is not just the father and mother that come in to see the lawyer, the children are involved as well.  There is no reason why this approach should not take hold in Canada as well.  I am starting to work with forward-thinking family business owners in this area and the reaction has been great. 

So the question is – should the family trust be called a “trust” or would it be more accurate to call it a “lack of trust”?  The trust threatens to be one of the great misnomers of our time.


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