Wills and direct investments: the most expensive neglect

Eduardo Schindler is founder and CEO of 2thePoint in Zurich.

The wealth of families is usually invested in various asset classes including listed securities, real estate, hobby assets – not least the family business itself. How does the current leader pass on this wealth to the next generation, avoiding potential detriment to both business and family? Eduardo Schindler uses a case study to illustrate the dilemma

Mr Late-Decisions left the office of his lawyer in London with mixed feelings about the meeting. The last three weekly sessions had been going smoothly and productively. However he had no idea on how to prepare for the last session.

It has been years since the last will was made. In the meantime the family's wealth has reached more than €450m, and new investments have been made in a variety of asset classes – including several direct investments in privately-held companies. Over time he has simply lost the overview of both the wealth structure and its possible value. In itself this is not a problem, however Mr Late's oldest son is about to marry his pregnant girlfriend, his daughter has reached adulthood and then there was his 17-year old son. The divorce from the mother of all three heirs has been settled – at least financially. However, Mr Late wanted to make sure that a number of loose ends would not pop-up at the wrong time and place. In the face of all these events, plus his own age nearing retirement as Chairman of the Germany-based family company, the time had come to re-write his will.
 
And as in all cases in the past, the reworking of his will has always been an excruciating experience. Facing mortality is in itself a tough demand on the emotional stability of any person. And doing it with the dual objectives of establishing a proper distribution among the three heirs and making the right allocation of the fortune accumulated by the family over the last 80 years does not render the task any easier. However, Mr Late's lawyer, Mr Nice Guy, finally managed to convince him to address the matter and planned to dedicate a weekly session to each asset class.

The initial sessions
The first session, covering all private banking depots, was the easiest. Thanks to the good work of a family-office unit from a well-known Swiss bank there was an accurate, complete and up-dated record of all the on-going investments in listed securities such as bonds, equities, funds, and even hedge funds. Practically all the investments had a daily market price and it did look as if gathering the data and consolidating it in a meaningful way was rapidly done by bankers assisted by personal computers. Tracking performance and measuring valuations has become almost routine work across the entire spectrum of the €100m portfolio. And of course there were what seemed to be an unlimited number of banks and asset managers willing to take care of these assets in all possible forms.
 
The next session was equally productive but somehow less straightforward than the initial one. Listing all the items to be allocated was easy: the real estate, the art collection, and the few hobby assets gathered by Mr Late out of pleasure - like a vineyard producing delicious wines in Chile.
 
The problem appeared when Mr Late attempted to define the value and the divisibility of the various investments. The real estate was rapidly and accurately measured (€55-65m) and it was not too difficult to allocate the many houses, factories, land, forests, and other properties. The art collection had a value of anywhere between €40-70m and, to avoid a potential complication for his children, he decided to transfer the collection into a Liechtenstein Trust with full use and benefit rights for the family. Finally, there were all the hobby investments with a combined acquisition price of €35m. but with a totally unknown market value – if any. Mr Late was fully aware that none of his three children would know what to do with these hobby assets so he instructed his lawyer to dispose of all such investments as soon as possible and to place the revenues in banks in London, Frankfurt, Zürich and New York.

Until this session Mr Late had been satisfied that his objective of proportionate distribution was being achieved. He felt that no antagonism would arise among his three heirs, as there was ample objective measurement of the value of what was being allocated to each 'basket'. He was also proud to see that each of his three children would be able to finance their education and a comfortable lifestyle for a few generations.

Last session – how to prepare?
The final session was to take care of the largest portion of the family wealth – the vast portfolio of direct investments in the equities of privately-held companies. And there was the 60% stake in the 80-year family business that Mr Late received from his father – and then successfully turned into an industrial conglomerate generating €600m of sales per year.

The wealth of families in the €100m+ league is usually invested in various asset classes and often there is a large portfolio of direct investments in privately-held companies – including the non-listed family business as the largest item. Many of the distinctive features of these companies have severe implications in the (un)successful formulation of someone's will and may confront the will-writer with potentially very costly difficulties.

Mr Nice made a list of the investments and asked Mr Late how to go about placing a value against each. Should he use the acquisition price – in which case the portfolio would be worth about €140m? Or should he use the 2-year old estimated book value of the participations – which a local auditor measured to be between €190-250m depending on certain confusing accounting methods. In addition, Mr. Nice indicated that his golfing pal was the CFO of a listed company and that he used both the so-called market multiples and the well-established discounted cash-flow methods to estimate what he would see as the fair true industrial value of the non-listed securities being held in their portfolio of investments.
 
This experienced CFO also said that it would take several months of continuous work to estimate a fair range of the possible market value of the portfolio. He added that the value of any single investment could be as different as twice or even three times its book or acquisition value and hoped that Mr Late had arranged for shareholder agreements to exist in all these direct investments. If not it could be possible that some of them were totally illiquid - thus effectively having a market value close to zero.
 
In some ways the CFO's reflections were suggesting that the true value of Mr Late's portfolio of direct investments could be anywhere between €160–320m, and that there was no way to know for sure until extensive valuation work had been done by dedicated professionals.

But the question that was really worrying Mr Late was how to allocate the portfolio of investments without the true value of the equities? Mr Late felt overwhelmed at the prospects that the wrong division and allocation of such investments would have a potential impact going well beyond the value of the entire portfolio.
 
This problem was more than rhetoric to Mr Late, since like most of his peers, he had been toying with the idea of allocating more of the industrial portfolio to the son with the finest business sense – and compensating the other two heirs by allocating more of the real estate and the financial portfolio. It became clear to Mr Late that it would be impossible to do this without a fair value of the direct investment portfolio.
 
He wondered if his three heirs would be equally prepared to assume the duties and the responsibilities that would go with the ownership of non-listed equity shares? He knew that it can actually take very little in the realm of 'corporate governance' for an entire company to be destabilised to the point of bankruptcy.

To make matters worse, Mr Nice also wrote that given the level of excess cash, hidden reserves and non-declare nature of some of the investments, there was a potential tax burden of €65m to be borne by the three heirs if the industrial portfolio were to be disentangled in a husky manner. Also, if the 60% stake in the family company were to be divided, one heir dissenting on any important matter could loose the absolute control in the governance of the family business.

Mr Late did not know where to turn to for assistance. Suddenly Mr Late remembered a conversation he once had with his acquaintance, Mr Wise Investor. He explained that he had a simple but effective way to look into his direct investments by dividing them according to two criteria: the attractiveness of the investment – itself a mixture of past performance, business prospects and 'exitability'; and the level of influence he wanted to exercise (directly and indirectly) in the underlying company. He would then decide whether to stay or exit each investment accordingly. He also justified the time dedicated to these investments acknowledging that he took substantially more pleasure in looking after meaningful industrial activities "instead of endless look-alike private banking printouts".
 
Mr Wise explained that he had been working with a small group of financial advisors that helped him to assess the deluge of investment proposals he received continually. These advisors worked rapidly, in secrecy, and free of the self-serving interests usually affecting the services of many institutions.

They had helped Mr Wise save millions by saying no to poor investment proposals, and to make millions by indicating the proper time to exit a mature investment and/or by identifying the best natural buyer for some of his many companies. Since working with these advisors it has been possible for Mr Wise to keep his will updated every year.