The trillion dollar wealth transfer question

The largest transfer of wealth in human history is predicted to occur over the next two decades, as $10 trillion in the United States and $1.3 trillion in Canada is passed on by baby boomers to the next generation.

The trillion dollar wealth transfer question
The largest transfer of wealth in human history is predicted to occur over the next two decades, as $10 trillion in the United States and $1.3 trillion in Canada is passed on by baby boomers to the next generation.

A significant portion of this wealth resides with business owners or children who inherited or will inherit wealth either directly or indirectly through family trusts. If we believe the statistics, 90 per cent of these transfers will fail. Think about it… some of these businesses, which represent up to 45 per cent of the GDP in the economy, may be wiped from the economic landscape. What’s worse, disputes are destroying families while lawyer fees and diffusion drain the family asset, which took years to cultivate.

CFIB Research Reports on over 10,000 small to medium sized business owners in 2004 and 2006 found that transfers will fail for two reasons: the lack of a formal succession plan and family dynamics. Yet, less than 7 per cent had a formal, written succession plan.

So what is stopping these successful, task oriented, entrepreneurial boomers from taking the bull by the horns and ensuring the company thrives when they’re gone? 

There is certainly no shortage of advice on this subject from life insurance advisors, accountants, lawyers, private wealth bankers and a host of other advisors. There is an article a week in the major newspapers on the subject.  

The advice tends to focus on two problems triggered by the death of the key shareholder of a family enterprise.  These problems usually fit into two categories:
  1. A liquidity event or need for cash
  2.  A harmony problem in the family
The first problem can be solved in the most economical and tax efficient manner by acquiring a permanent life insurance policy to fund the income tax liability and estate costs if the owner can pass an insurance medical. This is particularly important for small to medium sized enterprises where the good will is more personal than business. Many family enterprises set up a corporate structure involving family trusts and a family holding company as a beneficiary of the trust to ensure maximum tax savings and creditor protection at death. The Family Holdco can be the owner and beneficiary of the life insurance policy creating a tax free capital dividend account at death which can potentially be paid almost entirely tax free to family shareholders.

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The second problem may be alleviated by a family agreement which is a non-legal document whereby the owner, her spouse and family member stakeholders come up with a shared vision of a succession and estate plan. This plan is well rehearsed and everyone knows their role so that when the key owner or owners leave the stage at death, the new family owners are ready and willing to step up as stewards of the family enterprise thereby growing the business and improving not harming lifelong family relationships.

This harmony problem is often created by focussing too much on saving tax and protecting wealth from potentially greedy family stakeholders (don’t get me wrong, it is important to have an up to date will, a tax and estate plan and trusts to minimize tax and protect wealth) but not at the expense of creating toxic conflict rather than healthy disagreement. A more open focus on best practices taken from research of some of the most successful multi-generational family enterprises in the world can be helpful to prepare the family for ownership transition. The key strategy to improve harmony is to involve the family members in the process early enough to come up with a shared vision for a successful transition of wealth. In fact, many successful multi-generational families prepare their family first for processes and structures before they get the specialists to help implement the shared vision.

I think it was Einstein who said that if he had one hour to solve a problem he would take 55 minutes to think about what question to ask and then he would take only 5 minutes to solve it.

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So here is the challenge: What are the right questions to ask to ensure successful wealth transfer?

Here are a few questions for owners of family enterprises and their advisors to consider:
  • What is stopping task-oriented, entrepreneurial owners from taking something they feel is important and dealing with it as they would with any business problem?   The answer to this question may be more emotional than logical.  Chip and Dan Heath are two Stanford professors who authored the book “Switch” which may give some guidance on how to make change when change is hard.  They use the metaphor of the changee being the rider, which represents the logical part of the brain, sitting on an elephant, representing the emotional part of the brain. They need the energy needed to make change happen but there has to be a path for the rider and the elephant to travel.
  • Is there any hard evidence that a succession plan by itself will guarantee a successful transition of wealth and ownership to the next generation?  Eisenhauer said that in preparing for battle, plans are useless but the process of planning is indispensable.
  • Is the traditional approach of meeting almost exclusively with financial advisors, with little or no discussion with the family members who are the key stakeholders and beneficiaries of the wealth at death, a viable strategy? It may be that we as advisors are focusing on the right problems but we are leaving out a critical step in the sequence of where and when the family stakeholders get involved.
It is important to realize on a more positive note that a transition is only a failure if there is a significant reduction of wealth to the family enterprise during this period and if family relationships are harmed. Oftentimes, the operating business is sold by shrewd families at its optimum value only to be re-invested in other more profitable enterprises, real estate and philanthropic assets. The point is that the family enterprise or wealth from the family enterprise continues to grow and the family relationships remain strong and harmonious. This should be the goal for a successful transition.

The good news is that advisors who “sharpen the saw” and get trained on best practices gleaned from research of some of the most successful multi-generational family controlled companies in the world will be in demand. It is more of a facilitative skill to help the family gain some consensus on what needs to be done and less about the advisor “rifling” out a solution too early and potentially harming the family.

There is actually a professional designation for Family Enterprise Advisor (“FEA”) that trusted advisors can qualify for in a one-year program through the Institute of Family Enterprise advisors.  It is well worth the investment for advisors who have these types of clients.  It can be a great extension to your business.

Who knows, you may help save the next Michelin Tire, Ford Motor Company or Canadian Tire and their families.

Hugh MacDonald ,CPA,CA,CLU.FEA is a Financial, advisor  and President of Canadian Succession Protection Company, a life Insurance agency in Toronto that provides life insurance and succession planning strategies  to owners of family enterprises and their families.



 

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