Seeking Succession-
Trusts: Protecting Your Family Business
By Loyd Rawls
There is a common saying, "You cannot control beyond the grave." For the most part, this is a true statement; however, in estate planning, to a limited degree, trusts do allow a decedent to control the management and disposition of assets beyond the grave. A trust is a legal entity taken from English common law, created by an individual or institution that delegates specific management authority over the assets within the entity.
Trusts come in various forms as defined by the nature of the management activity and the laws of the location of the trust. There are grantor trusts, such as the Revocable Living Trust, beneficial trusts, and testamentary trusts. A grantor trust is an asset management entity that is created for the benefit of the grantor. A beneficial trust is an asset management entity created for a second party. Living trusts are created during the lifetime of the grantor. Testamentary trusts are created after the grantor's death by his last will and testament. There are revocable trusts and irrevocable trusts. As the names imply, some or all of the terms of an irrevocable trust cannot be changed, whereas the terms of a revocable trust are changeable by the grantor or a party the grantor may designate within the trust. Within the parameters just described, there are an infinite number of utility trusts carrying titles that describe their function. Limited only by the creativity of estate planners, the list of utility trusts includes, but is by no means limited to:
- Voting Trust
- Term Trust
- Qualified Terminal Interest Property Trust
- Blind Trust
- Life Insurance Trust
- Key Man Capital Replacement Trust
- Skip Generation Trust
- Disclaimer Trust
To be recognized and binding, trusts should be, and in some cases must be, in writing and executed with the same formalities as a will. However, there is also an oral or parole trust. In other words, one party can say to a second party "You are my trustee," and if the second party agrees and acts like a trustee, then this may be a legally recognizable trust. This may seem farfetched, but I worked with a woman who had massive land holdings which she planned to divide among four children. She was in poor health, and in my presence she told her oldest son, her attorney, and one other child that the oldest son was to be the trustee of her estate and responsible for dividing the property among himself and his three brothers and sisters. She further asked the attorney to start drawing up the necessary legal documents to formalize this arrangement. The oldest son began administering the estate on behalf of his mother. The woman died before a written trust could be funded.
Later, one of the children became disgruntled with how the older brother was dividing the property and brought suit, contending that no trust existed and that all of his mother's estate must be administered through the probate court. Needless to say he also petitioned to have himself appointed executor. Much to my surprise, a trial and several appeals affirmed that the probate estate had no control over the assets because the woman had verbally and legally formed and funded a trust. Although it is interesting to note the versatility of a trust, formally adopting a written trust document and transferring the title of assets to the trust is a safer, simpler, and less costly adoption procedure.
The purpose of a trust is to provide asset management and administration. The authority for trust structure, management, and taxation is found in state and federal statutes. The trustee or co-trustees are designated by the trust instrument as the parties responsible for asset management. The authority and responsibility of the trustee are specifically described in the trust and generally in the state and federal fiduciary statutes. Depending upon the wishes of the grantor and the discretion of the drafting attorney, trust documents carry varying authority and responsibility of the trustee. From both a general asset management and a family business succession perspective, a trust should be as specific as possible to protect the grantor's intentions. If you question whether the trustee will do what you want done, give specific instructions. Prudent, on-the-spot judgment is the vital asset that a trustee provides. Specific intentions regarding the management of an asset, especially a family business, or the distribution of an asset, must be supported with specific instructions within the trust document. Otherwise, the best judgment and subsequent actions of the trustees may be contradictory to what you feel is prudent.
A trust is the classic instrument to provide for the continued management of estate assets. Most business owners develop substantial assets independent from the business through retirement plans and personal investments, which require competent, if not professional, management. Business owners often question why I recommend successor asset managers. The hard reality is that a business owner's death is usually preceded by an extended period during which husband, wife, or the survivor is not capable of meeting the demands of asset management because of either health or mental acuity. In addition, the spouse who manages the assets could die first, leaving the surviving spouse with the dilemma of asset management. One or more of the children who are beneficiaries of the estate may also lack the knowledge, experience, or maturity to deal with asset management. Addressing asset management contingencies is a very important estate planning issue, for no one wants hard earned assets to be squandered away due to poor management.
Responsible estate asset management is very important to the achievement of estate distribution and business succession goals. If you have no doubt whatsoever that a spouse, son or daughter can manage the assets allocated to them, designate them as trustee of the trust account that you provide for them. Give them the power to select co-trustees to help manage the funds or the power to terminate the trust and take free and clear ownership of the assets, reflecting your total confidence in their good judgment and financial acumen. Do not complicate their lives by requiring that they work with a trustee or even maintain the trust.
Under any other circumstances of less than total unreserved confidence, provide a trustee or a co-trustee for asset management assistance. Trustees can be individuals or institutions. Being a trustee is a significant responsibility, so pick someone who can deal with this assignment. Also, be realistic as to the capability of a potential trustee to manage your family's assets. Just because an uncle or a close friend is a "good guy" does not mean he is a qualified asset manager. Just because your attorney is a whiz bang litigator does not mean he/she is qualified to manage a portfolio. Remember, if you designate your attorney as trustee, a conflict of interest may require him/her to hire another attorney to represent the trust.
When you do not have confidence in a qualified individual, select a responsible, bright individual to serve as co-trustee with an institution that has a good track record of success as an asset manager. This individual will keep the institution in touch with the important issues of the beneficiaries and serve as a balance to the bureaucracy and personnel turnover of the bank or trust company. The institution will take care of investing the funds, providing the accounting and investing the funds. As the beneficiaries of your trust reach age twenty-five, allow them to serve as co-trustees with the institution. They will learn a great deal about financial management that will be of significant value when the trust is distributed.
In the event it is necessary for you to utilize an institutional trustee, do not burn any brain cells trying to pick the "best" institution. Financial management is a dynamic profession which is subject to ebb and flow because of turnover of talented personnel, mergers, changes in corporate policy, and change in location of the beneficiary. What you think is a great institution today could be an awkward arrangement or real loser in five, ten, or fifteen years. In lieu of designating a specific institution in the trust document, empower the co-trustee, beneficiary, or, in case of a minor, the guardian of the beneficiary to appoint an institutional trustee at the time of need. Equally important, give this same individual the ability to discharge the trustee and select another one if he/she sees fit. I assure you that with this "portability provision," the institutional trustee will return calls faster, be more conscious of trust expenses, and spend more time in genuine communications to keep their customer satisfied.
Family businesses have a unique culture and are, for the most part, not compatible to management by an uninvolved third party such as a corporate trustee. A corporate trustee or an individual trustee who is given responsibility for business management should be familiar with the culture of your industry, your business, and your family. Otherwise, giving the trustee responsibility for anything other than supervising the liquidation of your business could prove disastrous. I would not even recommend utilization of a corporate trustee or an independent third party trustee to sell the business on behalf of your beneficiaries. They often do not understand the unique nuances of business valuation. Do not overestimate the capability of corporate trustees or third party trustees to serve any important role critical to your business or your family's value in your business.
There is an abundance of trust management needs for family business interests. Children may be minors or unprepared to assume a responsible role in ownership or management. Financial security and/or deferral of estate taxes may dictate that the business interests be maintained in a trust for the benefit of a surviving spouse during their lifetime. Circumstances, such as the lack of estate liquidity, may dictate that family members who are not active in the business receive interest in the family business. Under all reasonable circumstances, control of the trust holding the business should be directed to a responsible person who is knowledgeable about the family's business, respected as a leader, and motivated to achieve optimum business operating capability.
Loyd H. Rawls, CLU, ChFC, MSFS, of The Rawls Company in Orlando, Florida, has specialized in family estate and succession planning for closely-held, family owned dealerships since 1973. Well respected in his field, Mr. Rawls is a highly requested speaker and has contributed to many publications on this subject. lrawls@dealeronline.com.
