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Inheritance VS. Private Capital - Pat Soldano

by Mark J. Richards, The Madison Group

Sometimes our perceptions are formed by the words that are chosen. An example is the renaming of the estate tax as the “death tax,” which had the impact of reframing the whole argument to the advantage of those advocating for the repeal of the estate tax. Who doesn’t agree that you should not be taxed for dying? Similarly, I believe that if families think of family wealth in terms of private capital rather than inheritance, it forms a different perception and reframes the discussion.

 

Most wealth creators possess a high degree of self-efficacy. They believe deeply that if all their wealth were suddenly taken away, they would be able to build it all back again. They have a high degree of confidence in their ability to make it through life without reliance on anyone or anything. And, as Exhibit A, they have their Dickens-like story of rags to riches. It is the classic hero’s journey. Striking out on their own, facing overwhelming obstacles, and emerging victorious with the result of wealth well in excess of their needs and wants occurring almost as a byproduct and typically not the goal. Therefore, when we have discussions about family wealth , often the concerns are that too much wealth will be transferred to their children or grandchildren, and that will result in the destruction of their initiative, self-reliance, and the same self-efficacy that has been, in retrospect, so central to the wealth creator’s life journey.  Often this results in the adoption of a family wealth transfer philosophy like Warren Buffet’s famous quote regarding how much money he wants to leave his children, “…enough money so that they would feel they could do anything, but not so much that they could do nothing.”

 

While there is nothing wrong with this approach, it does beg the question, “Where will the remainder of the family wealth go?”  Most often, the answer to this question is that it will go to philanthropy. The world has a great deal of needs, and to the extent that a family is willing to get involved in solving those needs through their intellect, social capital, and financial capital , it can make a difference in the lives of individuals, as well as the communities they live in and the world at large. So, yes, changing the world for the better is a wonderful ambition. However, there is a great deal of thought and planning that goes into executing a philanthropic strategy well, and still, it often goes awry. Further, money that has been set aside for charity is, by definition, money that is limited to philanthropy, so the actual distribution doesn’t require many sacrifices for future generations since they were never in line to receive the wealth in any other form. In our experience, we have found that there is some advantage in families holding onto family wealth longer so that they can invest it as they wish and grow the family wealth through generations. This can result in more financial support for philanthropy, as well as restoring the crux of giving, which is to forego all the other uses that one might have for the funds given to philanthropy. The sacrificial element of a philanthropic gift is powerful and creates an ownership mentality to the charitable giving.

We know of one family who had been very successful in transferring ownership of their family-held business into multigenerational trusts long before an ultimate monetizing event. When the family sold their chain of grocery stores to a large corporation and monetized the value of those stores, the wealth that transferred to multigeneration trusts was well beyond anyone’s original expectations. The family also had funded a family foundation. Over time, as the family gathered and discussed both the family wealth and investments, as well as the philanthropic wealth and charities, the next generation agreed that the wealth that was going to philanthropy was doing great work, and they decided that they would like to have more financial resources to support the charities that they were interested in. The family unanimously concluded that they would move money from the tax-free multiple-generation trusts to the family foundation to allocate more to social capital versus private capital.

This is an unusual story, but it is an actual story and demonstrates the potential for families who leave it up to future generations to decide how to allocate private capital rather than irrevocably commit assets to family foundations or other philanthropy.

Perhaps even more telling is that wealth creators often view wealth retained for family members as consumptive wealth. There is often this underlying assumption that the function of the inheritance is to fund the living needs of the individual family members.  This is expressed with sentiments like, “They will have plenty.” This seems to be a disconnect. A wealth creator typically views wealth as private capital to be invested. Nevertheless, they often assume their financial legacy is wealth that will be used for consumption. Our experience has been that oftentimes future generations achieve success well beyond what the wealth creator ever imagined. These families are often serving a role that is critical to the functioning of our economic system. Just as government capital and institutional capital have their roles, private capital serves a unique role as well. One of the great strengths of the United States of America is that there is no central autocratic government that is directing capital, both private and public; instead, there is a multitude of funding sources including entrepreneurs and investors who are funding a plethora of investment and philanthropic ventures. Inherent in this model is that some will fail, and some will succeed. This is actually the strength of the system – that we learn by trial and error and failure is not final. Rather, failure will educate and inform and make the surviving ventures stronger. Oftentimes, it is only because of private capital that a crazy idea makes it to market and enhances the lives of everyone.

When families are making decisions around family wealth, we encourage them to think of family wealth as private capital. Think not only of the individual needs but also the investment and wealth creation that many families have proven to be able to perpetuate throughout generations . In what is predicted to become a more capital-restrained world, private capital will likely be more critical than ever before. Likewise, opportunities may be greater than ever before. The rapid increase in family office funding of private equity investments exemplifies this phenomenon.

When families become adept at deploying private capital to invest in someone else’s ideas or their own, they are breaking the natural entropy of wealth which is summed up in the axiom, “Shirt sleeves to shirt sleeves in three generations.” Interestingly, this expression exists in every culture such as, “clogs to clogs” for the Dutch. It has been observed, and it is largely true, that wealth passes through the creation phase to the stewardship phase, to the dissipation phase during three generations. However, we now know so much more than we used to know as to why this is and how to change it. One of the more empowering ways for families to look at wealth is to view it as private capital with a shared mission to grow wealth in each generation so that each new generation has more opportunities for deploying both private capital and philanthropic capital. This allows each generation to be in a position to influence the world around them through their investments and their philanthropy. This results in families growing all forms of capital including their social capital and their intellectual capital. It also keeps families together with a shared mission, vision, and values. A common identity is the number one predictor of a family’s chances of staying together across multiple generations.

One of my favorite expressions concerning wealth is, “If your children have strong values and no money, they will be fine. If they have money and poor values, it will be a mess. If they have strong values and money, they can change the world.” This expression embodies the perfection of a family financial legacy.

We encourage families to not think of family wealth in the traditional sense of wealth that will support an individual’s need, but instead to think of family wealth as that and more. Strategies like family banking and family investment entities can facilitate an entrepreneurial mindset but it starts with family culture.  Building a family culture that fosters investment and philanthropy is intentional and being impeccable in your choice of words may be a good place to begin.

So, before alienating future generations from capital that was created in one generation, consider how you can empower future generations to view family wealth as private capital and set about to change the world for the good.

“The most important thing in life is to stop saying ‘I wish’ and start saying ‘I will’. Consider nothing impossible, then treat possibilities as probabilities.” David Copperfield by Charles Dickens

About The Madison Group
The Madison Group is one of the largest independent financial firms in the U.S. dedicated to comprehensive wealth preservation since 1968. We specialize in providing affluent families, business owners and executives with unique, tax-efficient wealth transfer and business continuity strategies. We value solutions that have simplicity at their heart and are manageable across generations.

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The need for fact-based reporting of issues important to multi generational businesses and protecting a lifetime of savings has never been greater. Now more than ever, multi generational businesses and family businesses are under fire. That’s why Family Enterprise USA is passionately working to increase the awareness of issues important to generationally-owned family businesses built on hard work, while continuing to strengthen our presence on Capitol Hill. The issues we fight for or against with Congress in Washington DC include high income tax rates, possible elimination of valuation discounts, increase in capital gains tax, enactment of a wealth tax, and the continued burden of the gift tax, estate tax and generation skipping tax.


Family Enterprise USA promotes family business and job creation, growth, and sustainability by advocating for family businesses, their lifetime of savings, and the issues they face running their businesses every day. Some of the issues we fight for or against with Congress in Washington DC are high Income tax rates, possible elimination of valuation discounts, increase in capital gains tax, enactment of a wealth tax, and the continued burden of the gift, estate and generation skipping taxes. Family Enterprise USA represents and celebrates all sizes and industries of family businesses and multi-generational employers.

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Family Enterprise USA is the organization that represents all family businesses on a national level in DC; it is not unique to any industry. Family Enterprise USA is different from other organizations because it represents and advocates for the families of family businesses and the issues, they face running their businesses every day. Our sole mission and purpose is to promote family businesses and their job growth in America. We also support the work of Family Business Centers across the country. We hope your family will choose to be a member of Family Enterprise USA.