By John Ambrecht on October 4, 2013
The drive to survive — one of humanity’s strongest, most basic instincts — has become both friend and foe to family businesses in the Tri-Counties. While it has created mega-wealth for many, it has also led to the loss of significant family fortunes when power-holding parents pass away and family businesses are transferred to heirs.
Roughly 66 percent of tri-county families tend to lose their wealth after the first generational transfer, and only about 14 percent succeed to the third generation.
But some regional families are beating these odds. Here’s how:
• First, they don’t buy into the “not my family” belief. Ask most professionals in the legal estate planning profession and they’ll tell you they often hear clients say: “Not my family. My kids would never treat each other that way. My brother would never do that to our family business. My son would never try to steer me or our business in an unhealthy direction. My second spouse would never treat my children like that.”
Successful families who hang onto their generational wealth usually recognize that passing the business baton and an inheritance to the next generation almost always changes how heirs view and treat each other, and that old family issues typically resurface when parents pass away. They also recognize that natural survival instincts often manifest in negative behaviors such as narcissism, greed or sibling rivalry, and they plan for this potential fallout ahead of time.
• Second, families that beat the odds recognize that private family matters quickly become public and extremely costly in a court of law if they’re not handled up front. The most successful planning approaches deal with a family’s emotional hot buttons before they start dealing with assets and numbers.
• Third, successful families embrace H.B. Karp’s philosophy in his book, The Change Leader: “No human being has the right to make a unilateral decision that affects the lives of other individuals without offering them a voice in that decision.”
Here’s a real-life example with names and titles changed to protect the privacy of those involved:
Fred and Pat built a small, lucrative commercial real estate empire of office and apartment buildings. They also turned the avocado groves on their tri-county ranch into an income-producing business. Their real estate holdings suffered badly during the Great Recession, but they had made millions over the years and their holdings are recovering.
They had two sons and two daughters by prior marriages and one shared son. All but one — Pat’s middle son, Jack — lived locally and worked in the family business.
Before starting the planning process, Fred and Pat engaged professionals and involved their children, giving everyone, including spouses, a voice. Their attorneys brought in a family communications specialist who helped the family and their lawyers work through personal and family issues that people are often reluctant to discuss with a lawyer. Everyone signed a legal paper confirming that Fred and Pat were the actual clients and reserved the right to make all final decisions.
Fred and Pat asked their children for input on every issue that could impact them after the parents passed away. The kids admitted that conflict would likely happen. With the help of the communications expert and attorneys, the children presented ideas to their parents. The professionals emphasized that change is hard, especially when there’s a death — it’s a process, not just an event, and it takes time.
Fred and Pat considered most of the recommendations fair and gave permission to include their children’s ideas in several legal documents, including a Shared Family Limited Partnership and a Management LLC with special management provisions, which they all learned to manage together.
By the time Pat died, the eldest son, Jim, was running the company. Jack, the middle son, came home for Pat’s funeral and stayed, and a year later, after an unhappy period of widowhood, Fred took a new wife. Jack, who’d been gone for awhile, started questioning his brother’s decisions at the helm of the family business; Fred began to hear his new wife’s worries about being protected if he died before her; and Fred’s daughters became defensive, trying to mediate between their two older brothers. The youngest son, Matthew, just tried to survive it all while working part-time in the family business and finishing college.
Fortunately, the family had set up the family limited partnership management structure in advance and had a plan for resolving conflicts. That reduced these potential challenges to small irritants, which they successfully worked through.
The preparation also helped the family reduce their estate tax burden. The evidence of working together within the management LLC had a solid track record by then, which meant the IRS couldn’t argue that the family’s legal structures and estate tax deductions were solely about reducing estate taxes. The lesson is that creating a successful succession plan is not easy, but it’s worth it to do the work up front and mitigate your risks down the road.
• John Ambrecht is the managing partner of Santa Barbara-based Ambrecht & Associates, an estate planning, trust, tax and tax litigation law firm. Contact him at firstname.lastname@example.org.