Divided we plan

The great wealth transfer, the unprecedented transfer of wealth from the baby boomer generation to millennials, is underway. Over the next 25 years, a vast amount of money will be passed on, with one estimate putting the figure as high as USD68 trillion in the US alone.

Generational transfers of wealth are often accompanied by a division of assets among several children, and so the potential for tension and conflict can be high. This article discusses some key concepts that family offices (FOs) and wealth management professionals will need to consider, including structuring, decision making and dispute resolution.

Structuring: whose interests win?

Generally, FOs have carefully considered structures in place for their assets and investments. However, those structures may not remain fit for purpose when priorities shift from the growth and perseveration of wealth to ensuring a smooth transfer of ownership.

Consider the common situation of a family with several adult children, each of whom has established themselves in a different jurisdiction to that of the FO. Suddenly, without proper planning, the inheriting children and/or the estates of their parents could be subject to a raft of avoidable tax implications. Tax analysis is, however, only one piece of the puzzle. A thorough review of a FO’s tax planning should be conducted whenever circumstances change, however, substantial pitfalls also lie in how assets are distributed.

When looking to transfer assets of any kind it is crucial to ensure that the transfer is achieved carefully and correctly. Primarily, this is to ensure compliance with relevant laws, but any transfer much also be considered more holistically when dealing with families. For example, transferring one way as opposed to another might give rise to unnecessary costs or, worse, opportunities for conflict and even litigation.

For these reasons, it is often beneficial to involve the next generation in detailed conversation about any intended transfer of wealth before the transfer occurs. Not only is this likely to reduce friction and resentment about how the transfer will occur (who will make the key decisions, when the transfer will happen and how assets will be split) but it is also likely to bring to light any considerations that may be relevant in the post-transfer landscape.

Such conversations help parents to understand how the next generation intends to use and manage the family wealth. This process can be a valuable tool in focusing the intentions of those leaving their legacy and assessing their confidence in their beneficiaries’ ability to manage the family wealth independently.

Can wealth be split equitably?

How members of the next generation receive their inheritance can vary significantly depending on the nature of the assets. For example, although many FOs have invested in private equity funds for sensible commercial reasons, it is generally not a liquid asset class if it needs to be divided among children or grandchildren (especially if the fund documents are drafted to be intentionally restrictive).

Consider a family with three adult children with an age disparity of ten years. The FO intends to implement a policy whereby the children can receive their portion of the family wealth during the lifetime of the parents, but only upon each child reaching the age of 40 (or some other objective transfer trigger). At first, this arrangement might be seen as quite equitable and of greater benefit to the children than having to wait until the death of their parents. However, if a substantial portion of the family’s wealth is invested in private equity funds (or other illiquid assets such as property) then two fundamental questions arise: how can (or should) the transfer/s take place? In addition, how can any disparity in value between the bequests be reconciled?

Mechanics: in specie transfers

By their nature, illiquid assets can be difficult to divide. However, there are often several options available to achieve any desired end goal. Below are some of the methods most commonly used for dividing two prime examples: private equity fund investments and property.

Private equity fund investments

If an FO’s interest in a fund is held in a transferable asset (such as a limited partnership interest or shareholding), then it may be possible to transfer part of the overall holding, depending on the terms of the fund’s governing documents and whether this is permitted. This way, the child receives the interest in the fund in lieu of any cash distribution and, therefore, bears the risk in the fund’s future performance.

Alternatively, it may be necessary (or desirable) to simply withdraw the FO’s entire interest in a fund, distribute a portion in cash to a given child and then re-invest the remainder until another transfer becomes due.

Property

This will always depend on how property assets are held. If there are multiple properties each held in a separate special purpose vehicle (SPV), then one option is simply to transfer ownership of the relevant SPV to the intended beneficiary. If a particularly substantial property is held by an SPV, then a portion of the shares in that company could be transferred to an intended beneficiary; however, this may require various amendments to be made to the company’s governing documents, particularly as to how decision making among shareholders will occur after the transfer. Naturally, there is also the more straightforward option of selling a property and distributing the proceeds.

These are just some of the options available for these asset types. For more ‘exotic’ assets (such as art, collectible vehicles, non-fungible tokens or other crypto-assets) similar themes will apply, though the mechanics will differ.

Disparities in value

All transfer options present an obvious conundrum: whether a beneficiary receives cash (or cash equivalent, liquid assets) or an in specie transfer of existing assets, the value between what they receive and what another beneficiary receives could fluctuate wildly, especially over time as different asset classes perform differently. This issue is exacerbated with illiquid assets, as the distribution options may be quite limited. Suppose one child in the above example requests an in specie transfer of a private equity fund interest. If that fund outperforms the rest of the family structure, the other family members may understandably complain. FO principals, especially those who find themselves in a fiduciary capacity, should be particularly conscious of such dynamics.

These are questions the FO decision makers will need to consider, but if equity between the family’s children is their goal then there are mechanisms to achieve this. For example, using the earlier case study, the FO could withhold a ‘reserve’ portion of its overall portfolio that will not be distributed until the youngest child receives their entitlements, at which point the ‘reserve’ would serve to balance out each child’s distributions on a pre-determined basis. However, these options will depend greatly on the underlying assets and clients’ specific circumstances.

Simplicity in harmony

In some cases, where beneficiaries all support a broader investment programme, beneficiaries could simply receive a percentage interest in the family’s ultimate holding entity. This avoids the need for in specie transfers. However, where family members are not supportive of the investment programme or want to manage their allocation independently, this route will not be appropriate.

Timing is everything

Commercial factors must also be considered when disposing of or transferring any asset. If distributions of assets are tied to a trigger event (such as a child reaching a certain age or the death of a parent) then it can be problematic if that event occurs at an inopportune time, from a commercial perspective. To alleviate this, it is recommended that the mechanisms of distribution always afford the decision makers sufficient flexibility to orchestrate any liquidation, division, sale or transfer of assets in the most commercially efficient manner.