Adam Chodos, Wealth Preservation Group LLC; Angelo J Robles, Hedge Fund Association
Those who focus on alternative investments devote significant effort to accumulating net worth, yet how much effort is devoted to protecting it? The everyday risks, such as car accidents, are covered by insurance; the concern of the affluent focuses on the aggressive litigation that can claim a large part of their asset base. Even when there was no intent, liability is often based on net worth rather than wrongdoing; few juries relate to a defendant with a Greenwich address. Our legal system makes it easy for a plaintiff to bring a large lawsuit and thus it has become increasingly important for those of substance to protect their wealth.
The United States is saturated with litigation; we are host to 95% of the world's lawsuits. Expanding theories of liability and significant judgments have made lawsuits big business, and to be profitable, one sues people who have assets and an ability to pay. While the lawsuits that get press tend to be class actions against big companies, the most common cases affect business owners and the financial industry. Some of the more common lawsuits today are divorce, business break-ups, claims by investors against funds and management, acts of employees or children or agents, leases, social liability (hosting events), employee lawsuits (harassment, wrongful discharge, etc), serving on boards, etc.
The concern with protecting assets is not new; in the past many would use a corporation, buy large amounts of liability insurance, or move assets into the name of a child or a non-working spouse. A corporation is intended to limit business claims to business assets, meaning a creditor could take the business but not personal assets. However, corporations are routinely pierced and personal liability attached. Even if the corporate entity stays intact, shouldn't business assets also be insulated? Liability insurance is important, however, there are many claims it does not cover (divorce, most employment claims, business disputes) and it has liability limits. Using other family member's as owners merely shifts the risk to another person, often triggers a transfer tax, and makes controlling children and dealing with divorce very difficult.
The way we own assets is directly linked to a creditor's ability to reach it. Assets owned personally, jointly, corporately, in general partnership, etc can be reached by a creditor. A successful lawsuit can put a lien on the property preventing the owner from selling or borrowing against the asset until the lawsuit is resolved, which can be years. Furthermore, a few states, including Connecticut, permit attachment/asset freezing before a trial. Alternatively, we can own assets in legal entities making them unattractive to a would-be creditor. The use of preferred entities and proven jurisdictions can insulate virtually all types of assets without sacrificing control and, as the years pass, the structure can continue to benefit younger generations.
Tax efficiency is another common consideration and as net worth grows we should consider what happens to the assets we have earned, paid income tax on, and now wish to transfer to those we care for most. Upon transfer (alive or at death) the federal, and now state, governments impose a death tax with effective rates of 50%. Since few families maintain 50% liquidity, there is often a forced selling or repositioning of assets to be able to pay the taxes. This risk to wealth can be reduced significantly by coordinating asset ownership. This does not involve gifting assets or ceding control to another, but rather exploiting the traits of various vehicles which can significantly discount and/or eliminate death taxes. With relatively straightforward steps, we can save seven figures in tax while maintaining full control.
Most of our business efforts are aimed at generating enough net worth and income to care for our families. While most think estate planning revolves around a will, it is broader and involves tools to establish a plan of action, organised, tax efficient and workable to run affairs and care for the family when we are incapacitated or deceased. Wills are not legal documents per se, but merely an expression of intent that must be approved by a probate court and be supervised by a paper intense court administration process that is open to public review. Smartly designed trusts can address asset disposition but eliminate the public disclosure, time and cost of administration, and provide a more organised transition. The most significant flaw in most estate plans is rigidity – it is drafted based on the family's current structure, assets and feelings without room to adjust to changing circumstances. Few families are static and virtually all aspects of a family evolve over the years, yet the documents do not. Rather than redrafting on a regular basis, flexibility is a key component that should be built into all plans. The right to be wrong is invaluable.
Many of the alternative investment professionals we work with have deals and ventures with partners. One of the often overlooked areas of planning is business exit strategy. The exit strategy to an investment position is almost always considered before investing but few businesses consider how they exit from their own business in the event of a death, disability, disagreement, etc. What happens if a partner dies? Is his wife now half owner of your business, does she wish to have her late husband's job, or just his salary? If this is your wife, will your partner pay her a fair amount? Could she run this business? How will she pay taxes on an asset she cannot liquidate? If you and your partner go different ways, who owns the clients? If there is arguing, will the clients stay with either one of you? Prepared business owners use specialised contracts including buysells to address these risks. Its function is to provide a sophisticated mechanism to deal with the fate of most businesses – most do not last forever and an owner will die, become disabled, leave, be fired, etc and a transition that is smooth, tax smart and eliminates litigation maximises your business value.
The more one has accumulated, the more worthwhile it is to protect it from tax, unexpected business changes and the explosion of lawsuits. Today's environment has juries who are not shy in handing down large awards which can eliminate years' worth of efforts in one day. For some, this occurs at a point when the funds can not be re-earned or replaced.