In the industry-wide scramble to attract wealthy clients, advisors can sometimes overlook essential elements of differentiation. Consider structures governing ownership and control. A family member may own the corpus of an asset, but another family member may own the income it throws off. One member of a limited liability company (LLC) set up as a joint investment opportunity may be a family trust, another may be a real estate developer who shares in the profits of the concern. Knowing who owns what and how can be key to unlocking access to client assets that have previously been elusive.
"The industry is trying to consolidate a lot of information for families, but within that consolidation has to be some clarification and articulation of the different categories of structures you're dealing with," explains Patricia M. Angus, vice president and family wealth advisor for Asset Management Advisors in Greenwich, Conn. "Clients at virtually all levels of wealth are likely to have a good number of different structures with different objectives."
Without such consideration, clarification and articulation, things can easily go awry. An advisor constructs a portfolio to offer maximum yield and tax efficiency, but the portfolio fails to provide enough cash flow for a specific class of beneficiaries.
Or perhaps the founding generation of a successful family enterprise sets up a grantor trust for the purpose of divesting a $5 million concentrated stock position. An advisor sells the entire block of stock without realizing that Mom and Dad will be stuck with a huge tax bill since their cost basis on the asset is now zero.
But how is ownership really defined? An asset may theoretically be owned by one entity but actually controlled by another. For example, the beneficiary of a trust may theoretically "own" the assets in the trust, but in reality, the assets are controlled by the tenets of the trust and subject to the oversight of the trustee until they are distributed to the beneficiary. The manner in which the distributions are made can directly impact a beneficiary's asset allocation or financial plan.
Ownership structures can have different purposes, requiring the assets contained to be allocated accordingly. Limited partnerships can be used to co-invest, to segue assets to the next generation, or to combine assets to meet investment minimums for certain money managers. Therefore, the issues of control and purpose are guiding factors in defining ownership structures and identifying implications of the underlying assets.
The best way for advisors to ramp up the learning curve is to understand the basics of ownership structures favored by clients of varying wealth levels.
According to Angus, "Advisors take a great risk if they don't know the implications of their actions and how they relate to the structures for which they are investing. Different structures have different legal parameters for permissible investments and activities." She further explains that advisors need to know who has the authority in an account as well as the procedures for acting on an investment strategy.
Advisors tend to do less than they should when they don't ask the right questions. Important questions to ask regarding ownership and positioning of assets include:
Who pays the taxes?
Who has benefit of the assets?
Are the assets divided in some way between actual ownership and income flow?
Is the structure's purpose guided toward current or future generations?
Thomas J. Handler, J.D., P.C., and principal of Handler, Thayer & Duggan LLC in Chicago, adds, "It's critical for advisors to be aware of the various baskets and control mechanisms and able to distinguish between the two." A good many of the baskets are going to be trusts and the other baskets will be family limited partnerships (FLPs) and family limited liability companies (FLLCs).
When working with advisors to wealthy families, Handler's firm develops schematic diagrams to illustrate the relationship between the structures a family may set up--from the simplest to the most complex--and how they work together. Such a schematic shows the linkage between enterprises and helps the advisor to understand how the cash flows run through the system and what the control mechanisms are. Figures 1 - 3 illustrate sample scenarios showing baskets of trusts and baskets of partnerships ranging from simple to complex.
Figure 1 Figure 2 Figure 3
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Such full understanding on the part of the investment advisor often requires collaboration with other advisors--another of the finer aspects of serving the wealthy--for the overall benefit of the family client. "An advisor should either have in-house expertise who is familiar with the different entities or seek advice from outside counsel. Ideally, the client's own legal and tax counsel should be involved--that points to the whole teamwork issue. "The best way to handle someone's wealth is from a multi-disciplinary standpoint with everyone working together," explains Angus.
What do ownership structures look like in real life? Mark J. Blumenthal, CPA, partner and chairman of the Family Office Services Group at Blackman Kallick in Chicago, cites a few examples using the LLC structure. He likens the flexibility as well as the risks of an LLC to that of an egg: "An egg is the most flexible and versatile food for cooking, but if you handle it incorrectly, it will crack and become worthless. Similarly, the LLC is the most flexible and versatile entity for choice of ownership structure, but if it's put together improperly, it can become worthless, especially in the area of wealth transfer," Blumenthal says.
Example 1: A family decides to diversify its holdings by investing $5 million with a local real estate developer to develop a shopping center. The family negotiates the deal as follows: Before any distribution to the developer or the family, the family receives a preferred return on the $5 million at an accrued rate of 10 percent compounded. The family and developer then split the residual profit on a 60-family/40-developer basis. To spice up the deal, the initial 60/40 split applies only to the next $2 million of profit after the preferred return; on the next $3 million, the split would be 50/50; and on any further profit (both from sales and operations), the split would be reversed at 40 family/60 developer .
Such an arrangement has significant implications for investment decisions concerning cash flow, asset allocation and wealth transfer issues. There could be additional provisions in the partnership agreement to cover a partner's death or as a restriction on the ability of the investor (the family) to sell its interest. In addition, Blumenthal notes, the income tax regulations governing LLC allocations of income or loss are quite complex. Therefore, the family and the developer also should be thinking about wealth transfer opportunities using the new LLC.
Example 2: Ownership structures might be used to pool family assets. A patriarch and matriarch in their 70s could have three sets of married adult children. The family's combined net worth of $15 million enables them make some alternative investments. But the allocation of the individual family members' assets and the percentages allocated to the appropriate investment classes fall under the minimums for each money manager they have chosen. The family could form an FLP or FLLC for the purpose of co-investing in these funds.
The advisor working with such a family would need to have his or her antennae up in order to see the potential mine fields associated with this arrangement. Perhaps one of the children was a late life baby and is in his 30s, compared to his brother and sister who are in their 50s. Obviously, the advisor would need to consider which investments are suitable for which family members. In such a case, multiple partnerships could be set up or the single partnership could be structured so that each family member could pick and choose within the partnership structure and decide with which managers funds would be placed. With a $50 million family, one partnership with multiple investment choices might work better; with lesser amounts, multiple partnerships may offer a simpler solution.
Example 3: The multiple partnership concept also may be applied to multiple clients. "We've worked with advisors who set up a single purpose LLC only to invest in a single investment," explains Blumenthal. "Although there would be some costs involved, an advisor could provide his or her clients access to an investment that would otherwise be out of reach by pooling the assets of various clients into an investment LLC." In such a case, the advisor would need to seek counsel of a competent securities attorney to properly abide by securities laws. "It's a private placement that can allow advisors to offer greater diversification for client portfolios and have their own investment product," Blumenthal adds.
Developing knowledge and expertise in the area of ownership structures can equip advisors with an effective approach to attracting and serving wealthy clients. Advisors can position themselves as a critical component of the family's advisory team.. But simply becoming familiar with the various ownership structures is not enough. Advisors must also understand how those structures work together for the benefit of multiple family members, incorporating the considerations of multiple clients and multiple goals into the mix.
In the process, such considerations draw a line in the sand for advisors from several perspectives. Advisors must decide what level of service to offer in their quest to earn the trust of the wealthy. Are they willing to participate in the level of relationship required to attract and keep larger assets? Are they willing to dig deeper into the knowledge pool and to reach outside their own practices as part of an advisory team for the client?
"Ownership structures have a very significant relationship, not only to the way assets are managed but to the holistic aspect of the financial relationship with the client. It's an integral part of understanding what the client is trying to accomplish--whether asset protection, estate planning, privacy, or tax planning," offers David A. Pickler, J.D., CFP, ChFC, and president of Pickler Wealth Advisors in Memphis, Tenn.
Angus connects such expertise to an even deeper relationship focus. "Working across disciplines to understand a family's objectives, how to make it all work together is key. The values and motivations of human beings have to come above all these other things because, regardless of the investments, no structure will succeed unless the human side has been taken into account."
"Rather than view the relationship as one with the matriarch or patriarch or the second generation, the investment advisor should think of the relationship in terms of the family and its advisors. That makes for greater stickiness and you don't get fired the minute a generation ceases to be involved or passes away," adds Handler. A solid relationship between an investment advisor/manager and the family office entity has the potential to survive deaths and changes over multiple generations.
Lisa Gray (firstname.lastname@example.org) writes extensively on family office and wealth management topics and has 18 years' wealth management industry experience.