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Preparing Heirs Through Experiential Learning By Timothy J. Belber JD AEP®

“My children and grandchildren do not appreciate what they have.”

Though their descendants often dispute it, this observation not only is common amongst wealth owners, but it also is true. Large homes, nice vacations, new cars, expensive clothes, and private schools are the status quo to children born into families of wealth.

In his book Strangers in Paradise: How Families Adapt to Wealth Across Generations, Dr. James Grubman explains this phenomenon. The Land of Wealth, he writes, is occupied by immigrants and natives. Immigrants to any land appreciate the newness of the land while natives take their surroundings for granted. An immigrant from a third-world country moving to the United States, for instance, has great appreciation for indoor plumbing and the flushing toilet while those of us who are natives take those things for granted. We expect them. We rarely show gratitude for them.

Financial wealth is similar. If you are an immigrant to the Land of Wealth, you know what your previous life was like. Because you have a point of comparison, you appreciate what you now have. You are grateful for your achievement.

But your children and grandchildren are natives: They were born in the Land of Wealth. They take large homes, nice vacations, new cars, expensive clothes, and private schools for granted. This land if the only land they know, so showing appreciation does not come naturally.

Experiential Learning and Family Practices

Augmenting this no-appreciation mindset is a culture that bombards us with constant marketing messages: Life would be better if you had this car, this couch, this leather jacket, or this latest smart phone. For any person, appreciating what you have is difficult when the messages you receive tell you that you do not have enough.

Yet, descendants of wealth owners can learn to be grateful if families intentionally provide their children and grandchildren with experiential learning.

A diversity of experience creates points of perspective, comparison, and understanding. This is particularly true when it comes to financial assets. How else can a descendant have any understanding of or appreciation for wealth when it has always

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“just been there”? And how will the money be protected if succeeding generations do not know what it is like to create and grow assets?

The best chance a family has for transferring appreciation to descendants, and thereby strengthening multigenerational success, is to intentionally use family practices designed to build gratitude and appreciation.

Three Opportunities to Create Meaningful Experiential Learning

While successful families use many rituals and practices to transfer appreciation, three are particularly powerful in creating gratitude: family philanthropy, the family bank, and the family investment company. Following is a high-level discussion of each.

Family Philanthropy

The best family philanthropy plans occur when each member of a family shares his or her individual experience of philanthropy.

Take a look at what happened in one family when the five adult children, ranging in age from 27 to 49, were allocated funds to donate to a charity of choice. In this family, the parents charged each grown child with making a short presentation about his or her respective philanthropic choice before the family.

For several years prior, the oldest child, Robert, had been distant from his siblings. His two sisters in particular had previously demonstrated great disrespect for him, his lack of formal education, and his seeming lack of interest in any family events involving money. They even denigrated his deep interest in the American Civil War, referring to him as a “Civil War nut.”

When it was his turn to announce his charity, he spoke about the importance of maintaining Civil War memorials so that we never forget what happens when brother is pitted against brother. His passion about the consequences of that war and the lessons to be remembered came through so clearly that both his sisters changed their minds and decided to donate to his cause instead of their previously selected ones. His sisters saw him in a new light, and he learned that money can be deployed in ways to keep families together rather than in ways that divide them.

Everyone grew a greater appreciation for each other, and for the role of money within their family.

The key ingredient was that each family member had the opportunity to think about

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how he or she could use money to impact or further a cause. They then shared the experience of coming together to learn about each other and to witness how financial assets can be used to improve society. Instead of attending a fundraising gala or seeing the family name on a professorial chair, the children shared the individual experience of taking action on something with personal importance.

While many families create formal arrangements and structures for philanthropic giving, this simple strategy, whereby the parents share a portion of the philanthropic budget, has the dual impact of allowing succeeding generations to witness the impact money can have in supporting causes and strengthening relationships. (Keep in mind that many wealth owners use this as a starting point and create a more complex structure such as a Private Family Foundation or Donor Advised Fund.)

The Family Bank

Creating a family bank is another powerful opportunity to create perspective that leads to an immigrant-like appreciation of the Land of Wealth. Family banks have the added benefit of keeping the entrepreneurial spark alive, and they can be customized to suit the individual family situation.

In general, a family bank works like this: The current wealth-owning generation makes the decision to create a pseudo “bank” with the intention of funding opportunities for succeeding generations via loans. Most often, family banks are used to fund businesses or homes, but wealth owners can and should set goals for the family bank, and determine funding opportunities accordingly.

Loans through the family bank are available to all of the adult members of the coming generation who are willing to meet the requirements set by the wealth owners. These requirements must be set with care and intention, so the importance of working with a skilled advisor or advisory team cannot be stressed enough.

In one family, Mom and Dad have established a family bank to allow their four adult children and their spouses to either upgrade their homes or invest in businesses. The family bank will fund a mortgage of up to $250,000 per household, assuming that the household provides a minimum down payment of 15 percent of the house’s cost and a formal appraisal.

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(Keep in mind that the wealth owner, working alongside skilled advisors, can decide what these requirements are ahead of time. Some family banks offer 100 percent financing, but family banks have more impact if they offer a loan terms that are more true-to-life.)

In this example, the family bank offers fixed interest rates for a 15- or 30-year amortization term. As part of the loan terms, the borrower must provide proof of his or her ability to make the monthly payments.

In the case of a business, the family bank provides up to $250,000 per household as an unsecured business loan. The borrower must provide a business plan and proof that he or she has secured funding from a commercial source (such as a bank) for at least 30 percent of the start-up cost.

One way or another, all adult family members should be considered stakeholders in the family bank, and the bank should be treated as a true bank. Remember that the bank must have funds available to address future loan requests. With this goal in mind, stakeholders must have honest conversations about how to proceed if borrowers do not honor their loan agreements. Successful family banks issue periodic reports on their loans, both performing and non-performing. This is another reason for all stakeholders to treat the transaction seriously: They will suffer embarrassment if they cannot perform per the terms of the loan. (With this in mind, we suggest that borrowers meet with their “banker” to create a strategy should they run into unexpected trouble and be unable to make payments per the original loan term. As long as the borrowers act responsibly, their loans are not reported to stakeholders as non-performing.)

When created with intention and forethought, the family bank is a tremendous expression of a family’s commitment to helping members pursue their dreams without buying those dreams for them.

The Family Investment Company

A common generational wealth strategy is to transfer non-voting interests in entities to the coming generations. This is done to give descendants an opportunity to work with advisors, experience in owning of a business, and practice in working as a team. As such, descendants gain appreciation for all that goes into owning and stewarding family wealth.

Keep in mind that a family investment company can often be created using discounted values, which makes the strategy tax efficient.

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In a successful family investment company, Mom and Dad involve the next generation from the beginning.

First, an advisor presents the entire family with the idea of forming a family investment company. Mom and Dad support the idea with comments like, “We have decided we need to make investments together as a family.”

Next, the entire family has the opportunity to suggest names for the entity before putting all options up for a vote. One family named their investment LLC after the two dogs the family owned when the children were growing up.

Next the family investment company is presented to the entire group. Having the adult children present at creation increases engagement and the overall impact of the experience.

From here, the investment company charts out the course of action. For a family with four adult children, the investment company’s course of action might look like this:

1. Mom and Dad establish The Aspen Slope LLC and complete the required state filings.

2. Mom and Dad contribute $1 million to fund The Aspen Slope LLC, receiving 4 voting interests and 96 non-voting interests.

3. Mom and Dad gift (with a statement of intent as to what they hope the gift will mean to each child) 24 non-voting interests to each child.

4. Mom and Dad, with the help of a trusted advisor, explain the filing of a gift tax return.

5. Mom and Dad, with the help of an advisor, explain how ownership in an LLC works, what it means to each child’s personal balance sheet, and how the operating agreement works.

6. The Aspen Slope LLC has its first board meeting with all owners in attendance (either by phone or in person), as well as the investment advisor, to discuss the investment policy statement, distributions, and the investment process. Mom and Dad guide the conversation and let the adult children ask questions and respond directly to the investment advisor.

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7. Board members decide on a meeting strategy. During Year One, this usually occurs quarterly, with the investment advisor providing progress reports on the implementation of the investment strategy. On a rotating basis (usually annually) one of the adult children is named the contact person for the investment advisor.

Initially, Mom and Dad retain management control as the children practice wealth ownership and experience joint decision-making. At some point, Mom and Dad will feel comfortable gifting the remaining voting interests to the children and letting them run the investment company. This traditionally occurs within four or five years, though families can move much faster if each member is attentive and willing to learn.

Working With a Team

Building experiential learning opportunities does not come naturally for most families of wealth, which is why so many wealth-owners worry about the ability of the succeeding generations to appreciate and manage wealth. Fortunately, more and more skilled advisors are helping families discover qualitative goals (such as stewardship, empowerment of future generations, and appreciation) and create quantitative plans that address these goals. These advisors use values-based wealth planning to make sure that wealth owners’ concerns about appreciation and gratitude are addressed and alleviated.