David Koch Retiring and The Future of Koch Industries Estate Planning

So with David Koch recently retiring (his official retirement date is July 1, 2018), and I mentioned in my last post that Preston Marshall was accused of spousal abuse and this may affect his ability to own Koch Industries stock. Clearly, the chairman and CEO Charles Koch is dealing with plenty of issues right now. Honestly Charles hasn't had to deal with anything like this since the Koch vs. Koch trial back in the late 1990's. 

The Preston Marshall issue should be interesting. It is mentioned that Preston Marshall owns the most amount of shares outside Charles and David Koch. Earlier in 2018 Preston was accused of spousal abuse. It is said that his wife is in the process of divorce proceedings with him. Of course I am sure he was smart and had a prenuptial agreement for this situation to block her access from his wealth.

The Koch Family has a family office called 1888 Management LLC. Family offices typically handle the investment strategy, the philanthropy strategy, and manage the assets and the entities for one family and facilitate communication between the older generation and younger generation to ensure that there is family harmony when assets are passed down to future generations. In addition to this, a family office can handle things like paying bills for the family, coordinating travel plans, ensuring the security detail, among other tasks. The board of managers for 1888 Management LLC are Steven Feilmeier who is currently the CFO of Koch Industries, Elizabeth B. Koch (wife of Charles Koch), David Koch, Anna B Koch (wife of Chase Koch), Jason Kakoyiannis (who is married to Elizabeth Koch-daughter of Charles and Liz Koch). It should be

It appears David Koch is in bad shape health wise and may not have long to live (personally I wish David Koch had written an autobiography at some point-he has had a very interesting life for sure).  I covered his lifestyle in depth in this post. As someone who worked at Koch Industries his whole career he must not be happy not being able to go to board meetings and make decisions at Koch Industries. The question is what will happen to his ownership of Koch Industries stock?

Most likely his shares would go to his wife Julia. His shares can pass to Julia without having any estate tax consequences (this is known as the martial deduction). Even Charles Koch doesn't have a few billion dollars laying around since nearly all his net worth tied up in Koch Industries stock. David Koch has said in this article regarding the shares of Koch Industries "once we pass on, our children will acquire the stock, and I want to see Koch Industries continue to grow". His shares probably would go first to Julia Koch and then to the children of David and Julia Koch. If Julia Koch is in her mid 50's she would have many decades and possibly see if her children would get involved in Koch Industries.

There are some strategies that Koch Industries could use for the estate planning. The first option would be to go public in order to access capital. However, Charles Koch has said many times that Koch Industries will go public literally over his dead body. Charles Koch in this Forbes article did mention that the family has been performing estate planning for "many years". With this comment and given my last post on the Marshall family. Charles and David Koch have most likely engaged in setting up trusts and trying to get Koch Industries out of their estates and passing it on to future generations. By using grantor retained annuity trusts (like J Howard Marshall III and the Marshall family) and family limited partnerships (FLPs) Koch can pass shares to their children. The only issue is that the family is to pass $22.4 million for a couple without hitting estate taxes. There is not only estate taxes but also generation skipping tax (GST) which are in addition to estate taxes. This is to prevent generations from continuing to pass down wealth. At some point a future generation will have to pay generational skipping tax (of course unless they set up a dynasty trust).The Koch family has personal experience with estate taxes. Fred Koch was concerned about making sure Koch Industries kept liquidity before he passed. During the 1960's the estate tax rate was 77% for anything over $60,000.  In 1962 Charles and Sterling Varner (who had worked at Koch Industries since 1946) wanted to purchase two trucking companies to further expand the crude oil gathering business for Koch Industries. However, Charles from his father was only given approval to purchase one company. Fred Koch went on a trip to Africa and when Charles picked his father up from the airport Charles told his father he ended up purchasing both companies. Fred Koch was furious as he was trying to save cash to pay estate taxes. Charles Koch couldn't pass up an opportunity for growth even if it pissed off his own father. A similar situation occurred in 1967  when Charles Koch wanted to start construction on a new manufacturing facility for Koch Engineering. Charles explained to his father that there was farmland that Koch owned and Charles suggested it be used to build a bigger and better facility to handle the growth of the company. The cost of the facility would be $1.5 million (which would be about $11 million today and Fred Koch replied "A million and a half" We can't afford that".  The deal would lead to the home of Koch-Glitsch which would represent the company to expand their product offerings. Fred Koch would pass away later that year on November 11, 1967.

Another strategy that is sometimes used for high net worth individuals is to purchase life insurance to cover estate taxes. Charles and David Koch were planning to have a meeting with an insurance agent to discuss this however the agent (Michael D. Brown) was unable to make the meeting and lost a $8 million commission as a result. The IRS would comment that this technique would not be advisable. However, if individuals purchase life insurance three years before they pass they can get that out of their estate. This strategy is known as setting up an irrevocable life insurance trust (ILIT). An insurance policy is purchased and placed in a trust. As long as the individual lives more than 3 years the life insurance policy will not be included in their estate. The only issue with this as you age the cost of the insurance premiums increase and it may be uneconomical to do. For executives or important individuals at a company often companies will purchase key person insurance. The purpose is to recognize individuals that have an important role with the company and the insurance pays out of that key individual passes to help the business continue on.

The company could use cash flow from the business to cover the estate taxes. It is estimated that Koch Industries in 2012 earned $8 billion before income taxes and depreciation. Koch on average tries to double every 6 years which would say that the company in 2018 earns closer to $16 billion before income taxes and depreciation. If we assume Charles and David Koch are each worth $51 billion then their total net worth is $102 billion. With an estate tax rate of 40% this would say that roughly a little over $40 billion would be needed to pay the estate tax (this of course assumes no estate planning had been done already). Also for David Koch since he lives in New York he will owe New York estate taxes as well. New York estate tax rates are 16% (this would add another $6 billion of taxes roughly). You are able to deduct the state taxes you pay on your federal estate tax return though. On the positive side Koch Industries could pay this out over a number of years. Using Section 6166 the Koch family could have up to 14 years to pay the estate tax. Although they would have to pay interest (however you would have to compare the rate Koch Industries was going versus this). There is no question over this amount of time Koch Industries could pay off the estate taxes owed by using the cash flow from the ongoing business.

There is no doubt that the next few years for Koch Industries will be interesting and be critical for the future as you have a major shareholder retiring. The Koch family most likely has done extensive estate planning to relieve the possible burden of estate taxes. Property records for example show David Koch has set up his homes into different trusts. Charles Koch also has his homes in trusts as well too.  The objective here is by having a home in trust it avoids going through the probate process-which is public.  I would imagine they have set up trusts, done complicated estate planning, purchased life insurance, and have some cash set aside to cover the estate taxes. There is a good chance that the IRS will contest the estate value of Koch Industries stock as it is a closely held business (this could end up lasting years) and there isn't much of a market for the stock. My prediction would be shares will ultimately end up in the hands of Chase Koch (it should be pointed out that he has children of his own), Elizabeth Koch, John Mark Koch, David Koch Jr, Mary Julia Koch, and the children of Preston Marshall and E. Pierce Marshall Jr. With this number of shareholders there could be no doubts fights and feuds over ownership of the company which could lead to buyouts of certain shareholders down the road. Koch Industries has done very well over a long period of time.  In my last post it was reported that Elaine Marshall who is a shareholder of Koch Industries earned $120 million in 2015 (she has roughly a 15% ownership of Koch Industries stock). This would say that even a 1% interest in Koch Industries stock would yield about $8 million of a dividend (this would say Koch pays out roughly $800 million in total of dividends). Charles and David Koch has grown the company dramatically which has increased not only the earnings but also the dividends. There is no doubt that the future for Koch Industries will be interesting and perhaps even more interesting than the past. As the modern philosopher Sean "Puff Daddy" Combs says "it's like the more money we come across the more problems we see".

Preston Marshall Spousal Abuse and Marshall Family Ownership of Koch Industries

As I covered in my last post David Koch recently retired from Koch Industries. It was mentioned that his effective retirement date is July 1, 2018. Also a number of months ago Preston Marshall who is in his mid forties has been alleged to have committed spousal abuse. Preston's is the grandson of J. Howard Marshall III and the son of E. Pierce Marshall. Family matters in the family haven't gone well. Preston in 2015 filed a lawsuit against his mother (Elaine Marshall) regarding the payout of the trusts that were established. The Marshall family own 14.6% of Koch Industries stock. A spokesperson for the Marshall family said that "Mrs. Marshall does not own any Koch Industries stock in her name"-this is true as the stock is owned by trusts. Charles and David Koch own 84% of Koch Industries stock. Preston also sits on the board of directors for the libertarian think tank the CATO Institute. Bob Levy who is chairman of the CATO Institute has said that if Marshall is found guilty of the allegations he will be removed from the CATO Institute Board. It is alleged that Preston Marshall is the largest shareholder of Koch Industries outside Charles and David Koch. The question would be if Preston is found guilty of spousal abuse would Charles Koch force him out as a shareholder?

On May 12, 2017, Preston went to the Petroleum Club in Houston and became intoxicated and physically assaulted his wife (he ended up headbutting her). Preston in his testimony would assert his fifth amendment right. As a result of this his wife Anastasia has started the proceedings to file for divorce. This is important because the Marshall family is a shareholder of Koch Industries stock and if Marshall is found guilty this could have other implications as well given he is a shareholder of Koch Industries stock too. I couldn't imagine Charles Koch having a shareholder who was found guilty of spousal abuse (but then again J Howard Marshall III use to visit strip clubs and pay women thousands of dollars per month in "consulting fees"). Although let's also be clear this is perfectly legal.

Preston is a graduate of Baylor University and in his earlier years worked as a management consultant for Ernst and Young. Also he was a managing director of CarTech Systems. Preston was quite engaged member of many social organizations. In 2015 he became a trustee of the elite Houston Kincaid School. In the summer of 2015 he was named as a Trustee for the school. He and his wife Anastasia currently have two daughters in Kincaid (three children total). His children are between the ages of 7-12. Preston was also part of the Petroleum Club's Capital Campaign Committee in 2015 and was on the board of directors from 2015 to 2016. Property records shows that Preston and his wife own a condo in Houston that is only 1 bedroom.  Preston married Anastasia McCarthy in January 2008 (the marriage certificate can be seen here) by a justice of the peace. Preston started to work for MarOpCo in the late 1990's (the family office of the Marshall family) and became President of MarOpCo (the family office for the Marshall family) after his father would pass. As part of his duties he would handle the tax return preparation and facilitating trust distributions  In June 2015, Preston would be not only fired; but locked outside his office with all his records and books removed from the office. Marshall recently resigned as a trustee from the elite private Kincaid School due to personal reasons.

The brother of Preston Marshall, E. Pierce Marshall Jr. appears to be a contrast from his brother Preston. E. Pierce Jr graduated from Tulane with a finance degree and then graduated from Yale Law school (J Howard Marshall III also went to Yale as well). He is the President and CEO of Elevage Capital Management.

As part of his will father E. Pierce Marshall (son of J Howard Marshall III) set up a grantor retained annuity trust (GRAT) that transferred to the EPM Martial Income trust (this trust would benefit Elaine Marshall). What is quite interesting is Pierce established the martial trust 6 weeks before he passed away. Also before he passed E. Pierce set up both the Irrevocable Harrier Trust and The Falcon Trust were established in May 2006. Elaine Marshall would serve a trustee for both trusts. Elaine then hired a Louisiana law firm to hire five people as co-trustees that she had never met or knew (a lawsuit would arise from this). According to a court case  the Marshall family owns Koch Industries Inc. and Koch Holdings LLC through various trusts (EPM Martial Trust, Harrier Trust, and Grandchildren's #2 Trust). In order to manage all these various different trusts the Marshall family has had a history of different holding companies to manage all these entities and trusts. The first entity that was established was MPI (Marshall Petroleum Industries) by J Howard Marshall III. Then Trof Inc. was established on February 26, 1985. Inside the Trof Inc. company is a grantor retained annuity trust (GRAT) known as the 2006 Grantor Retained Annuity Trust (GRAT). Inside the GRAT are Ribsome L.P. units which are actually family limited partnership units that actually holds Koch Industries stock. The idea setting up GRAT's is to get assets out of the estate that people believe will highly appreciate. Typically wealthy families will use family limited partnerships to transfer ownership from the older generation to the younger generation to avoid estate taxes. Often times families that set up an FLP will receive a discount for estate taxes on the valuation of the assets they give away allowing them to get it out of those assets estate. According to his testimony Preston says that Koch Industries shares can't be sold directly to Koch without the consent of other shareholders.

An expert valuation stated from the time that J. Howard Marshall III ownership of Koch Industries stock in 1994 the stock was worth $741 million and by 1999 the Koch Industries stock was worth $1.6 billion. Texas Commerce Bank would say at the end of 1995 the stock was worth $780 million. During 1994-1995 J Howard Marshall III would earn $7-$8 million in dividends from Koch Industries stock. This would say that he would receive less than a 1% dividend yield on his total net worth of Koch Industries stock. Marshall would even use 59% of his Koch Industries stock as collateral for the bank!  In more recent times the income Elaine Marshall would receive through all her trusts was roughly $120 million for a 14.6% interest. The $120 million income amount would represent the last figure Preston Marshall remembers from June 2015.Charles Koch has a philosophy of investing 90% of the earnings of Koch Industries back into the company and providing a dividend for remaining shareholders to live comfortably.

The growth of Koch Industries over the last 50 years has significantly increased the net value of the Marshall family and allowed them to have ample income due the dividends of Koch Industries. Although the dividends of Koch Industries is low on a percentage basis the growth of Koch Industries has dramatically grown the dividends as well. Also it appears the family has done sophisticated estate planning to try to get Koch Industries out of the estate of Elaine Marshall. Given that Koch Industries has grown substantially over the years the GRAT and FLP were good vehicles to get this out of the estate of the Marshall family. However, I am sure the IRS will have some questions on the valuation of Koch Industries stock once Elaine Marshall passes. Most likely the stock would pass (if it hasn't done so already) to Preston Marshall and E. Pierce Marshall Jr. Then after that it would pass to any children of the Marshall family. However, it will be interesting to see if Preston Marshall is found guilty on charges of spousal abuse will he be able to sell his shares back to the Koch Industries? Will Charles be able to buy out both the shares of Preston and brother David? Time will tell and most likely Charles Koch has plenty on his plate right now with his long time partner and brother David Koch retiring.

David Koch Retires What Happens Now?

So on June 4, 2018 it was announced that David Koch would retire from Koch Industries citing health issues. In addition to retiring from Koch Industries David would also retire from his board position at Americans For Prosperity. David will still stay on the Koch Industries board as an emeritus director. The letter from Charles Koch to all employees of Koch Industries read more somewhat of an obituary. Charles wrote "My thoughts of David will always be overflowing with the experiences, challenges, laughter, and love of our life together". The one page letter also notes that David helped grow the Chemical Technology Group of Koch 1,000 fold during his tenure.  Koch Chemical Technology Group has 6 different divisions and Bob DiFulgentiz runs the day to day operations of the company. In the roughly 48 years David was at Koch Chemical Technology group he massively expanded the subsidiary of Koch Industries from a single-product business into many different products and services. While David Koch's tenure the subsidiary purchased more than 50 businesses. These days the chemical technology group is sells and offer many different products. The company sells: mist elimination equipment for refineries and chemical plants, sells equipment to purify the water supply, offers products for companies to control their emissions (yes Koch Industries actually sells products that helps companies reduce the amount of pollution), assists companies in turnaround projects (this is typically where a chemical or refinery plant is shut down for some time and the company is performing maintenance or upgrading the plant capabilities).

David started with Koch Industries in 1970 as a technical services manager and founding the New York office. In 1979 he became in charge of Koch Engineering. In his most recent position he was an Executive Vice President of Koch Industries and oversaw Koch Chemical Technology Group. This subsidiary of Koch actually does help companies become more efficient and pollute less. Just recently Koch helped reduce the nitrious oxides emissions of a tomato company by 1,600 lbs in one year even while the company increased doubled the capacity.  David nearly every week would fly from New York to Boston and spend 2 days at Koch Membrane Systems in Massachusetts. Back in 2008 Koch Membrane had sales of $110 million. Koch Membrane turns dirty water from the ocean or that is left over from a refinery and converts it into clean/drinkable water. Back in 2011 the company was building a facility that would be used by local industrial companies that would save enough drinking water to supply 600,000 residents.

What is interesting is that Koch Industries doesn't have a replacement for David Koch. Usually large Fortune 500 companies spend years grooming successors to step in for them to learn the job and also to prepare for situations like this. Also I am sure customers, suppliers, and employees within the company are wondering what the next steps are for the company. The letter that Charles wrote said that David had been hospitalized during the summer of 2016 and at that point had been suffering from declining health. To me this signals that David Koch is in quite bad shape given he really enjoys working. In fact in this Newsmax profile from 2012 he said "my brother and I are going to be carried out of our offices feet first. We'll work until we drop". Koch is known as a hard worker as he often would get to the office at 9 A.M. and stay until 7 P.M. (with 12 hour days not being unusual). For a man nearly 80 years old this could take a toll. In addition to his job Koch also serves on the board of 21 different organizations (this would be a full-job in itself).

Koch has long battled prostate cancer and was initially diagnosed in 1992 with prostate cancer. According to Sons of Wichita in August 1993 after being treated with radiation and finally entering remission thanks to Sloan-Kettering David decided to have a $100,000 fireworks display along with an orchestra champagne soiree at his Southampton place. Back in 2012 David had a bout with diverticulitis and was given antibiotics intravenously for a week and then oral antibiotics. Koch says if he didn't have those antibiotics his colon would have ruptured and he most likely would have died. While in college Koch played basketball and completely wore out his knees which lead to an artificial knee replacement. Koch joked "that if you had spent as many years as I did begging girls for favors, you'd have bad knees too".

Since David Koch is now retired the question is where his shares go to. There are only a few possible options. The first is the shares could go to his wife. Married couples can pass an unlimited amount of money between one another due to the unlimited martial deduction. This would most likely mean that Julia Koch would become a shareholder of Koch Industries and show up to board meetings. This isn't far fetched since Elaine Marshall (the daughter in law of J. Howard Marshall) is currently shareholder of Koch Industries stock. David Koch did mention in this article that "almost all our money is in Koch Industries. Once we pass, our children will acquire the stock". By we I believe he is referring to him and his wife Julie. His wife Julia is roughly 54 years old and his children: David Jr is near 19 years old, Maria Julia is roughly 16 years old, and youngest son John Mark is around 11 years old. Given these ages the children in the future might be involved in the business.

Another possibility is for other shareholders to purchase the interest of David Koch. However, this seems unlikely has his interest in Koch Industries is worth according to Bloomberg is worth over $47 billion and it would be hard for Charles or the Marshall family to come up with that kind of cash since they both have nearly all their net worth in Koch Industries stock and don't have much liquid.

Sometimes individuals with a high net worth purchase life insurance to cover possible estate taxes. They can even use estate planning tricks buy purchasing life insurance and putting it inside a trust to get it out of the estate so it isn't taxed (known as an ILIT trust). According to a court case back in the early 2000's an insurance agent sold an insurance policy to the Koch family and received a $8 million commission for selling the policy. So perhaps this policy was purchase to cover some estate taxes (given that commission it would be hard to justify that all the estate taxes could be covered). According to this article from an agent that was suppose to sell Charles and David Koch on the insurance policy for every $1 of premium would save $9 in taxes which would mean the policy sold to them would avoid $72 million of estate taxes (which yes is a large sum but wouldn't cover the whole estate tax bill). Also Koch could talk to multiple agents and have different policies in place.

In my own view given that David Koch retired I believed he may be near the end. Individuals who work 12 hours days until they are near 80 years old typically don't leave easily unless they are told they must. The most likely situation is the ownership David Koch owns would be transferred to his wife and then ultimately to his kids (will be easier to transfer if they are in the business). Even if you combined the liquidity of Charles Koch, the Marshall family, and the other shareholders I don't think it would be enough to buy out his $47 billion position. If the Koch family purchased life insurance policies this will certainly help but the issue with insurance premiums is the older you get the more expensive the policy becomes (often times making it uneconomical). There is no doubt the future of Koch Industries and who controls it will be interesting.