The Legacy Trap


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In this white paper, Rick Raybin and Eric Von Berg discuss the challenges successful entrepreneurs face when trying to leave a legacy, the consequences if estate planning and succession issues are ignored, and the ways successful families have addressed
these challenges.

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The Legacy Trap

  1. 1. The Legacy Trap
  2. 2. The Legacy Traperic Von Berg, a commercial property mortgage banker, and rick raybin, a wealth management expert,have several clients in common. Over the years, they both have seen, too often, the acrimonious and costlylawsuits that sometimes follow a developer-dad’s passing. These lawsuits dismantle and divide the family trustcontaining the parents’ commercial real estate portfolio, and, at resolution (and after $1 or $4 million in legalfees), none of the children are happy and they are no longer speaking to each other. a suit to reach familyestate settlement is akin to a messy divorce. But in these cases, it is often the surviving parent who is caught inthe middle and has to hear the vitriol, mistrust and accusations between her children.however, all is not lost. From their different perspectives, eric and rickwill discuss the challenges successful entrepreneurs face when trying toleave a legacy, the consequences if estate planning and succession below are comments on thisissues are ignored, and the ways successful families have addressed subject from two of eric’sthese challenges. mortgage banking clients, both survivors of siblingWhen is trying to leave a legacy a problem? divorce—messy law suits toeric von berg: When you mix money and children you face potential break up the family trust andproblems. Let’s look at a typical profile. A successful developer or divide assets among maker created a fortune in his lifetime. he wants to leave a their comments are below,legacy in property but he also wants to see his family business carry with names changed.on. his daughter is in the business but the patriarch is currently makingall important decisions. Let’s say he has three other children. One bill: “complex estate planningdaughter is a stay-at-home mom, the other daughter is a doctor, and originates from the fear ofthe only boy runs kayaking trips and has never been able to save or paying estate taxes.”earn a dime. michael: “real estateWhat brings a successful real estate entrepreneur to the entrepreneurs have beenrealization they need a plan for succession? given many tax advantages.rick raybin: I would like to say my persuasive arguments motivate a under irs status 6166 if at leastdesire for planning and change, but the desire to craft a succession 35% of the assets are in familyplan usually comes from a combination of two things: (1) an real estate holdings you canattachment to a real estate portfolio with a desire to see it maintained pay the estate tax liabilityas a family legacy, and (2) some outside event; a health problem, an over 15 years at a favorableeconomic setback, or the death of a spouse or partner. interest rate. you can structure the ownership of the propertye: Most real estate entrepreneurs take care of estate tax issues but to significantly reduce thedon’t really put together a proper succession plan. I agree many value used for calculating theowners are very attached to their portfolios and these properties are estate tax. these are hugetheir babies. So, maintaining the portfolio is the priority. advantages.”What Would be the goals of such a client?r: Succession planning is just one element of effective estate andlegacy planning. The true work of estate and succession planningis often subtle, and can be summarized as overcoming the age-oldpattern of “from shirtsleeves to shirtsleeves in three generations.” It
  3. 3. involves considering a host of issues involving your family’s relationships,values and goals, including:• Imparting your values to offspring and descendants m: “most people wait until• Building an enduring family culture their kids are out of college to• Keeping family―and family values―intact do any succession planning.• Easing business succession and establishing the role of the next and that is too late to impart family future generations values.”• Transitioning from a role as creator and deal maker to a position as executive/patriarchWhy is a planned succession so important?e: If your legacy is to survive, you need to make sure your portfolio canbe run without you. hopefully, you can see it running well under a new m: “transferring control ischief when you are around to give advice. complex as the business leader’s self esteem isIf you have brought a son or daughter into the business, you need to connected to his success andwork on handing over first the operations and later the deal-making position in the community.”role. This is always hard, but there are ways to ease the transition,including creating a board of directors, bringing in consultants, definingroles, and setting a time line for shifting duties and decision making tothe next generation.If you intend for your children to rely on third-party management, thisprocess is easier. But, remember that asset management is a separate b: “you have to be carefulrole from property management. asset management can never be in letting experts craft anfully contracted out unless you convert your holdings to stock in a well- estate plan. complex estatemanaged reIT through an up-reIT process. planning is sometimes so complex that no one reallyr: as a successful entrepreneur, you’ll want to leave a real, lasting understands it. and becauselegacy―not just your assets―to your children and their descendants. To mom and dad don’t reallydo this, you need to think through your family’s unique issues and the understand it they do notpotential consequences of your decisions. you’ll need to be honest explain it to their kids.”with yourself about your family dynamics and your children’s interests,skills and shortcomings. This kind of comprehensive planning will helpguide the outcome to what you think will be best for your family.While a succession without planning is possible, it is unlikely to besuccessful. Instead, it’s critical to take concrete steps, including m: “to begin to shift control,considering how to provide for different needs among offspring and you need to shift focus awaydescendants and avoid strife; strategies for protecting the estate from from wealth creation. therecreditors (including divorce); and whether to continue to focus on real are far more people who canestate or pursue a broader diversification of your wealth. manage wealth than can create wealth.”What is the biggest mistake? We both agree, waiting tooe: Most successful real estate long to think through anddevelopers and investors love plan for a smooth The hunt for the next
  4. 4. deal, negotiating leases and creating value keeps them young. But,too often I see my clients transfer the reins of their empire when they b: “siblings want to askare on the way to the hospital for the last time. The assets collected questions about their parentsduring their real estate career are often not a fit for the next generation plans for succession, butand the “child” taking over the business is in his or her 50s or 60s. at this don’t because they fear thepoint, it’s a bit late to start to command the respect of employees, answers.”vendors, investors and lenders. Unfortunately, it is also too late for thenew boss-child to gain the trust of the siblings who are not in the familyreal estate business.r: Successfully transferring the business you’ve worked so hard to build m: “parents avoid discussingto the next generation doesn’t happen overnight. If you envision your succession plans with theirchildren taking over the management of your company, you need children because they do notto start planning for that long before the actual transfer of control want to air family secrets noroccurs. even if your children won’t be actively involved in day-to-day to they want to point to a childbusiness operations, you still need to address concerns about how your and say; ‘i don’t trust you or iwealth will be distributed and how your legacy will be maintained. This don’t trust your spouse.’”isn’t always easy to do, and the process can bring old resentments orpreviously unrealized feelings to the surface―both in yourself and inother family members. But, in my experience, avoiding these sometimes m: “When you bring a childdifficult planning issues is a recipe for legacy planning failure. into the family real estate business you need to give himhoW do you bring the children or a child into the business? or her a way to make it theirr: you can’t assume that sharing your passion for your business will be own.”enough. Instead, your children should learn by working in the familybusiness. For a successful transition to happen, you must prepareyour business for a time when you will no longer be making the key m: “the patriarch needs todecisions. embrace this need for change. he needs to put as much effortFirst, one must realize that creating a successful real estate firm is very into developing a sustainabledifferent from sustaining one. The roll-up-your-sleeves approach to legacy as was invested intomaking sure everything gets done―your way―does not work well in a creating the wealth in the firstlarger organization with employees. Instead of being dominated by place. the patriarch alsoone individual who made certain what needed to get done was done needs to embrace having anow, a sustaining firm will rely on people who are well organized and child central to the business.have good attention to detail. Most will not tolerate the “drop what finding ways to changeyou’re doing now” approach. gracefully opens an excitingSecond, what you needed to do when you started your firm may no opportunity to work togetherlonger be sufficient. During the last 30 years the competitive landscape and develop skills. if thehas changed. The sophistication, breadth and scope of issues facing founder cannot teach hisreal estate owners and developers have increased dramatically. What techniques and inspire with theone person could handle before often requires two or more today. vision that started and grew the company, he will neverThird, many successful families have learned that they don’t have all be comfortable letting thethe answers and send their children to work in other successful real successor find his own way.”estate organizations before returning to run the family’s firm. I haveworked with families without that experience and found significantshortcomings in one or more of their approaches.
  5. 5. but i love deal making. do i need to give this up?e: No. But do not get wedded to your specific assets. It is time to beginmaking changes. recognize that assets that take effort (i.e. assets thatneed renovation or ongoing value-creation) usually do not fit with the m: “blood is thicker than watergoals of everyone in the next generation. It only takes one disgruntled and money is thicker thanchild to throw a monkey wrench into the workings of the estate. Once blood.”the value has been created in an asset, think about trading it for onethat does not need as high a level of effort and expertise.If you have a child in the business who is a good deal maker, able totake risks and able to create value, try to set that child up to do dealswhen you are gone, without risking the assets of his or her brothers andsisters who may not be risk-takers. This often requires separating assetsand creating two or more trusts.r: My advice to the next generation taking control: One of your great m: “hiring third-party talentstrengths is doing what you love to do and doing it well. rather than when the patriarch is still ontrying to learn a new skill set, especially if it means doing less of what the scene is difficult. There isyou do well, I recommend that you hire the talent, whether it’s an usually a lack of trust and aemployee or contractor, to handle the other duties. strong fear of losing control.”but my kids love each other. Money issues are the biggestWhy should i plan my affairs threat to family if they Will fight over myWealth?e: The objective is to head off strife. If I tell you the horror stories I’vewitnessed, you will claim that such fights could never happen in your b: “as the patriarch, youfamily. But ask yourself: My kids get along now, but will they in 10 years need to face your worst fear:time? Will their spouses trust the child I left in charge of my portfolio? that you have created a generation of entitled siblingsr: If you have taken one or more of your children into the real waiting for the parents to passestate business, that son or daughter has a special status due to so they can cash in their lotterytheir knowledge, responsibilities and their own contribution to value tickets.”creation. Unfortunately, that status may not be trusted or understoodwhen you’re gone. you should anticipate that the child with specialstatus will not get the respect from his siblings that you enjoy as theirparent. Planning for conflict now may be unpleasant, but it will makeit easier for your family to deal with a disagreement if one does ariseafter you’re gone.What changes should i make Shift real estate asset from b: “legacy is just another wordto my real estate portfolio? wealth-creation to income for ego.”e: If you are like most successful, generation in the latter stageself-made real estate investors, of your career.your focus has been on buildingwealth. you have been ready
  6. 6. to reinvest if it creates value. I have many clients who made tens ofmillions but lived frugally for most of their lives. assume that one or moreof your children or their spouses will be more focused on receiving asteady income from the portfolio than seeing that portfolio managedto maximize the creation of wealth.r: In my experience, I’ve found that the disruption of steadydistributions is one of the most common issues for strife in family-runportfolios. at the risk of spouting heresy, I am a proponent of broaddiversification. Although you may have created your wealth through b: “When one sibling is cho-real estate and never enjoyed much success with other types of sen to run the business, the biginvestments, there are significant benefits that come from diversifying question is always: if mom andyour wealth. Diversification reduces your exposure to an unsuccessful dad loved us all equally, howsuccession or the squabbling over the family fortune. also, it is come the sibling in charge ofunrealistic to expect that real estate will continue to outpace other the business is getting moreinvestments. comparing the returns reported in the NcreIF property money than the rest of us? it isIndex with other asset classes bears this out. I have found the key to an uncomfortable subject forsuccessful diversification is avoiding investment programs that favor both parents and children, so itthe sponsor at your expense. Fortunately, there is a growing cadre of festers below the surface untilfinancial products and advisors who can help you successfully diversify. the parents are gone.”Why does the single entity Because, rather than solvingestate planning solution differences on an asset-create so much strife? by-asset basis, the onlye: Most developers have built a solution is a break-up of thereal estate portfolio of which they single trust. Think of this as aare proud, and they hate the contentious divorce betweenthought of it being dismantled. as your children. The lawyersa result, they gravitate toward a do well but usually no one m: “preventing family strife issingle entity solution, which is also wins or is satisfied with the an honorable objective, buteasier on the estate planner. This outcome. it can only be accomplishedexpert, usually a cpa or attorney, with insight, cooperation andis primarily focused on minimizing estate taxes. The continuity of your continuous management thatbusiness or avoiding family strife is not usually an area of expertise. is open to adjustment for life’sr: To avoid strife, think about creating separate entities for each asset changes and eventualities.”or at least two entities. One might contain the “coupon clipping” realestate and one would contain the assets that will need reinvestmentor redevelopment. To do this, it helps to work with a professional who isexperienced not only in estate planning, but also has a background inreal estate and creating legacy solutions designed to avoid conflict.Lawsuits over estate issues usually happen when the flow of checksstop. Separating assets out of a single pool will allow for a child whocannot or refuses to make their capital call to sell out or be squeezeddown in ownership in that one asset, without jeopardizing that child’sownership and cash flow from the other assets. Several small problemsare easier to solve than one large problem.
  7. 7. What else causes the most The role of the sibling(s)sibling strife? active in the real estatee: The parent often splits the business is not understood,estate evenly between the appreciated and/orchildren. an even split is the easy compensated.solution.If some siblings go on to professions or careers and one or morestays behind to help run the real estate business, that sacrifice isseldom understood, appreciated or compensated by the siblingswho are not in the real estate business. So where is the reward for thechild running the assets for the benefit of his brothers and sisters? Aproperty management fee is usually not enough. even so, a propertymanagement or asset management fee paid to the sibling in thebusiness is still often resented by the other siblings.r: Besides money, control can be a problem. Many trusts vest controlproportional to ownership in the trust. Because the siblings outside thebusiness don’t understand the vicissitudes of commercial real estate,they mistrust the advice of the active brother or sister.Ongoing mistrust too often leads to accusations. and accusations canlead to a messy lawsuit that breaks up the estate. These lawsuits areby design confrontational, and this confrontation too often leads toestrangement among family members. The last thing most successfulentrepreneurs want is to see what they’ve built destroyed becausetheir heirs can’t work together in a constructive way to continue thefamily legacy.As a financial advisor, my goal is to try to prevent family strife so thatthe wealth that mom and dad worked so hard so to accumulateallows their kids―and the generations that follow―to be happy andsuccessful.
  8. 8. rick raybin, cpa eric von berg, cmba principal with the lifetime capital group. a commercial property mortgage banker with newmark realty capital, inc.I am a financial advisor specializing in cross-generational wealth transfer. I started my career I started my mortgage banking career withas a cpa. From 1979 to 1990, I was the cFO of clients who were 20 to 40 years older than me.the rreeF Funds (now the real estate investment Now I am working with these same families asmanagement business of Deutsche Bank’s Asset the assets move to the next generation. I haveManagement division) and also served as the first seen too much family strife that could havepresident of NcreIF. as ceO of Lifetime capital been prevented. reworking a real estategroup, I help successful individuals and their portfolio takes planning, time, skill and financialfamilies build financial security by serving as their engineering: I enjoy working as part of anpersonal chief financial officer. My work includes estate planning team as the real estate andlegacy and estate planning for families with finance expert. I attended good schools, butsignificant real estate investments my real expertise—both in real estate and estate matters—comes from watching my clients’ mistakes.
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