Lessons From Rinehart

As published on www.DynamicBusiness.com.au

Regardless of where fault lies, you have to feel for the Rinehart family.  All families have conflict from time to time behind the privacy of closed doors.  Wealth creates a platform that allows individuals to “shout louder” through the courts and the media. 

The Rinehart family dispute reminds us that we are in the early days of the largest generational wealth transfer in Australian history.  Here are some sobering facts history offers.  Only 30% of businesses make it to the second generation (3% profitable by the third). In wealth terms, the second generation loses 65% of family wealth, increasing to 90% by the third.  Wealthy families often manage inheritance badly.

Here are 5 things that could have assisted in preventing the conflict we have seen played out in the courts and on the public stage.

(1)    Prevent vesting by using perpetual structures

“Bankrupting” tax liabilities when a trust ends or “vests” makes for great headlines, but this is serious news for anyone with a trust.  Most family trusts have a lifecycle of about 80 years, sometimes less.  The consequences of vesting are appalling.  On a good run, a family loses about 24% of the growth in its wealth as tax.  Unmanaged, I have seen rescue missions to prevent liabilities of more than 60%.  Either you sell the asset to pay the tax or if the asset is illiquid, the family is placed in significant debt.  Neither option appeals.   Yet the tragedy is that is possible to set up perpetual structures which remove the issue.

(2)    Split assets into separated structures

Arguments between adult children can destroy family unity for generations annihilating not only wealth, but a family legacy.  As unbelievable as it might sound, I regularly see battle lines drawn by adult children around who was the favoured child and who has the higher “entitlement”.

At an adult level, these conversations manifest themselves as disputes over who gets the low yield second tier commercial property assets and who gets the high yield blue chip growth stocks.  Put 3 adult children in control of a single pool of assets in a structure and voting can be used by two against one, or one attempts to dominate.  The simple solution is to progressively separate assets into separate structures.  Choose which asset goes to who.  Perhaps get the adult children involved in the choice.  This leaves children with nothing to dispute and removes a key obstacle to family unity

(3)    Choose the right assets to pass to future generations

It is extremely difficult to leave management of an active business to adult children but put ownership of part of the equity in a structure for the benefit of grandchildren.  If the business comes to a substantial “fork in the road” (a certainty across the span of 2-3 generations) and the children choose one path, it is always possible to use the benefit of hindsight to say that the better decision for the grandchildren would have been to take the other path.  Personal, business and lifestyle needs of the adult children may be in complete conflict with the objective of growing equity for the grandchildren.  One solution can be to change the nature of the grandchildren’s interest to a non-equity interest.  For example, using a secured loan into the business which can be repaid to the grandchildren’s structure if the business is sold, merged or restructured without dispute over the “value”.

(4)    Address independence and control issues up-front

Where control of assets and the intended beneficiaries are not in complete alignment, conflict occurs.  A classic example is where grandchildren are due to inherit at a certain age, but parents who have control defer this inheritance due to concerns about “readiness”.

Time poor parents may confront an affluenza affliction that often faces the younger generations in wealthy families – heirs lacking a purposeful pursuit in life develop personal character issues such as a false sense of entitlement, a desire for instant gratification – fast cars, boats and big houses – without the self control to moderate consumption.

You can remove conflict and control issues by putting clear and unambiguous rules in place from the outset.  Involvement of independent and experienced professionals in the management of the asset base and the resolution of issues such as suitability to inherit, can take the heat out of family dispute.  The art of doing this is another article in itself on governance.

(5)    Build character, teach and live enduring family values

If your parent is the richest person in Australia, how do you develop a sense of achievement and identity that is not dwarfed by them?  This may seem to be an impossible challenge without the right support structures.

To be a member of a Family means something, whether it is written or unwritten.  Big Families are a big business.  The controllers of wealth can often be so busy in the management of the family business that they lack the time to coach the next generations.  Transfer of values from parent to child to grandchild can be difficult if contact is limited. Clear communication of what the family is, what it stands for, and what conventions of behaviour are appropriate is critical.  Engaging family members in business with aligned leaders and can deepen engagement.  Philanthropy can be another mechanism which teaches key skills.  How families use tools like family constitutions and governance structures will be the subject of another article.

Universal principles

Most people would say “all of this does not apply to me and my family, I’m too small to care”.  But I disagree.  The legacy of any family is worth preserving.  The steps outlined above are as relevant to a family with $1.5 million in assets to pass to the next generation as they are to a family with $1.5 billion.  Disputes still arise.  Things may be much less complex to manage but the principles have broad application.

Derisking your Business Partnership – Some simple but important steps

Running a business with others whether through a company, trust or partnership is not something that many people step into lightly.  Most get to know their business partners for months or years before they go into business, building trust, rapport and structure around them as they go. 

So it makes sense that many partnerships are now insuring against the unexpected exit of a partner from the business  with Buy/Sell insurance that allows remaining stakeholders to buy a partner out in the event of specific events like death and disability.  

It is an important element of succession planning in partnerships, where individuals rely on each other to run their business and deliver their services or products to the market.

Take for instance the business run by Mark, Jeff and Drew, partners in a firm that sold high profile residential property.  The real estate agency had a premium referral based clientele and a superb reputation that enabled them to live a good life.  Despite their success, the partners had never taken the time out to build a succession plan, put business agreements or insurances in place.

Sadly, Jeff’s lifestyle got the better of him, and he died suddenly and unexpectedly from a heart attack.  His wife, Kathy, who had never really been interested in the business since she left to have children 10 years ago decided return to work again, demanding to be treated like and equal partner by the other two as she was a beneficiary of Jeff’s 33% shareholding.

It soon became obvious to Mark and Drew that Kathy was out of her depth.  Clients who had previously worked with the agency were complaining, two of their best staff resigned and the agency was denied an important regional contract they had held for 12 years.

The hostility and resentment between Kathy  and Mark and Drew grew to the point where Lawyers became their best way of communicating.

The situation was stressful for everyone in the office, and it had virtually destroyed the value of their once buoyant and successful business to the point where it was virtually worthless.  When one of the senior staff left and set up an agency down the road in competition with them, they knew their run was over.

Had Mark, Jeff and Drew sought advice on succession planning their partnership and implemented buy/sell agreements and insurance this situation could have been avoided altogether.  When Jeff died, funding would have immediately triggered to buy Jeff’s ownership share from his estate.  The inclusion of staff incentives schemes in their succession plans may also have kept staff in the business, minimizing the risk of them setting up in competition with the firm.

Are you in a business with others?  What should you do?

  • Seek professional advice to draft a buy/sell agreement
  • Put in place buy/sell insurance
  • Draw up an effective succession plan that take into consideration sudden and planned exits
  • Ensure your buy/sell agreement is regularly revised and amended as circumstances change.
Image source: Flickr: o5com