Margaret Thatcher once said:
“Standing in the middle of the road is very dangerous; you get knocked down by the traffic from both sides.”
Like many successful people, she recognised that one of the secrets to success is to clearly and precisely set out your position. In her world, and in the minds of many other successful people, ambiguity is the enemy and precision is the key. It is not surprising that many of my successful family business succession clients share this view.
In addition to being focused, successful business owners tend to be strong, determined and decisive people.
As a family business owner, it may be that these characteristics also apply to your own success in business. However, when you apply them to the future of your family wealth, they can sometimes lead to problems.
The reason is that when you make normal business decisions, you do so based on a clear understanding of the current situation. Your decisions are implemented immediately or soon, and you are always around to adjust if things go wrong.
In contrast, the family wealth management decisions you make today are not implemented tomorrow, but rather in 20 years’ time, or 50 years’ time, in a different world, and sometimes after you are no longer around to make adjustments if they are needed.
The Problem
Here’s an example of a simple and precise rule:
Distributions from the family wealth to my descendants will not be permitted if the distribution exceeds the amount that the person is earning from gainful employment.
I love the logic that underlies this rule. The idea is to give effect to what I call the Warren Buffett principle:
“I want to give my kids just enough so that they would feel that they could do anything, but not so much that they would feel like doing nothing.”
The logic here is that, in order to benefit from the trust, your children need to work, and the harder they work, the more they can benefit. In contrast, children who do nothing won’t get anything from the family wealth at all.
A great rule, right?
Yes, until you apply it to the real world. Consider people who take lower-paid jobs because they prioritise personal fulfilment over money. So if one child takes a job as a primary school teacher while another is working as an investment banker, then should we ‘value’ the investment banker’s work more, simply because she makes more money?
What about if one of them then loses their spouse in an accident and gives up work to care full-time for their children? No gainful employment means no distribution from the family wealth. Is that what you would have actually wanted?
Here are some more rules that look great at first glance, but do not stand up well to ‘stress testing’
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- Only blood descendants may benefit from the family wealth.
- Do not sell XYZ Ltd before 2075 and then only with the consent of 75% or more of my descendants living at that time.
- The duration of the trust is fixed at 75 years.
- The holiday home shall be maintained for the exclusive use of family members.
- No married descendant may receive a distribution unless they have a prenuptial agreement that prevents their spouse from benefiting from the family wealth in the event of divorce.
- Pay 10 million to Anna when she reaches the age of 25.
- Distribute no more than 10% of the profit generated by the business each year to the beneficiaries.
- Anything else which includes a fixed amount or percentage.
I see rules like this all the time.
(If you are having trouble working out what is wrong with these rules, try imagining a range of ‘what if’ scenarios, or get in touch and I will explain).
The First Solution – Documentation
There is no need for you to compromise on your requirements. You are the one who created the wealth and it your absolute right to decide what to do with it. The secret to success is not necessarily to change the rules, but rather to change how they are expressed.
In a well-designed family dynasty structure, you will find a range of different documents. For example, if there is a family trust, then there will be a trust deed or trust statute. There will also normally be a family constitution and a letter of wishes.
All of these documents are places where you can express your rules, but there is a difference;
The Trust Deed or Foundation Articles
The trust deed and similar documents such as Foundation Articles are relatively ‘public’ documents. In most cases, beneficiaries have the right to see these documents, and they are also often filed with regulators. The other important thing about these documents is that they are absolutely binding on your trustees.
If you put a rule that says “Pay 10 million to Anna when she reaches the age of 25” then Anna will be able to see that rule and will know that 10 million is coming her way, for sure. Does that knowledge have a positive influence on her life?
Even worse, because the rule is expressed in your trust deed, then your trustees must make the payment, no matter if doing so would actually produce a nonsensical result. So they will pay her the money even if she is struggling with drug addiction, even if she is in the middle of a messy divorce, even if she is bankrupt.
Finally, what will be the real value of 10 million at the relevant time. If the distribution is going to be made next year, then it’s clear enough. But what if Anna is only five now. Will 10 million be a lot of money in 20 years? Enough to buy a house? Enough to buy a car? Maybe just a bicycle?
It is a good rule, but strict application can lead to bad results.
Because you made a fixed rule, you took away your trustees’ ability to apply common sense.
And that’s the thing; a good trustee wants to try to put himself or herself in your shoes when you are no longer around and try to make the decision as you would have made it. Fixed rules like this take away this ability of the trustees and the chance for them to use common sense.
The Family Constitution or Letter of Wishes
These are much better places to put these rules. Why? Because the rules you put in these documents are ‘sort of binding’ on your trustees but not absolutely binding. Without going into too much detail, a good structure will have strong mechanisms to make sure your rules are obeyed, but the difference with these documents is that they also allow for the application of logic and common sense. In other words, if it turns out that your well-intentioned rule is going to deliver a nonsensical result, the trustee can decide not to apply it. They will be able to do this only after careful discussion, documentation and decision, usually with the support of the protector, and only for a very good reason.
By simply moving most of the rules above from the trust deed (hard rules) to the letter of wishes (still hard, but slightly less hard), most of the problems are solved.
The trust deed should generally not contain more than the absolute minimum of immutable detail. Please resist the (admittedly very strong) temptation to add lists of detailed rules. Doing so almost inevitably ends in tears.
Most of our problems are solved. But not all of them.
The second solution – Guidance
Let’s go back to our original example:
Distributions from the family wealth to my descendants will not be permitted if the distribution exceeds the amount that the person is earning from gainful employment.
Let’s assume we have moved this from the trust deed to the letter of wishes. That’s a good first step. If I am your trustee, I am now free to use common sense in the application of the rule.
But how do I do that? I now have freedom to avoid obviously unfair results, which is great, but what about our example of the schoolteacher and the investment banker? How should I deal with this? The truth is that I do not know. I do not have enough information. The words above are not enough to guide me on their own.
For example, perhaps you value money over personal fulfilment. Perhaps you think it’s right that the investment banker receives more than the teacher. Personally, I don’t agree with that approach, but if I am a trustee, it is your view that matters. It’s your family and your money, not mine.
So how can I know what you really want?
In practice, as a trustee, it is my job to find out in advance. I need to meet with you, talk these scenarios through, take copious notes, and ideally get you to sign off on my notes. Then, once you are gone, I, or the future trustees, will know what to do.
So we have come full circle. Don’t make precise rules. Instead, it is better to provide softer guidelines but with precise guidance.
Putting it into practice
If you have strict rules in your foundation or trust, or you are thinking about including them, I am very happy to help you review how best to achieve what you actually want without creating unnecessary problems in the future.
Please get in touch – I am always happy to have a chat.