By Patricia M. Angus – Originally published in Trusts & Estates, February 2024

The scenario is all too common. The founders (or non-founding owners) of a family business realize it’s time to do some estate planning. Their email inboxes have been inundated with alarming notices that the U.S. estate tax exemption is going down, or going away, and that tax rates are going up—soon. They’re implored to act—now. And they do. The founders or non-founding family owners get some recommendations and enter their lawyers’ offices. In each case, the lawyer reviews the situation, sees potential deterioration through estate tax and recommends that these owners set up one or more trusts. The owners are advised to transfer their business shares into trust during life or at death.

Even if the owners’ net worth is less than the current exemption ($13.61 million for an individual or $27.22 million for a married couple), the lawyer will likely have the same recommendation: To provide asset protection and succession planning, the clients need to set up trusts that will become owners of the clients’ shares of their family business. The idea is that the trust will help the business stay in the family long into the future. For all these reasons, family businesses are being transferred into trusts at ever increasing rates.

From the perspectives of estate, tax and asset protection planning, the lawyers have done their jobs well. The clients may even feel some comfort that they’ve heeded the call and taken care of business, so to speak. But the implications of these actions will only begin to be felt in the years to come and not just for the clients and their families. Because most businesses are owned by families, these actions have a far-reaching and long-lasting impact on the economy. Here’s an exploration of some of those implications.

Family Business Ownership

Despite the difficulty of determining exact percentages (especially because most businesses are private), there’s a general consensus that founders and/or their families own and/or control most businesses worldwide.¹ Even in the United States, where family ownership is less common than in other parts of the world, an oft-cited study reveals that one-third of public companies are family owned,² while the percentages are far higher in the private sector. Family-owned businesses are everywhere, ranging from Tata in India and Walmart in the United States, to the dry cleaner on the corner in your home town.

Further, while statistics are hard to come by, the percentage of businesses held in trust is only growing, especially thanks to an increasingly sophisticated professional planning industry and the fact that the great intergenerational wealth transfer is fully underway. While U.S. states and international jurisdictions furiously compete for trust business, more families are using trusts than ever before. Outside the United States, countries are fast adopting trust laws to keep up with the trend. Even China, which a generation ago didn’t allow private property ownership, now has its own trust laws. The number of trusts will only continue to grow through future planning and as existing trusts divide into more trusts as they pass across generations.

Motivations for Trust Ownership

As noted above, in the United States and increasingly around the world, one of the primary motivations for transferring ownership of a business into trust is tax reduction. But that’s not the only reason families transfer ownership into trust. A trust can add an extra layer of protection between the business and its family owners to ward against liability for the company’s actions or inactions. To keep the business “in the family,” founders may decide that trust ownership will provide better continuity of the business than distributing ownership among multiple heirs. Families with multiple members—therefore potential owners— may wish to consolidate power and control within the family and/or ward against control or influence of non-family owners.

In all cases, a trust may seem to be a wise way to streamline the transfer across generations, ensure family ownership and control and ensure that the business will have qualified oversight. A trust is a versatile vehicle that can provide these advantages and more. That’s why so many well-known family businesses aren’t in fact owned by the family, but— either wholly or in part—owned by trusts.³

It’s worth noting that an owner of a family business has a different relationship with the business because of their family affiliation. Indeed, one of the most interesting areas of research in the field today centers on the recognition that families are motivated by more than financial returns from their ownership of a family founded and owned firm. The concept of “socioemotional wealth” serves as an umbrella for the many ways in which a family is connected to its business and what it seeks from it.⁴ This concept includes family identity, relationships, reputation and emotional bonds. For example, family members will feel the effects of positive and negative press about their business, even if those family members haven’t owned the business for many years. As a corollary, researchers have identified the idea of “emotional ownership”— that is, the connection a family member might have to a business founded by an ancestor or relative, even if the family member has no actual, financial ownership in it.⁵

Implications of Trust Ownership

Trusts can accomplish many of the goals discussed above. But there are implications that should be fully understood by family owners not only when the business is transferred into trust but also on an ongoing basis and across generations. At bottom, the nature of the family’s ownership shifts fundamentally in ways the family itself might not fully understand when it’s transferred to a trust. Most family members will become beneficial owners as beneficiaries of the trust, as their trustees take on legal ownership. Family members will no longer have their own vote in electing board members to govern the business; that role and authority will shift to the trustees of their trust. Trustees will become parties to Shareholders’ Agreements alongside or instead of family members.⁶ Trustees, who may or may not be family members, will have the legal authority to vote in board elections and be involved, from a legal standpoint, in oversight of the business.

Any family considering transferring a business into trust would do well, with the help of their advisors, to consider some of the following questions:

Is the trust revocable or irrevocable? If a business owner transfers shares into a revocable trust, control remains in the owner’s hands while the owner is alive and not incapacitated. A revocable trust could be attractive to an owner who wants to provide for a smooth transfer in case of incapacity or an untimely death. In either case, a trustee will be in place to step in immediately and take on the rights and responsibilities of the owner. In addition, the trust can map out the future path of ownership and control of the business. At the same time, the owner leaves open the option of changing plans during life. Because the trust can be revoked, the owner can change it and redefine its future with relatively minimal effort. The flexibility afforded by revocability is balanced by the fact that the trust won’t, in most cases, provide any income or transfer-tax (estate, gift and generation-skipping) benefits.

Alternatively, when an owner transfers shares into an irrevocable trust, whether by gift or sale or a combination of both, it results in a far more permanent shift in the nature of ownership of the business. Too many founders and business owners fail to understand that irrevocable means just that— for the most part, it can’t be undone.⁷ This restriction can provide tax, asset protection and other benefits so long as the trust is properly formed or administered. But future flexibility will depend in large part on the terms of the trust and the jurisdiction where it’s established. The rise in intentionally defective grantor trusts (the grantor pays income tax on income earned by the trust after transferring the business shares) has led to much confusion in families afterwards. Too often, a family owner won’t understand that when shares are transferred to a trustee while the owner retains the responsibility for paying taxes, they’ve accomplished one major goal— maximizing the value of the transfer to heirs—but at the cost of a loss of control. Despite the legal reality, family members, employees and other stakeholders will often continue to defer to the original owner as though they still have legal authority over the fate of those shares. But they don’t. The grantor has the right to pay taxes but not the right to determine the fate of the business. This can feel like a Faustian bargain after the fact. More education of family business owners in this area is woefully needed. It’s extremely hard to ensure all involved understand this paradoxical situation.

What kind of trust is being used? In the family business context, lawyers will often recommend a voting trust to streamline power and control over ownership while keeping the business in the family. These trusts are fundamentally different from those that most lawyers and clients are familiar with for estate-planning purposes. While the trust will contain provisions about distributions, those are generally only a secondary priority to the exercise of the votes held by the trustee. Advisors need to pay special attention to the ways in which members of the family will retain the ability to provide input. Which family members will have the right to give input on behalf of their fellow family members? Will the others feel silenced?

Who should be the trustee? Selecting a trustee is one of the hardest parts of doing an estate plan and one with the greatest long-term impact on the success of the plan. An advisor working with a client who’s transferring ownership of a business into trust must explain to the client the unique, complex situation of the trustee when ownership of a business has come under their purview. The trustee must have the competence to oversee the business while at the same time balance its duty toward beneficiaries.⁸ Trust drafting has come a long way in this area, and trusts often exempt the trustee from the prudent investor rule requirements that would require diversification (in fact, any trust that may at some point own an operating business needs such a provision). However, even if the trust allows the trustee to own the business, that doesn’t mean that any trustee has the skill set to do so. Indeed, trustees will need an understanding of the industry’s challenges, opportunities and strategic issues, as well as a deep knowledge of the particular business itself. It’s a best practice to have trustees meet regularly as soon as shares of a family business are transferred into an irrevocable trust so that they can develop such understanding and expertise. They aren’t waiting on the sidelines—they’re the owners and need to be treated as such.

Simultaneously, the trustees owe a duty toward the beneficiaries, who don’t have legal ownership but have their own set of rights and responsibilities as beneficial owners of the business. Beneficiaries who are shut out of business knowledge, and who don’t understand the nature of their interests, do a favor to neither the family nor the trustee.⁹

Who are the beneficiaries? Remainderpersons? When transferring shares of a business into trust, it’s understandable that the primary focus will be on the health and well-being of the business, but that will miss half the point. The health and well-being of current and future beneficiaries must be considered as well. Does it make sense to tie siblings together in a trust that owns a family business in which some might be involved, and others have no interest? If there comes a time to consider a sale of the business, how will their potentially conflicting and competing interests and wishes be taken into consideration? Trust ownership of a family business can further exacerbate the feeling of family “insiders” and “outsiders” that often occurs with family businesses.

How about the rest of the world? Under stakeholder theory, which is supplanting shareholder theory as the guidepost for businesses, it’s imperative to consider all stakeholders related to a family business – including employees, customers, communities and regulatory bodies. When a business is transferred into trust, it can create more distance between the family owners and these stakeholders, who must be taken into consideration. On a higher level, there’s growing concern that the rise in legal structuring and practices known as “high wealth exceptionalism” may further exacerbate societal concerns such as inequality and threats to democracy.¹⁰

Practical Advice

The questions discussed above only cover the surface of some of the very complex issues and implications related to family business ownership in trust. Any advisor working with a founder or family business owner would do well to add some practical advice alongside their professional counsel. Some suggestions include:

1. Consider the intended and potentially unintended consequences of family business ownership in trust before a trust is created. Will this help the business? How will it impact the family? What pathways are possible?
2. Choose trustees who understand the business and their fiduciary duties to beneficiaries. Encourage engagement as soon as the trust is created. Start regular trustee meetings, and create opportunities for them to understand the business. Foster relationships between the trustees and beneficiaries.
3. Anticipate the psychological impact of trust ownership on family members. Emotional ownership of the business, even for those not involved in management, is a driving force behind individual and group identity and relationships.
4. Don’t underestimate the power of socioemotional wealth for the family. Families are seeking more than financial returns from their businesses. Trust ownership doesn’t change this reality.
5. Incorporate flexibility. Most readers of Trusts & Estates are familiar with cases in which trustees were forced to continue holding shares of a family business long after it was clear that its demise was imminent. Other trustees have been held liable for selling too soon. Trusts shouldn’t contain “black or white” provisions requiring retention or disposal of a business. Drafting should include room for future changes to be made within the limits of the law. Protectors can be included to provide independent oversight and step in to initiate re-structuring if needed.
6. Encourage family engagement. The family’s values and goals are the ultimate North Star for any family business.
7. Finally, if advisors and family business founders and owners can work together to consider potential consequences, aim toward desirable outcomes and provide flexibility to adjust along the way, the results will not only be better for them but also for all other stakeholders impacted by family businesses.

Endnotes

1. See Belén Villalonga and Raphael Amit, “Family Ownership,” Oxford Review of Economic Policy (2020), https://academic.oup.com/ oxrep/article-abstract/36/2/241/5813058; Joseph H. Astrachan and Melissa Carey Shanker, “Family Businesses’ Contribution to the U.S. Economy: A Closer Look,” Family Business Review (September 2003).
2. Ronald C. Anderson and David M. Reeb, “Founding-Family Ownership and Firm Performance: Evidence from the S&P 500,” The Journal of Finance (2003), www.jstor.org/stable/3094581.
3. For a discussion of different ownership models, see www.wealthmanagement.com/high-net-worth/new-family-business- ownership-model.
4. Pascual Berrone, Cristina Cruz and Luis R. Gomez-Mejia, “Socioemotional Wealth in Family Firms: Theoretical.
5. Dimensions, Assessment Approaches, and Agenda for Future Research,” Family Business Review (February 2012), https://doi. org/10.1177/0894486511435355.
6. See, e.g., Fabian Bernhard and Michael P. O’Driscoll, “Psychological Ownership in Small Family-Owned Businesses: Leadership Style and Nonfamily-Employees’ Work Attitudes and Behaviors,” Group & Organization Management (2011), https://doi. org/10.1177/1059601111402684; Asa Björnberg and Nigel Nicholson, “Emotional Ownership: The Next Generation’s Relationship With the Family Firm,” Family Business Review (2012).
7. See Patricia M. Angus, “Who’s in Charge?” Trusts & Estates.
8. (March 2019).
9. While there’s more flexibility to alter trusts through decanting, this doesn’t negate the general rule and practice related to trust irrecovability.
   • See Patricia M. Angus, The Trustee Primer, Angus Advisory Group LLC (2015).
   • See Patricia M. Angus, The Beneficiary Primer, Angus Advisory Group LLC (2020).
10. See www.law.ua.edu/lawreview/files/2020/06/2-Tait-981-1037.pdf.