Estate constraints often do not work as planned

By Mariana Martinez Berlanga and Peter M. Bloom

In a letter to James Madison dated September 6, 1789, Thomas Jefferson wrote, "[T]he earth belongs in usufruct to the living . . . the dead have neither powers nor rights over it." But contrary to Jefferson's suggestion, in multigenerational family businesses the earth often belongs to the dead.

While we are all influenced by past generations, some family businesses (and their stakeholders) are not only influenced but also controlled by them. Devices such as elaborate estate constraints, incentive trusts and restrictive gifts determine which actions the living must take to inherit a full share in a family business, how the living will manage the business and the terms under which they may sell it.

When family business owners are deciding how to dispose of their interests, they are typically concerned not only with the preservation of the business, but also with the development and self-sufficiency of their heirs and the strengthening of the family that owns the business. The way these dispositions are made affects the long-term sustainability of the business, the functioning of the family as a group and the functioning of individual family members. Despite the attention usually put into the structure of transfers, some of the most serious problems family businesses experience result from intergenerational transfers that do not accurately assess such impacts.

Decision making after death

Consider the following hypothetical: The patriarch of a family established a chain of local hardware stores that has thrived despite vast changes in the competitive landscape, especially intense pressure from larger, well-capitalized competitors such as Home Depot and Lowe's. The business owner also shrewdly purchased the real estate in the stores' locations. In his estate plan, the father transfers ownership of the stores (the family business) to his two children in equal shares. One child works in the family business but the other does not.

The terms of the transfer prohibit the alienation of the shares during the children's lifetime for less than a price predetermined by the parent. They require that if a transfer is to be made, all of the family business assets must be disposed (e.g., the non-real estate assets may not be sold without the real estate, and vice versa). The terms of the transfer also require the creation of a board of directors consisting of three people—the two children and the father's financial adviser.

Despite the father's best intentions to plan for the future, this restrictive structure may generate a set of problems once he dies. A restrictive transfer implies that the transferor views his or her heirs as immature and doubts their capacity for judgment and for cooperation in the present and the future. Thus, it may limit the heirs' personal development. In addition, it puts extra pressure on the relationship between the heirs as they engage in joint decision making about the business. Even after death, the transferor remains the decision maker. Yet, for a transfer to have long-term success, the next generation must make a transition from "the children of the family" to a partnership of mature adults who are able to make their own decisions.

Overfunctioning and underfunctioning

Family Systems Theory, introduced by Dr. Murray Bowen in the 1960s, describes "over/underfunctioning pattern," a relationship pattern that is helpful in understanding the underlying family dynamics of a restrictive transfer and its implications for the future. One family member (often a parent)—the overfunctioner—takes more responsibility than appropriate for a given situation, while another (often a spouse or a child)—the underfunctioner—takes less responsibility than appropriate. Both postures have costs, yet the pattern tends to perpetuate over time. Overfunctioners often feel overburdened, tired and resentful of the excessive load but are convinced that things will fall apart if they fail to act. Underfunctioners deny themselves the chance of living life to the fullest of their capacities by staying in a more dependent and immature position. Underfunctioners are convinced that they can't do anything different and resent the miserable position they are in. Analysis, thinking and effort can unlock an over/underfunctioning pattern. Regrettably, a restrictive type of transfer can contribute to the persistence of this pattern for generations to come.

In addition to locking such a pattern in place, restrictive transfers of family business interests can carry other serious complications. No transfer can fully and accurately foresee the future circumstances that family members and the business will face. In the hypothetical example above, the parent limited the rights of his children to exit the family business by establishing a minimum sale price. That price may not be realistic by the time the siblings inherit the business. Further, if one of the children experiences significant financial need—because of an illness or for another reason—and a sale becomes necessary, the restriction is likely to cause serious consequences for that child as well as conflict between the siblings, who in this case have very different roles in the business.

Beyond a foreseeable circumstance such as financial need, other situations may arise in which the only rational option is to sell the family business. It may turn out, for example, that the land proves to be far more valuable than the business itself. The children or family members need to have the freedom to sell in that situation, or else one goal of the parent (the financial health of the heirs) is jeopardized. The restriction itself, contrary to the father's desire to promote his family's financial security in the present and in the future, may cause unnecessary and otherwise avoidable stress to the family as well as undermine their well-being.

Other alternatives

There are many alternative paths that do not carry the risks that restrictive transfers do, while preserving both the family business and the family itself. The identification of such alternatives should begin with a serious analysis of the transferor's goals in making a property disposition, as well as an analysis of the family's relationship style. Often, it becomes apparent that less restrictive devices are more effective in accomplishing the transferor's purpose while avoiding the downside of a restrictive transfer. In the example above, the father imposed on his children a governance structure for the family business. This imposition may imply a concern over the children's ability to cooperate. If that is the underlying reason for the imposition, the desirability of transferring any asset to them in some form of joint ownership may not be the right course. But if, after further analysis and discussion, it appears that the siblings might be able to learn to work together, an intermediate approach may carry the most potential. For example, the father could transfer certain limited management and ownership rights to the children while he is alive, but retain some control to intervene and guide the children until some determination can be made regarding their ultimate ability to work together.

Another benefit of a serious analysis of the transferor's goals and family dynamics is less obvious. Upon deeper examination it may become clear that multigenerational family dynamics play a larger role in a transferor's decisions than at first appears. For example, a transferor's birth order (whether the transferor was the oldest, middle or youngest child) and role in the family help explain the degree to which the transferor tends to overstep the boundaries of his or her areas of responsibility. Another example is a family in which irresponsible behavior and decision making from a young family member in a previous generation jeopardized the business. This past experience might explain a transferor's apprehension about giving authority to the next generation. Awareness of these factors (family history, habits, fears, values and strengths) may lead the transferor to assess the extent to which decisions regarding property dispositions are based on past events rather than on a realistic evaluation of the present circumstances.

An experienced professional can contribute a great deal in crafting an effective asset transfer process (whether by estate planning or otherwise) by encouraging an in-depth examination of the transferor's goals and family situation. It should be acknowledged that the success of an intergenerational transfer is never guaranteed. Nonetheless, the prognosis is better if a transferor, aided by professional expertise, considers the characteristics, history, strengths and vulnerabilities of both the business and the family involved. Exploring possibilities other than restrictive transfers may provide, in the long run, a better chance of achieving the transferor's goal of preserving and strengthening the family as well as the family business.

Mariana Martinez Berlanga, Psy.D., operates Bethesda Family Therapy in Bethesda, Md. (www.bethesda familytherapy.com), and is on the faculty of the Bowen Center for the Study of the Family in Washington, D.C. Peter M. Bloom, Esq., operates The Bloom Group LLC in Washington, D.C. (www.thebloomgroupllc.com).

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