In their presentation, “Taking Care of Business: New Approaches to Business Succession Planning,” at the 59th annual Heckerling Institute on Estate Planning, Ellen K. Harrison and Natalie Reitman-White focused on the use of non-charitable purpose trusts in succession planning for family businesses. They noted that Patagonia’s well-publicized use of a purpose trust to own its voting shares to preserve the founder’s mission of promoting employee welfare and “sustainable practices” stimulated interest in alternative ownership structures for succession planning. Similar structures have been used for decades in Europe but were relatively unknown and untested in the United States.
Purpose trusts are different from ordinary common law trusts because they have no ascertainable beneficiaries who have standing to enforce the trustee’s fiduciary obligations. Instead of serving beneficiaries, purpose trusts exist to serve a stated purpose. An enforcer or protector is appointed to enforce the trustee’s fiduciary obligations to serve the trust’s stated purpose.
State-Focused
Most states authorize purpose trusts by statute, typically modeled after the Uniform Trust Code (UTC). UTC Section 409 has a brief statute recognizing the validity of non-charitable purpose trusts. Non–charitable purpose trusts may not be valid if no state statute authorizing them exists. Because state law varies, it’s important to pick the right jurisdiction.
These types of trusts may not be considered trusts for federal tax law purposes. The definition of trusts for federal purposes doesn’t fit the purpose trust because there are no beneficiaries. The Internal Revenue Service has provided limited guidance about whether a purpose trust is a trust for federal tax purposes.
Motivations for Trust
The speakers noted that people are starting to rethink the role businesses should play in society. There’s a sense that businesses should benefit employees and have a lasting impact. Business owners who are thinking about legacy are looking for solutions to ensure their businesses endure into the future. This has led to a trend toward alternative ownership solutions.
There are a variety of reasons for setting up this type of trust, including preserving the founder’s mission, avoiding a sale and liquidation of the business, giving voting control to trusted advisors or “stewards” who may have no or only a limited economic interest in the business and are directed to protect the interests of all “stakeholders”—employees, customers, suppliers, investors, the community and the environment—rather than maximize shareholder returns.
Natalie mentioned that a recent Northern Trust study showed that 43% of owners think it’s important that their businesses continue for the next 50 to 100 years. Owners have considered other options but choose the non-charitable purpose trust to promote:
- Continuity and legacy. Owners care about the businesses they’ve built, their employees, suppliers and communities. With a non-charitable purpose trust, they get to design a new owner that will never die, retire or need liquidity from the business. People can come and go and carry different values. But owners can structure trust agreement to say what values that way to promote. They’re designing something that will outlast individuals.
- Self-governance. The individuals who are active in business can control the business. The company is self-owned by and for its purpose.
How Structure Works
The purpose trust owns the voting and control rights of the operating company. It replaces the human owner with a non-human owner. The trust doesn’t need income other than operating and administrative expenses, and it doesn’t need liquidity.
The company’s stock is transferred to the trust, which will hold stock forever.
The trust agreement directs where the money goes, while the for-profit company generates income.
The Purpose
Defining the purpose is key. Every company has a mission. For example, Patagonia wanted to be a leader in environmental issues. There’s a great deal of flexibility in drafting these trusts in terms of the trust’s purpose. The purpose needs to be general to let the company evolve. Owners need to consider what they want to see in place 50 years from now. Some companies may want to ensure that the business stays headquartered in a specific location and benefits employees through profits over time. The profits can be distributed towards the purpose in broad ways. For example, the business can take enough to invest in itself and have the rest go to its employees. State law provides that purpose trusts are enforceable by an enforcer, protector court.
Governance
Who decides who should lead the business? The trust stewardship committee is standing in for the owner and for the shareholder. This committee needs to ensure that the board delivers toward the purpose. The committee should set up a process for evaluating the board and reviewing the results. The trustee needs to be domiciled in a state that allows for a purpose trust. The trust should also have an independent enforcer to enforce the roles.
Investors
Investors can be added to the purpose trust. This can be helpful if it’s too expensive for the company to buy out existing founders.
Fitness Assessment
Here are some questions to think about when considering a purpose trust:
- Does the company have a strong foundation for why it exists?
- Does the mission vision live beyond the founders? Is it part of the company’s culture?
- Does the company have a viable business model and strategy?
- Is the company consistently profitable so it can support the buyout period?