The High Cost of Client Secrets | Lord Abbett

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Practice Management

For small businesses, it can be difficult to keep family and business affairs separate. Advisors should encourage their clients to increase communication and transparency when it comes to finances.

This Practice Management article is intended for financial advisors only (registered representatives of broker/dealers or associated persons of Registered Investment Advisors).

Transparency is a hot buzzword in the wealth management world. In the wake of the financial crisis, clients rightfully want more information about their investments. But transparency can evaporate when it comes to small family businesses, where money and relationships are often intertwined.

Sometimes, it’s merely that the use of multiple advisors clouds communication—perhaps a key piece of information remains unconsidered in a decision-making process. At other times, deliberate deception creates real mystery and financial havoc.

To underscore just how much businesses have to lose by keeping secrets, I sometimes tell the story of one of my clients—the co-owner and chief operating officer of a fifth-generation pawn shop.

I’m going to call him Steve; he was my client for 20 years. But when I read a recent study (by the Corporation for Enterprise Development) that found that the key to a small company’s success is the owner’s discipline in managing personal finances and business cash flow, I thought of him.

Steve was a disciplined numbers guy, dedicated to doing right by his business and family. Along with his brother, he built the company into a thriving business, worth $5 million.

Succession Planning
Although he was just 62, we had worked on succession planning. Steve and his brother purchased insurance policies on each other so that in the event one partner died, the other would use the insurance proceeds to buy out family members and become the sole proprietor. (Both wanted to avoid having the other’s wife as a business partner.)

Meanwhile, Steve could not have been happier when the younger of his two daughters began working with him.

With a succession plan in place, Steve and I spoke frequently about conducting business with the idea that someone else would one day take over. We talked about the need to document business procedures, maintain comprehensive financial records and nurture relationships.

Family and employees alike trusted Steve to make the right decisions. The future looked bright, until cancer intruded.

When Steve began chemotherapy, he hired a bookkeeper to help him with reconciliations so he could spend time tending to his affairs. He completed numerous household projects, bought new cars for his family members and even installed a putting green on the lawn where he could never get grass to grow.

Describing his final months as a “mad dash to take care of us,” his younger daughter—who is also a client of mine—told me, “I just want him taking care of himself. I don’t care about a new car.”

I reassured her that her father’s expenditures were nothing he couldn’t handle financially, and that they were probably bringing him great comfort.

Secrets Revealed
As it turns out, it all wasn’t quite so simple—and when Steve died a few months later, we found some surprises. The bookkeeper discovered significant amounts of money being transferred between Steve’s personal accounts and the store accounts.

When his younger daughter got spreadsheets showing the transactions from his last five months, she realized he had spent close to $400,000 of the company’s money. In addition to his home improvements, he’d made numerous direct transfers into her older sister’s checking account; he’d also paid the sister’s substantial medical bills, funded tuition for her three children and paid for improvements on her house in Ohio.

When asked, the elder sister said little to explain it; she said only that their father had told her to count on about $500 a month after his death.

Obviously, Steve’s secret spending affected the company’s value—and the price his brother paid to buy out the family—but, more significantly, it created a canyon-sized rift in his family. Steve’s wife and younger daughter, who suspected he was funding various rehab programs for the elder child, initially focused on understanding his behavior; the family became estranged. Steve’s elder daughter visited recently when her mother was in the hospital, but stayed only a few days and seemed most interested in her mother’s jewelry.

Meanwhile, I worked to adjust the risk in Steve’s widow’s and younger daughter’s personal portfolios—given that the company Steve left behind was worth less than they expected.

Better Options?
In the wake of Steve’s death, his younger daughter now works for her uncle, and has been elected to take her dad’s role at the National Pawnbrokers Association. Although businesses often stumble in the years immediately after a partner’s death, they are both optimistic—after all, this pawn shop has survived for generations.

But as I’ve helped the family deal with the aftermath, I find myself wishing Steve had shared more about this situation so we could have helped him.

If assets needed to be transferred to his elder daughter to cover her expenses, we could have passed along appreciated stock instead, since she would pay a 0% capital gains rate. And if I’d known she needed medical care, perhaps we could have had her do some work for the company, even on a part-time basis, so that the company’s health insurance could have funded some of her care.

For small businesses, it can be hard to separate the company books from the family’s financial situation. Advisors should seek to help their small business clients increase communication and transparency.

Some Ideas To Try:
Take the role of a lead advisor. Clients who use multiple advisors or who manage accounts themselves are the most likely, even unintentionally, to keep something from their advisor. A lead advisor can oversee the entire operation and investment portfolios and ensure that they support the client’s short- and long-term goals.

Review buy-sell agreements annually. If a business owner dies, a buy-sell agreement prevents the business from being sold at a fire-sale price. Work with an attorney who specializes in business succession and estate planning matters. Be sure the agreement specifies sales terms, and review it periodically to ensure everyone’s interests are protected.

Make loans, not gifts. If a family member needs money, structure a loan rather than give away assets. And disclose the loans: Keeping everything up front and in the open will help the family avoid conflict later on.

—By Kimberly Foss, CFP, CPWA

Kimberly Foss, CFP, CPWA, is a Financial Planning columnist and the founder and president of Empyrion Wealth Management in Roseville, Calif. Follow her on Twitter at @KimberlyFossCFP


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