Charles A Lowenhaupt is chairman and CEO of Lowenhaupt Global Advisors, a North American family office. Charles will be speaking at Campden Conferences' European Family Office Conference in London.
Charles Lowenhaupt explains how US families can use 'dynasty trusts' to ensure their business and financial legacy lives on beyond their generation – but the real key is finding the right trustee wealth steward to manage the assets beyond the benficiaries' lifetime
An elderly client was receiving a lesson in governance structures and tax savings, learning about trusts that could "last forever" to protect his progeny for evermore. His teacher was a young lawyer, eager to help his client set up this perpetuity of control. But the elderly client nodded off, unimpressed by the possibilities. As lunchtime approached, he looked at his watch and said he had to leave to go to his club, play golf with his friends and then return home for the afternoon to his young "trophy" wife. As he stood to leave I pleaded: "What about your children, grandchildren and great grandchildren? Don't you want to provide for them?" He replied: "Young man, I am too busy for this nonsense. Besides, what has posterity ever done for me?"
A lot it seems. Perpetuity trusts, or 'dynasty trusts' as they're more commonly referred to, are offered through most US jurisdictions and are a way for the wealth holder to place family assets including the family business into a trust that will last forever. Dynasty trusts make it possible to think of wealth as belonging to a family forever, run by trustees, and allowing the creator exemption from generation transfer tax – currently scheduled to increase to $3.5 million a person or $7 million for a US-domiciled husband and wife.
The beneficiaries of a dynasty trust do not own the trust or the assets – the trustee is the one with legal ownership and control. What this means is that the trust assets are not at risk of being taken by creditors of the creator, are not available to a divorcing spouse and can be held forever for family members, without availability to step-parents or step-children. Trustees control expenditure from assets held in a dynasty trust so any fears of wealth being eroded by a plethora of follies, from a successor drinking it away to a fourth wife taking her share of the company on divorce, are all protected. This means the family business can remain in family hands by way of the trustee. Many jurisdictions throughout the US now offer wealth holders the power to place assets into trusts that will last in perpetuity.
The complications of a perpetual trust are not tax complications, since such trusts can be easily designed to accomplish a variety of tax savings. The complications are complications of management: where does one find the right person to perform the job of the perpetual trustee, managing a portfolio of trust assets on a time scale well beyond anyone's lifetime? How does the so-called 'dead hand' of the trust settler extend its reach through that period of infinity? Trustworthiness, competence and sensitivity are all required of the trustee wealth steward. Selecting the trustee is not unlike the challenge of selecting family members who will be able to perpetuate the family business. These family members have the interest and capacity to run the business through infinite generations, as well as the ability to hire managers with that capacity to take over beyond their own lifetimes. The individual to manage a trust is as difficult to find as the individual to run the family business.
In the US, many successful family businesses are sold relatively early in the life of the business (usually in the first generation) as a way of capturing the value of the business for the family or settle disputes among family members. The sale often captures monetary value but leaves one or more family members without employment. I have watched many children encouraged to enter the family business at age 25 and forced to leave it 20 years later when Dad sells the business to monetise value and prove his own accomplishment.
The business 'sold out from under' the young inheritor by his or her father, though sad, is simple enough compared to what happens when the business is handed to further generations, some of whom do not want to work in the business but are happy to benefit from the dividends. Battles can often result in the eventual sale of the company or, otherwise, business failure. We have all seen fine family businesses ruined by professional management brought in to run the business with little effective supervision by family owners.
The wealth creator needs to consider their objectives while setting up "perpetuity" with or without a dynasty trust. If a primary objective is continuity over many generations, the family should forge a programme with the effect of leaving ownership and control to those family members in the business. If the goal is to give each family member the freedom to realise their own ambitions, then the family should build a strong management structure with a built-in exit strategy, so no family member feels obliged to run the business.
Dynasty trusts can often interfere with orderly management of the business and keeping the business in the family. The clearest way to save taxes is to start making gifts of shares in the business early in its development. Values at this point are low and growth occurs in the hands of future generations. Placing a fledgling business in a dynasty trust can ensure the business and its proceeds are never diluted by transfer taxes, estate, gift and generation-skipping transfer taxes. But remember that those gifts are irreversible and, depending on the age of your children, are likely to take place before you know which one is interested in working for the business and which one is likely to want dividends. The businesses "sold out" from under the 45-year old child working within it is usually owned not only by that child, but also by the child's siblings, nieces and nephews. Trustees holding a business in a dynasty trust are often required to do what is best for those other than the child working in the business.
Here is an example of a business which has a chance of lasting in perpetuity even without a dynasty trust. A 25-year old entrepreneur built a business around timber farming. He amassed hundreds of thousands of acres of land at a cheap price and built a timber operation around the concepts of sustainability and environmental preservation. He and his foresters shared the vision of preserving forests and natural resources while building an economically sound business. The entrepreneur thought of his business as a family business because he owned it and had no public shareholders. As he approached his 70th birthday he had huge wealth in the business (and large wealth outside). He saw that his children were not particularly interested in his business other than as a reflection of his own passion, though any one of them would have come into the business if he had asked. He and his wife had not raised the children to want large wealth and each of the children had their own life and career.
We considered various tax strategies to pass the value of the timber business to future generations under these conditions. Each would have been complex but effective; none would have resulted clearly in the continuation of the founder's passion of sustainable forestry. So the entrepreneur decided to build a functional foundation with board membership by family members, but substantial control of the affairs of the foundation by board members expert in timber and wood products. The entrepreneur spent ten years building the foundation's functionality and then gave his entire forest to the foundation, which will maintain the operations and procedures as the entrepreneur had designed them. In effect, his land is 'curated' by professionals; his business has a chance of perpetually reflecting his passion.
That entrepreneur's example is a model to follow. The lesson is not building a philanthropic structure into which to place the business, though that often works. What is important is the consideration of which part of the business is worth preserving and what purposes the business can serve for the family. It is the soundness of the business and the passion of the creator rather than the technical apparatus of ownership that will propel the business through perpetuity.