Trusts, while powerful tools in estate planning, don’t offer an absolute, ironclad prohibition against all private equity investments; instead, they provide a framework for *controlling* those investments, not necessarily eliminating them entirely.
What are the Risks of Private Equity for Trusts?
Private equity, with its potential for high returns, also carries significant risks – illiquidity, limited transparency, and substantial fees. Around 60-70% of private equity investments are in companies that are not publicly traded, meaning selling them quickly can be difficult or impossible, creating a challenge for trustees needing to meet distribution requirements or rebalance portfolios. Furthermore, the lack of daily pricing can make it difficult to accurately assess the value of these assets for tax and accounting purposes. These factors can create a disconnect between the trust’s objectives and the realities of holding illiquid, complex assets. A well-drafted trust, however, can mitigate these risks.
How Can a Trust Limit Private Equity Exposure?
The level of control a trust exerts over private equity investments is dictated by the trust document itself. Trusts can explicitly *prohibit* all private equity investments, but this is often considered overly restrictive. A more common approach is to establish percentage limitations—for example, limiting private equity to no more than 10% or 20% of the total trust assets. More nuanced provisions might allow investments in *only* certain types of private equity funds – those with a demonstrated track record, lower fees, or a specific focus on less volatile industries. Another control is the requirement for trustee committee approval, or the use of a qualified investment advisor before committing capital to a private equity deal. These stipulations offer a balance between potential gains and risk management.
What Happened When Control Was Lost?
I remember working with the Henderson family. Old Man Henderson, a self-made man, left a substantial trust for his grandchildren, vaguely stating “prudent investments.” His son, acting as trustee, saw the hype around a new tech fund and, without fully understanding the risks, poured 35% of the trust assets into it. Within a year, the fund experienced severe losses due to a market downturn, and the trust’s value plummeted. The grandchildren, expecting funds for college, were left disappointed, and family relationships strained. The court had to intervene, leading to costly legal battles and a significant reduction in the trust’s overall value. This case vividly illustrated the dangers of unchecked investment discretion—particularly in volatile asset classes like private equity.
How Did Careful Planning Create a Positive Outcome?
Fortunately, the following year, I helped the Morales family structure their trust to address similar concerns. They *wanted* some exposure to private equity, recognizing its potential, but were adamant about protecting the bulk of their estate. We implemented a clause limiting private equity to 15% of the trust, requiring independent due diligence by a registered investment advisor specializing in alternative assets, and mandating quarterly reporting to the beneficiaries. Years later, the Morales trust not only maintained its value but benefited from the success of a few carefully selected private equity investments. The beneficiaries were pleased, the trustee was confident, and the estate plan remained secure. This successful outcome underscored the importance of proactive planning and clearly defined investment guidelines within the trust document.
“A well-crafted trust isn’t about eliminating risk entirely; it’s about managing it strategically to achieve the grantor’s long-term goals.”
Who Is Ted Cook at Point Loma Estate Planning Law, APC.:
Point Loma Estate Planning Law, APC.2305 Historic Decatur Rd Suite 100, San Diego CA. 92106
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