Personal Finance

Making wealth last beyond 3 generations

Sonali Pradhan | Updated on January 16, 2018


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Clear roadmap and a strategic plan are vital to preserving wealth of family businesses

History has shown that wealth rarely lasts beyond three generations. There have been many studies undertaken to understand the reasons behind such a trend. Behind the success of family businesses, two attributes have acted as key differentiators.

The first is the ability to align the vision of family members and managing their needs and expectations without losing sight of the business’ objectives. This in turn calls for regular and open conversations among the family members, thereby avoiding potential conflicts among them.

The second formula adopted by such multi-generational businesses is framing a strategic succession plan.

In the past, a number of business owners have chosen to bequeath the shares of the business through a testamentary disposition such as a will, or by gifting them directly to their chosen legal heirs during their life time. However, the potential problem in such an approach is that, the distribution may not meet the expectations of the heir, resulting in possible family feuds.

Additionally, it also results in a transfer of an ownership right to an individual who may influence business decisions adversely because of vested voting rights. The heir may even take an impulsive decision to sell such rights, which may change the control and ownership dynamics of the business. Furthermore, as the the family tree grows, ownership of such shares and thereby the decision-making power becomes fragmented, particularly if there are a more legal heirs.

Collective ownership

To avoid such conflicts and perpetuate the existence of the business, many business houses have adopted a strategy of passing on a “collective ownership”, which can be illustrated with an example.

A patriarch starts a business. He has two sons and a daughter. After completing their education, one of the sons and his daughter decide to work with their father, while the second son chooses to pursue a career overseas.

The mother continues to play the role of “chief emotional officer” in the family. While expanding the business and grooming the children, the patriarch decides to work on his succession strategy.

He decides to put the shares of his business into a family trust and appoints a board of trustees and an advisory committee, with participation from both the family and the trusted advisers. The advisory committee acts to provide guidance to the trustees on crucial matters.

The desired qualification of the successor trustees and advisers is documented in the trust deed. The deed also defines all lineal descendants as the beneficiaries of the trust, distinguished from each other, depending on age and responsibility. The patriarch, otherwise also known as the settler in the trust, also defines the quantum of benefits to be given to each class of beneficiaries.

Further instructions could be provided by the settler to the trustees to set aside certain part of the dividend income towards creating a retirement, medical, education, marriage, and social contribution fund. The board of trustees is authorised to expend the money such allocated for each beneficiary at their discretion.

A formula to transfer a part of the dividend income to the different classes of beneficiaries is also defined. The guidelines are additionally provided to invest the surplus income and provide loans to the beneficiaries.

Multiple trusts

Few other families have created multiple trusts. For instance, one may also form a mother trust and have various sub-trusts as the beneficiaries of the mother trust.

While structuring such collective ownership, one has to consider the existing corporate structure. Some of the other key considerations include decisions on the mechanism to settle the shares and its tax implication, regulations around takeover code and exchange control and voting rights mechanism.

The selection of trustees and other adviser is also another critical aspect to the success of such a family trust. These days, family businesses are family enterprises (with multiple assets and multiple businesses) and one should not overlook a possibility of a sale or IPO of a part of the enterprise while putting shares in the trust.

Family constitution

Further, to supplement such a succession structure, the family may also draw up a family constitution to document the family’s vision, values and protocols for family employment, remuneration and the processes for deciding on ownership and leadership succession. The constitution can nourish the patriarch’s vision and business philosophy and, at the same time, provide freedom and scope for the following generations to build on it and introduce evolutionary change, if desired.

While the spell of three generations has reduced many family businesses to a glorious past, among the survivors are those who have successfully undone the jinx by segregating ownership and management of the business and converting such ownership into a collective one.

The writer is Head of wealth planning, Julius Baer Wealth Advisors, India

Published on October 23, 2016

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