About 10 years ago, a purveyor of tobacco-related retail products was seeking advice about an estate plan. His store was a family-owned business, established and run by him and his wife. The sales staff had expanded when their son joined them. The couple had always assumed they'd hand down their business through the generations.
The owners thought estate planning wouldn't take much - a simple, clear plan would smoothly chart a path for both the family's financial security and the eventual transfer of business ownership to the son and the son's children.
Not so fast: With unique assets, things aren't always so straightforward. Owners of such assets - such as family businesses, legacy real estate and valuable art, coin and other collections - need to consider specialized risk management.
A DIFFERENT DEFINITION
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 a company's exposure to financial loss. In personal financial planning, risk management often involves the use of various insurance and investment products to protect the financial well-being of an individual or family.
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 with ownership succession planning goals. It entails proactively plotting out scenarios that may threaten or undermine those objectives and finding solutions. That way, if a crisis hits, you're ready with an action plan.
When the retailer started looking into an estate plan, the son was already working at the shop. He had other business ventures on the side, including an investment with a business partner in a storage space for antiques. While the son's business interests were separate from his parents' store, his ventures still impacted his parents' financial and succession plan.
What would be the right steps to take, for example, if both the father and son died suddenly? While the father was willing to think through the situation, the son was reluctant. Ultimately, the father's estate plan outlined several succession scenarios, including how to keep the business' ownership intact if the son died with no plan of his own in place.
Tragically for the family, an accident with a drunken driver three years later took the life of the son. The couple was forced to move forward with their risk management program. A buy-sell agreement was already in place to repurchase the son's share of the business from his surviving spouse. Day-to-day operations were turned over to the couple's grandson.
Unfortunately, the son's widow became embroiled in litigation with her late husband's business partner, who attempted to take advantage by appropriating partnership assets for himself. The son's lack of estate and succession planning resulted in serious consequences for his wife's financial future, which remains a continuing battle.
It's easy to say, "Of course we should have a succession plan," but many people are reluctant to think about it. Or, if they do create an estate plan and financial plan, they separate the processes and fail to think about how to align them strategically. This can cause unintended consequences when unique or irreplaceable assets are involved.
COPING WITH CRISIS
A crisis may be as simple as making sure you're carrying enough insurance or as complex as deciding whether to keep a business or sell it. There's usually not only one solution to each potential issue.
When taking on personal risk management, list all potential issues that could arise. In the case of a family-owned business, the list could include 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 taken into consideration.
Also list the contingencies that allow you to have flexibility. What types of tax planning tools can you employ to mitigate tax expenses and still provide for the family's financial future? Who are the potential candidates to take on leadership roles at a business?
These principles apply to family-owned businesses and other unique assets, as well. The transfer of a family vacation home, a common form of legacy real estate, is a classic example.
One family owned property they wanted to keep as a family compound for their five children and many grandchildren. After the husband passed away and the wife developed Alzheimer's disease, one of the children lived at the house to take care of her mother. It 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 death because the children were having a hard time working together.
The children and grandchildren who used the house were encountering issues around who would pay for what expenses and what should happen if bills weren't paid. The main challenge was figuring out how to organize the feuding family before someone sued. The property was already in a trust, but this didn't solve the management issues. After much discussion, the family decided to vest the management of the property in a limited liability company.
One of the important lessons that came from this situation is that advisors should not always set clients' goals based on tax considerations. In this family's case, its longtime accountant was extremely resistant initially to an LLC.
From the accountant's perspective, the structure would not provide the most tax savings. The plan also did not fit squarely within her understanding of the tax code's treatment of LLCs. However, the clients weren't looking for a tax solution; they desperately needed a management solution, and they were willing to give up some of the tax savings in order to preserve ownership of the property.
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 them a vehicle through which to manage the property for the long term. Mitigating taxes, while an important consideration, was not the primary concern.
Collectors may face dilemmas similar to those confronting owners of family businesses and legacy real estate. Art and coin collectors, for example, often spend their lifetime purchasing their pieces, and the thought of disbursing them upon their death may be heartbreaking. Creating LLCs or other entities that can manage and lease the collections or maintain them in some other fashion 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 or where money has been invested. Instead, you are dealing with the clients' personalities as reflected through their family businesses, legacy real estate or collections.
Remember that these are personal assets. For the client, primary concerns are addressing ownership and control. Social, family and economic issues affect those concerns to a differing degree. By developing a risk management plan, you rehearse scenarios and create a process that helps clients figure out how to cope with events they can anticipate, but cannot predict.
Matthew F. Erskine, J.D., is principal of Erskine Co., a strategic advisory firm in Worcester, Mass., that helps clients manage unique family assets.