Family Business Director attended the 59^th Annual Heckerling Institute on Estate Planning earlier this month.  The world’s largest gathering of estate planning professionals, the Institute featured many educational sessions for the approximately 4,000 (in-person and virtual) attendees.

Purpose Trusts

One session of particular interest to our readers was “Taking Care of Business: New Approaches to Business Succession Planning.” Presenters Ellen K. Harrison (McDermott Will & Emery) and Natalie Reitman-White (Purpose Ownership Advisors, Ltd) reviewed succession options for business owners beyond the typical approach of simply passing shares along to the next generation.

What other options are there?  The session described the legal and practical ins and outs of purpose trusts.  Whereas most trust arrangements are established for the benefit of one or more specific and identifiable beneficiaries, under a purpose trust, the “beneficiary” is a purpose rather than a specific person or persons.

While not “new” under the law, the use of purpose trusts for business succession planning became more prominent when Yvon Chouinard, founder of clothing company Patagonia, transferred ownership of the company to a purpose trust in September 2022.

As described in the company’s press release, the Patagonia Purpose Trust owns all of the voting stock of the company (2% of the total outstanding) and the Holdfast Collective owns all of the non-voting stock of the company (the remaining 98%).  As the controlling shareholder, the Patagonia Purpose Trust

“…exists to create a more permanent legal structure to enshrine Patagonia’s purpose and values.  It will help ensure that there is never deviation from the intent of the founder and to facilitate what the company continues to do best: demonstrate as a for-profit business that capitalism can work for the planet.”

Patagonia’s succession plan did not turn the company into a non-profit.  Patagonia remains a for-profit company; the difference is that, rather than providing a financial return to shareholders, the company’s dividends will be used to “protect the planet” (i.e., fulfill the purpose of the Patagonia Purpose Trust).  Or — as noted prominently on the company’s website — “Earth is now our only shareholder.”

Purpose & Your Family Business

We suspect that using purpose trusts will continue to be the exception rather than the rule for family business owners contemplating ownership succession.  For many entrepreneurs, passing the business to the next generation of the family is a primary motivator for their toil over years and decades.  But even if a purpose trust is unlikely to be the next owner of your family business, the Heckerling presentation also highlights some important concepts to consider in planning for the succession (and success) of the business.  We will focus on three concepts in this post.

1 – Clarity of purpose is essential.

Under the purpose trust structure, ensuring fidelity to the animating purpose of the trust is the responsibility of a trust enforcer or protector (or, in some cases, a court).  As Harrison and Reitman-White noted in their presentation, “The mission of the enforcers (and the court) is made more difficult if the purposes of the trust are not clearly stated or become unworkable.”

Clarity of purpose is just as essential for family businesses as for purpose trusts.  Does your family business have a clearly articulated purpose?  If so, what is it?  If not, what do your family shareholders assume that purpose to be?  “Making money” can be a noble purpose, but upon further reflection, that doesn’t provide much clarity for directors and shareholders.  We are fond of thinking about the purpose of a family business under the heading of potential meanings (see, for example, What Does Your Family Business Mean to Your Family? – Mercer Capital).  Alternatively, the authors of the Harvard Business Review Family Business Handbook address purpose in the context of articulating an Owner Strategy.  Regardless of the framework you use, articulating a clear purpose for your family business is essential for setting shareholder expectations and equipping managers and directors to make the best decisions for the business.

2 – Thoughtful governance provides accountability to the purpose.

The Heckerling presenters noted that state law generally provides little specific guidance as to governance structures for purpose trusts.  They identified four key topics for consideration when designing governance structures for purpose trusts (such as appropriate checks and balances on authority and succession rules).

As family businesses transition from the founding generation, designing thoughtful governance structures that both meet current needs and anticipate likely future needs is essential.  As a practical matter, governance is often informal while the founding generation continues to exert their personal influence on the business.  While informality of governance may be a feature during the early years of a family business, it quickly becomes a bug as ownership transitions to subsequent generations.  Taking governance seriously and allocating resources to developing and implementing thoughtful governance structures is one of the best gifts founders can bequeath to the next generation.

3 – Interested parties deserve disciplined and transparent reporting.

Finally, the presentation at Heckerling noted the importance of transparent reporting mechanisms in purpose trusts for the benefit of interested parties.  In the context of family businesses, consistency and transparency of reporting is necessary to develop and maintain positive shareholder engagement with the business.  When you communicate with your family shareholders, does the information you disclose enable shareholders (and their professional advisors) to evaluate the degree to which the performance of the family business is consistent with its purpose?  Effective communication requires more than simply dumping data on family shareholders and assuming they will sort it out (or not).  Context, consistency, transparency, and balance are hallmarks of effective shareholder communication.  Investing in effective shareholder communication pays hand dividends for the family business over the long run.

Even if you are unlikely to follow suit, Patagonia’s novel business succession strategy provides important lessons and reminders for family directors.  Your family business may not have a purpose as lofty as “protecting the planet,” but you and your shareholders will benefit if the purpose is clearly articulated, protected by thoughtful governance structures, and visible through disciplined and transparent reporting.