Family Business Interests as a Trust Asset and the South Dakota Directed Trust

Trusts have grown enormously in popularity since the mid-1990s as a result of the devel­opment of modern trust laws, the dramatic increase in wealth and evolving family needs and goals. Modern trust laws promote many key desires of a client’s estate planning, such as flexibility, control, tax savings, asset protection, family values, governance, succession, education and privacy.

However, when designing and structuring a client’s estate plan, these key desires may not be properly coordinated with the selection of trust­ees, the type of trust and the type of trust administration. The assets funding the trust are another key factor that often gets overlooked and as a family’s net worth increases, their assets can be quite diverse.

In the United States, the top 10-12 percent of households own a large percent of illiquid assets, for example, closely held family businesses and real estate, which aren’t generally viewed as ideal assets for the typical non-modern trust. Moreover, many large institutional trustees are hired to provide full service (one stop shopping) trust administration. Many of these large institutional trustees may be reluc­tant to invest in anything but their own previously approved trust investment products that they’re familiar with and can easily monitor internally. Consequently, the products offered for trusts are usually more limited due to possible liability concerns. The trustee may view many of the desired asset allocation categories as too risky for a non-modern trust. Additionally, these large full service trustees generally have the ability to delegate investment management for products and services they don’t provide, though such institutions are often reluc­tant to do so as a result of the risk and possible liability associated with such delegation.

It’s also important to note that 70 percent of all wealthy families don’t use corporate fiduciaries. Popular trustee and co-trustee choices are: family members, business colleagues, friends, lawyers, CPAs and other advisors. However, most individual trustees don’t have the requisite invest­ment advisory and management expertise, and serving as trustee subjects an individual to very high standards of fiduciary liability as well as personal liability.

Modern South Dakota Directed Trusts

For trusts that hold closely held family business interests, the South Dakota directed trust is one of the most popular types of modern trust administration structures. A South Dakota directed trust generally trifurcates the traditional trustee role into an investment committee, distribution committee and a directed administrative trustee. The latter is typically a corporate administrative trustee based in South Dakota. Generally, if the trust is properly administered and has a substantial presence in South Dakota, the client’s resident state will recognize the trust and South Dakota’s directed trust laws. A South Dakota directed administrative trustee has no discretionary investment duties regarding the trust. The selection of asset allocation, monitoring and/or investment management is generally the responsibility of the investment committee (not deemed a co-trustee but instead a co-fiduciary), which is usually run by the family and the family advisors. The investment commit­tee members are typically subject to a gross negligence/willful misconduct standard of liability for serving in this role. This is a much lesser liability standard than serving individually and thus a South Dakota directed trust provides significantly more fiduciary protection. Further, there are few investment limitations with a directed trust as long as the trust investment management language allows for the investments, the investments are legal and they don’t have any environmental issues. Typically, advisors will draft trust investment clauses as general powers and generally won’t prohibit any specific types of investments. To further protect the investment committee of a directed trust, a trust protector may be added with the power to approve and/or veto trust investments.

A closely held family business may either be the main asset or a substantial asset of the trust as diversification isn’t generally required with a typical directed trust. The investment committee of a directed trust would be responsible for making decisions regarding the business interest held by the trust and again, subject to a lower liability standard (that is, gross negligence/willful mis­conduct). The South Dakota directed trust is a powerful tool to allow a family to maximize its estate-planning goals in the most advantageous manner.

For additional information on this or any topic, please visit our website at www.sdtrustco.com or contact us at (605) 338-9170.

About South Dakota Trust Company LLC:

• Trust accounts representing more than $140 billion in assets under administration
• Currently work with more than 115 billionaire and 360 centimillionaire clients
• No investment management products or services of any kind – purely trust administration services
• Work with all outside investment and insurance advisors of the client’s choice
• Experience with all types of liquid and illiquid assets (onshore & offshore) – including private equity
• Leader in the set-up, operation and administration of Private Family Trust Company (PFTC)
• Regulated (South Dakota) and Unregulated (Wyoming)/(Nevada)
• Highest ranked trust jurisdiction in the U.S. (#1 in all categories) by Trusts & Estates magazine (January 2022)

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