How can business-owning families use trusts to transfer ownership between generations, without demotivating and disengaging the next generation?

Last week I attended the annual conference of Attorneys for Family Held Enterprises (“AFHE”). Friday morning brought an excellent presentation by Marion McCollom Hampton and Andrew Hier of OMBI Consulting on “The Impact on Beneficiaries When Family Business Ownership is Held in Trust”. The speakers pointed out that trusts can undermine effective and healthy ownership of family businesses by removing the decision-making authority of family members and weakening initiatives for shareholder education, and by reducing or eliminating the incentive for the family to create governance structures and decision-making processes.

At Withers Consulting Group we recognize that transferring ownership of a family business in trust rather than outright can have a substantial negative impact on the business. Improperly drafted trusts can demotivate and disenfranchise next generation family members, who find themselves passive beneficiaries rather than active shareholders. Inserting a third party – the trustee – into the system can disrupt both the family and the business. However, given the potential upside to be gained from transferring ownership in trust – significant tax savings over generations, protection from creditors (including divorcing spouses), ensuring stable ownership even when the beneficiary is legally incompetent – our goal is to design trust structures for business-owning families that engage the family, promote effective family and business governance, and support business continuity.

As the OMBI team pointed out, and as I’ve emphasized in prior posts, choosing the right trustee for a family business trust is critical. Even more important is granting a trusted individual the power to remove the trustee, and to replace a trustee who has resigned or been removed. This remove/replace power can be held by a family member and won’t cause estate or gift tax inclusion so long as the successor trustee is not “related or subordinate to” the grantor or the beneficiaries (as that phrase is defined in Section 672(c) of the Internal Revenue Code. Thus, the holder of the remove/replace power has substantial indirect power over the trustee, and through that power, the ability to influence trustee decision-making. Typically, the holder of the remove/replace power is called the Protector.

Traditionally, the Protector of a trust has been an individual. At Withers Consulting Group, we suggest that families consider appointing a committee, or sometimes better yet, an entity, to serve as Protector, particularly for dynasty trusts, trusts holding substantial businesses, or other trusts of long duration.

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