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Structuring for success
WE have seen in recent years a surge in discussions on succession planning, partly because for many families, the older as well as the next generation are both "coming of age"; and also due to an environment in which succession structures are under increasing scrutiny.
For many, succession planning is synonymous with trust structures. In our view, while it is important to structure wealth to pass generationally, one should try to focus on how that wealth will be used and deployed towards agreed purposes.
In this article, we will explore three common misconceptions about succession planning and how they may be addressed. We also share three case illustrations on how families dealt with different succession planning issues and scenarios.
First, it isn't just about structuring for fiscal efficiency. For many families, their material wealth comes in different forms such as businesses, investments and land ownership. Increasingly these forms of material wealth are also located in different places around the world. The emerging reality is that the world is becoming "smaller" and many of the next generation consider themselves global citizens, identifying with more than one country. At the same time, various fiscal regimes are ever changing and under more scrutiny; and possibly converging as nations compete and economies mature (eg the United Kingdom headline corporate tax rate went from 52 per cent in 1978 to 19 per cent in 2018; whereas the comparable rate in Singapore tax has gone from 32 per cent in 1978 to 17 per cent in 2018).
Families that structure their wealth purely for tax and fiscal reasons not only find themselves in a constant costly game with authorities but also leave behind a mass/mess of complexity as a legacy that may burden and distract the next generation.
Second, it isn't just about structuring for business succession. In many cases, businesses make up the largest part of a family's material wealth, thus succession considerations weigh heavily into structuring for succession. The first generation fears the proverbial "shirtsleeves to shirtsleeves in three generations" applying to their family and so goes into two extremes: either (a) expending an inordinate amount of energy identifying - even dictating - who is going to assume control and responsibility, deciding how benefits will be distributed, etc or (b) not doing anything at all, having concluded that it would risk too much disharmony within the next generation and with the prior generation.
Perhaps the wiser approach is to structure for the "business family" rather than the "family business".
In other words, to focus on structuring that allows and encourages those that are capable of being entrepreneurial to find their own ways to create wealth and make a difference (be known as a "business family"); rather than try to make them manage the existing "family business" (think about how many business models have been disrupted or even made defunct in recent years).
Thirdly, it isn't just about structuring for "everything that we have". With material wealth coming in different forms and located in different places, there is a tendency to structure for "everything". Certainly, there are families for whom it makes sense to structure all that they have to be part of the legacy, but for most this may create unintended consequences. Some families take the approach of using a myriad of complex structures to protect their next generation from expending their fortunes, others use structures to leave their next generation "just enough".
In summary, a family could decide to structure only for those parts of wealth it chooses to be the legacy it wishes to maintain for as long as it can, and deal with the rest separately. For example, the wealth that is not deemed of value to a family's legacy may be used to allow future generations to find where they lie along the continuum of "doing anything" instead of being tied to long-term structures.
Case A: Structuring for business succession as focus
The first generation had created a very successful business addressing "fundamental" consumer needs (eg food and clothing). The family agreed that the legacy they wanted to preserve was for future generations to continue to be interested in their business and innovate so they can be known as a business family.
The business part of the family's material wealth was placed in a trust arrangement with clear governance including how successors were nurtured, identified and rewarded; as well as what would happen if no suitable family members were identified in a generation etc. All other parts of the family wealth were deemed unnecessary for legacy; distributions were made to various family members to create their own branch level structures, and the balance was placed in a philanthropic foundation that would improve education in their country.
Case B: Structuring for the value of enterprise building
The second generation had built significantly on the first generation's successes. However, they were faced with a third generation that was neither willing nor capable of managing and growing the existing family business despite trying, and this created tension and frustration.
After much consideration, the second generation decided to sell the business and after making some distributions to the second and third generation family units, a professional investment company was formed to manage the remaining bulk of the material wealth as a common pool from which the business-oriented third and future generations would be encouraged to build enterprises that they could succeed in.
A substantial part of the profits from the investments was also set aside for philanthropic purposes where future non-business oriented family members could work together. In this case, because the family had found it difficult to frame a legacy focused on existing businesses, their structuring was focused on the value of enterprise building, and to allow future generations to work and learn together on what it takes to succeed, rather than merely managing money from the liquidity event.
Case C: Structuring for different levels of business needs
A business family, now in the third generation, had a legacy encouraging each generation to build its own businesses rather than taking over existing family businesses. These businesses tended to be managed by professionals, with the family providing board and strategic oversight, and where possible "liquified" through public offerings or sale of substantial minority interests.
This approach provided liquidity to the next generation and freed up their time to undertake their own ventures. However, after several decades of operating in this manner, some challenges had arisen: (a) the entire family ended up with numerous stakes, including cross-holdings among different branches in businesses of each generation (b) the few family members who provided board and strategic oversight were starting to feel the strain.
To better structure for the entrepreneurial legacy of being a business family, the family formed its own version of a "limited partnership model" similar to private equity fund partnerships but adapted for their particular investment philosophy and needs. The "General Partners" were the few family members who provided the board and strategic oversight; the "Investee Companies" were the ones that the next generation members had created using family resources and the "Limited Partners" were those family members who were content to be "enjoying all the golden eggs" and didn't necessarily wish to be entrepreneurs. Creating such a structure allowed for the recognition of different roles and also compensated such differences and helped bring order to the structure.
To conclude, we believe the best advisers understand that the legacy of a family of significance is most enduring when over time, its material wealth reinforces its non-material wealth; and vice versa.
- The writer is head of wealth planning services, Credit Suisse, Private Banking Asia Pacific