Since the end of the Second World War, small specialty stores in the Northeast have managed to survive, through good times and bad. My client is the purveyor of tobacco related specialty retail products, creating a destination for those interested in a purchase of the special, and sometimes handmade pipes and other items, is the epitome of a family owned business: established, and run, by a husband-and-wife team, the sales staff expanded when their son was ready to join them. The husband and wife always assumed that they would hand down their business through the generations.
So when the owner approached me for an estate plan, in his mind the plan was straightforward: establish a path for both his family’s financial security and the eventual smooth transfer of ownership of the business to his son and his son’s children.
But in my experience, things aren’t always so straightforward. Owners of unique assets – which include family businesses, legacy real estate, and valuable art, coin and other collections – need to engage in what I call “risk management.”
In the corporate world, “risk management” is a familiar term, used to define exercises ranging from establishing data and technology security protocols to planning for natural disasters in ways that limit the corporation’s financial exposure to loss. In personal financial planning, “risk management” often involves the discussion, and use, of various insurance and other investment products to protect the financial well-being of an individual or family from financial loss.
However, when it comes to unique assets, risk management takes on another dimension. In this context, it is the process of aligning one’s financial security and ownership succession planning goals; proactively plotting out the potential scenarios that may threaten, or even undermine, those objectives; and coming up with alternative solutions.
That way, if what seemed like the unforeseeable occurs and a crisis hits, you’re ready with a plan of action.
In the case of my specialty store client, by the time he approached me for an estate plan his son was already working for the shop – and on the side expressing his own entrepreneurial spirit by venturing off into other business deals, one of which involved buying into a warehouse with a partner that provided high-quality storage for antiques. While the son’s business interests are technically independent of his parent’s retail store, his planning impacted his parent’s financial and succession plan.
I asked the specialty store owner to work through the steps we should take in the unlikely scenario that both him, and his son, suddenly passed away. While he was willing to think through the situation, his son was reluctant. So, as part of the store owner’s estate plan, we outlined several succession scenarios, including how to keep the business ownership intact, should the son die with no plan of his own in place.
The unforeseeable occurred, and the son’s untimely death at the hands of a drunk driver forced us to execute on our risk management program. A buy-sell agreement was already in place to repurchase the son’s share of the business from his widow. Day to day store operations was turned over to the owner’s grandson, who proved himself capable of running it. We are working with the family now on the next stage of scenarios, including how to bring the grandson into ownership of the retail store and what contingencies are in place when the next crisis occurs. Unfortunately, the widow, in the meantime, has become embroiled in litigation with her late husband’s business partner, who attempted to take advantage of her husband’s demise and appropriate partnership assets for himself. The son’s lack of estate, and succession, planning resulted in serious consequences for his wife’s financial future, which she continues to struggle with today.
In 20-20 hindsight, it’s easy to say, “Of course we should have a plan.” But when getting started, typically people don’t. Or, if they do create an estate and financial plan, they silo the two processes and fail to think about how to strategically align them. This can cause extreme and unintended consequences when unique assets are involved, as the unique nature of the asset is what makes it so valuable to the family and often makes it irreplaceable to its owners.
Risk management involves taking the time, and making the effort – right from the start – to figure out how to cope with a crisis. The crisis may be as simple as making sure you’re carrying enough insurance or as complex as whether to keep a business or sell it. Either way, it’s important to remember that there is not one scenario, or solution, to each potential issue.
Risk management is not a linear process. It’s like a tree with many branches growing from the main trunk. To do it successfully requires two important steps: First, make sure to list all potential trends. These trends may include a large amount of estate tax. In the case of a family owned business it could be estate taxes and dealing with minority stockholders. Succession issues with a business partner or an economy that’s made business conditions difficult should also be included on the list. Remember, each condition, and combination of conditions, leads to different results.
Second, list the contingencies that allow you to have flexibility. What types of tax-planning tools can you employ to mitigate that expense and still provide for the family’s financial future? Who are the potential candidates to take on a leadership role at the company?
These principles apply not only to family owned business but to other unique assets as well.
The transfer of a family vacation home, a common form of legacy real estate, is a classic example. I had a client who owned a beautiful piece of property at the end of a dirt road that they wanted to keep as a private family compound for their five children and myriad grandchildren. After the husband passed away and the wife developed Alzheimer’s, one of their children, who was not married, lived at the house to take care of her mother. It quickly became clear that the family would need to put a plan in place for the ownership and maintenance of the property upon the mother’s demise, as the children were having a hard time working together without one.
The children, and grandchildren, who used the house were encountering all kinds of issues around who pays for what expenses and what happens when someone doesn’t pay. The primary issue was how could these fighting family members be organized in such a way that it didn’t result in a lawsuit? The property was already in a trust, but this vehicle didn’t solve the management issues. After much discussion, we decided to vest the management of the property in a limited liability company (LLC).
One of the important lessons that came out of this project is that as advisors we should not always drive our client’s goals by tax considerations. I faced a significant uphill battle from the client’s long-time accountant when we formed the LLC. From her perspective, and correctly so, the structure would not achieve the most tax savings possible. Our plan also did not fit squarely within her understanding of the tax code’s treatment of LLCs, and therefore she believed we could not do it. However, the client wasn’t looking for a tax solution, they were looking for and desperately needed a management solution, and they were willing to give up some of the tax savings in order to preserve ownership of their unique family real estate.
In this situation, the purpose of aligning the estate and tax goals was twofold: to preserve ownership of the property within the extended family; and to give the family a vehicle through which to manage the property for the long term. Mitigating taxes, while an important consideration, was not the primary concern.
Collectors face similar choices to owners of family businesses and legacy real estate because of their emotional ties to their valuables. Art and coin collectors, for example, often spend their lifetimes purchasing their pieces, and the thought of simply disbursing them upon their death is often heartbreaking. Creating LLC or other entities that can manage and lease the collections or maintain them in some other fashion while still paying the appropriate taxes and providing for the financial future of the family is an important option to pursue when outlining a risk management plan.
The challenge of unique assets is that you are not dealing with the abstractions of how much money has been spent, where money has been invested, etc. Instead, you are dealing with the actual personalities of the people who are tied up in, and reflected through, their family businesses, legacy real estate and collections.
These are personal assets first and foremost. For the client, the primary concerns are addressing ownership and control. They are impacted by social, family and economic issues, and viewed through the prism of, “It’s mine and I want to do things the way I want to do them.”
By engaging a risk management process, you rehearse scenarios. You create a lifeline that helps your client figure out how to cope with the stuff that you can anticipate, but you cannot predict.