BanyanGlobal

The Inheritance Effect

In our society, company founders and entrepreneurs are typically lionized as risk-takers and wealth-makers, while those lucky enough to inherit their wealth are too often stigmatized as “silver spoon in the mouth kids.” Regardless of talent or effort, those dubbed “silver spoon” kids face an uphill battle to be regarded as business heroes and seem fated to remain “kids” in the eyes of their skeptics and senior folks in and around the business. We call this phenomenon the “Inheritance Effect”—the very real consequences that can arise from inheriting business wealth rather than earning it through personal investment or sweat equity. This effect can either push inheritors to work hard to prove their own worth and grow the family legacy or demoralize and stunt their chances for success. Sadly, both can occur at the same time.

When a senior family member gifts wealth to the next generation—whether it’s ownership of a family business or other assets—it always starts with the best of intentions: to give future generations a leg up. But, these gifts are almost always mediated through elaborate trusts and estate plans that are driven more by Internal Revenue Code considerations than the long- term benefits to the next generation. In the monomania for minimizing current tax consequences, patriarchs and matriarchs (and their advisors) lose sight of the long-term consequences of trusts that often will determine the nature of ownership for decades.

The mistake comes not (just) in focusing on how to avoid unnecessary tax consequences, but in assuming that gifting and inheritances are one-time events. In reality, the right way to prepare to transfer wealth between generations involves a long-term process in which your client considers not only the legal and tax structure of his gift but also its evolution in the future: how to best emotionally and psychologically prepare the inheritor (and the skeptics around him) for his future role.

Is your client in danger of triggering the Inheritance Effect in his family? Here’s what to do to avoid it.

The Cause

The Inheritance Effect is the result of short-sightedness—undervaluing the emotional and psychological factors that will play out for members of the next generation within themselves and the business.

First, a gift can distort the psychological power of ownership. By virtue of receiving a gift (instead of earning wealth), a sense of accomplishment is lost in the transfer. Because inheritors were given something freely, they may no longer have a burning need to go out and attain it themselves. But as a result, inheritors often don’t feel like they’re the psychological owners of the assets; they believe they’re just a placeholder or temporary beneficiary. “My great-grandfather built this wealth. I’m just trying not to screw it up for the next generation” is an adage we hear frequently. This perception can have damaging effects on self-worth. It can even become a self-imposed ceiling, for who possibly could achieve greater success than their noted ancestor? So, why even try?

Even those who do try are seldom given a clean slate where their accomplishments can be judged at face value. Instead, their accomplishments are always held up and compared to the achievements of the generation before. Every misstep is judged, often harshly, for how could a “lucky” inheritor possibly squander the gift bequeathed to him?

Adding to the anxiety for inheritors is the fact that, as Nobel prize winners Daniel Kahneman and Amos Tversky concluded, we have an inherent bias for “loss aversion,” which is more powerful than a desire to win.1 Fear of losing what we’ve been given is more powerful than the desire to gain more. The “gift” of wealth becomes a burden to feel guilty about, a responsibility to look after. As William Kissam Vanderbilt, third-generation descendant of the great Cornelius Vanderbilt, once put it, “Inherited wealth is a real handicap to happiness… It has left me with nothing to hope for, with nothing definite to seek or strive for.2

Second, the real power over the assets is typically “pruned” during estate planning. When assets are gifted through trusts, the founder chooses how to divide up the privileges of ownership before any transfer is made, often when latter generations are too young to show their true potential. From a patriarchal perspective, this is fantastic—it limits the capacity for mischief or misuse by the next generation and allows the founder to extend his ability to exert control over the asset. But, it has significant consequences as it can also take temporary considerations (“they aren’t ready yet”) and freeze them into major sociological givens for decades (“the trustee is there to protect the business from its owners”). Such sociological and personal intangibles are seldom considered during drafting, but over time, the impact on the next generation is real— often it’s felt as infantilization, lack of trust to manage a sizable asset or real fear of failure.

Third, ownership clout doesn’t automatically transfer across generations. Even if the next generation legally owns the assets, it’s not uncommon for them to be dismissed as “trust fund babies” by the corporate leadership of the family business. We consider “clout” as the authority and respect due to owners. In effect, there’s no form of ownership that carries less clout than beneficiaries of a trust with non-voting shares. Long term, the impact on individual next generation family members and the business can be severe.

We’ve seen, time and again, senior executives and board members of the operating businesses fail to take next generation family members seriously. Even if they grew up in the business, there can be a lingering memory of them as children playing in the office, which somehow gets preserved and diminishes their authority as leaders. Generations who are even further removed may find themselves forced into passivity “for the good of the business.”

We know of several family businesses in which less involved younger generation family members lost control of the business to non-family executives in a series of canny moves. One shareholder group didn’t realize until the eleventh hour that its non-family CEO had loaded the business up with debt in a power move to convince the shareholders to consider an employee-led buyout. When they discovered the extent of his contempt, it was a battle to regain control over the company (which they eventually did, with the help of new independent board directors, but at great financial and emotional cost).

Avoiding the Inheritance Effect

So, what can be done in light of this phenomenon? The trick is understanding that preparing for the legal transfer of an inheritance is just part of a long process to prepare the inheritor to be not only a responsible steward of the family’s wealth but also one with personal drive and ambition to build on it. We’ve worked with many families that have managed to do just that with some thought and long-term planning. Here’s what we suggest:

Guidance to senior generation grantors. This is what we say to our clients:

  1. Imagine yourself in the system you’re designing. Go beyond the tactical “how control will be divvied up” of estate planning, and put yourself in the three-dimensional world the trust sets up. What kind of world are you setting up for your family members to grow up in? Are you providing for them or coddling? Are you imbuing values to grow and succeed—or are you dampening their drive? Put yourself in their shoes—how would it have impacted your development if you had been born into such a privileged world? Sheldon Adelson, founder of the Las Vegas Sands casino company once shared:

    “My parents were poor. When they died in 1985, 11 days apart, they didn’t have as much as $100 in the bank… So I’m talking not from a white shoe background or from a privileged background. I’m talking [as] somebody who wore his skin down to his fingers trying to climb the ladder of success.3

    Sound relatable? Many founders we know have a similar “rags to riches” story that defined their early success. So, what does it mean for your children if they grow up under radically different, cushier conditions? (Which isn’t to say you should artificially create hardship for them, but rather consider the effect of the environment in which one grows up on his personal development.) What kind of world do you want to set up for your future generations?

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  3. Bring both generations into the estate-planning conversation. No matter how generous a gift is, our experience is that it won’t be received well until you can have an eye-to-eye conversation across generations to align what you want to do with what your next generation’s interests may be. As you develop your estate plan (not after it), treat your next generation as the adults they’ll be one day. Many grantors we know start their estate-planning process with their lawyers behind closed doors, only bringing in their beneficiaries after the plan is already baked. This is a mistake, in our opinion. If you want to set up future generations for success, your estate plan shouldn’t be a fait accompli to be handed over; it should be part of your transition process to set up the next generation for success.
     
    Have conversations with your beneficiaries and lawyers in the room together. Better yet, start the conversations around the dinner table first (and often). Talk about how you earned your wealth, what you hope to accomplish with it and, most importantly, what you aspire for your next generation’s future—what kind of life you hope they’ll lead and how the assets you accumulated may benefit them. Listen to how your next generation responds and develop a shared understanding of what wealth is and isn’t.
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  5. Consider how you treat the next generation around people you admire. As they mature, you can either dismiss them as “still kids” or, instead, intentionally and cautiously celebrate their successes as proof of their growing readiness for leadership. Recognize that their success in no way detracts from yours—if anything, it’s a testament to the values you instilled in them. We’ve seen many talented patriarchs fall into the trap of wanting to prove that they’re still on top when they talk with their peers and fellow business leaders. As tempting as this might be, use the opportunities you have to promote and elevate your next generation. When one daughter reflected to her mother at a young age, “you’re the smartest person I know,” her mother lovingly yet resolutely responded, “you will be more than me.” This simple statement became a self-fulfilling prophecy, with the daughter leading the business to the next level of growth.

Importantly, we’re not suggesting you should lavish undeserved praise on young owners, but rather that you should open yourself up to the often painful need to acknowledge the next generation’s growth, even if that slightly undercuts the “great man” cult you’ve unintentionally built among senior leaders in the company over decades. That selflessness is a huge gift, independent of giving shares in trust.

Guidance to professional advisors:

  1. Understand your clients’ interests as people first, before planning for their wealth. Encourage clients to play forward the impact on their family members in 10, 20 years before putting pen to paper on their estate planning. Ask them, “As a parent or grandparent, what do you want for your family members?” and “What values do you want to instill in future generations?” Then consider how to develop their estate planning to meet those goals (instead of vice versa). Rather than dive into the mechanics (at what ages a beneficiary has access to his trust and how much), ask them to describe what kind of life they want their descendants to lead. Then consider how the trust will adapt as the beneficiaries mature.
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  3. Consider how trust documents can mature with beneficiaries as they grow into their potential. Rather than making concrete decisions at a point in time that will have lasting impacts on beneficiaries, consider how to allow for qualitative determinations in your drafting, ones that accommodate the interests and capabilities of beneficiaries as they grow. In the words of Warren Buffett, the right amount to leave your children is “enough money so that they would feel they could do anything, but not so much that they could do nothing.4

Incentive trusts are a step in the right direction, but they’ve historically been one-dimensional. By rewarding certain behavior, such as graduating from college, with money, they motivate certain behaviors the grantor values. But, they also walk a fine line of puppeteering latter generations’ behavior and possibly forcing them down career paths they might not otherwise have chosen. Instead, consider how to accommodate the interests and capabilities of your beneficiaries as they mature. Could an income-matching program be beneficial (so that a beneficiary with a passion for teaching could find his income suitably supplemented)? How could it be adjusted for qualitative considerations, such as taking a few years off to join the Peace Corps?

We find that so much thought and expert guidance goes into setting up effective trusts and estate plans, but unless all parties put as much thought and planning into setting the next generation up to thrive with that gift, it can be counterproductive, at best, or damaging, at worst. The Inheritance Effect is often seen through the lens of its symptoms (next generations members who flounder or fail to launch). A better way to think about the challenge is preventative: how to correct the problem before it starts.

Endnotes
1. Daniel Kahneman, Thinking, Fast and Slow, (Farrar, Straus and Giroux 2011).
2. Arthur T. Vanderbilt, Fortune’s Children: The Fall of the House of Vanderbilt, William Morrow, 2001.
3. https://abcnews.go.com/Business/sheldon-adelson-vegas-billionaire-pummeled-recession-claws-back/story?id=12184313.
4. Richard I. Kirkland, Jr., “Should You Leave It All to the Children?” Fortune (Sept. 29, 1986).

Originally published in Trusts & Estates magazine, August 2020