Corporate Finance & Planning Insights for Multi-Generational Family Businesses
Over the years, we have used Thanksgiving as a time to remind family business directors that family is indeed the most important part of the family business. In this week’s post, we share some helpful resources before you sit down to eat some turkey with the family this Thursday. Happy Thanksgiving!
Among our family business clients, the issue of shareholder liquidity is always top of mind, and is occasionally a source of confusion among shareholders, managers, and directors. Large or small, regular or “special” dividends paid to family shareholders can really only come from five places. In this week’s post, we attempt to bring some clarity to the question of where dividends come from.
In our last post, we introduced a simple yet effective framework for developing and managing an ownership strategy. We follow up with some further thoughts on the framework as we look at the implications of the various combinations of the three points of the framework below. Thinking about the combinations of growth, liquidity, and control can allow family business owners to further fine-tune an ownership strategy in that it forces ownership groups to consider the benefits and tradeoffs that come with developing a strategy. We examine these tradeoffs and benefits in this week’s post.
We recently attended a family business symposium where owners, board members, and consultants gathered to share strategies and insights. During one of the presentations, we saw a graphic that piqued our interest. It was a simple triangle that provides a framework for developing and managing an ownership strategy in a privately held family business. We offer some thoughts on developing a strategy through the lens of the graphic in this week’s post.
Volatile times are never easy to navigate, but there are strategies family business directors can employ to keep their business on course. As the heat waves, hurricanes, and a potential recession loom, we wanted to take a step back and highlight three strategies family business directors can adhere to in these uncertain times.
Since the turn of the century, pension funds have increasingly turned to private equity investments in a bid to earn higher returns. As detailed in a recent Wall Street Journal article, pension funds have boosted private equity allocations from just 3% of their portfolios in 2001 to 14% in 2023.
The strategy was generally effective as average private equity returns over the past 20 years (as calculated per the MSCI index) outpaced the S&P 500 by over 4.0% per year (14% for private equity, compared to 9.7% for the S&P 500). For those inclined to do the math, the difference between earning 14% per year and 9.7% per year over 20 years is fairly dramatic: at 9.7% per year, $100,000 grows to approximately $637,000, but at 14% per year, that same $100,000 mushrooms to $1.37 million.
So while the private equity bet has paid off in terms of return, pension funds and other private equity investors are beginning to feel the risk that helped generate that extra return. Over the long run, returns follow risk, and private equity funds have provided outsized returns by taking outsized risks, the most significant of which are higher levels of financial leverage and accepting illiquidity.
What most family shareholders already knew – and pension fund managers are learning – is that illiquidity is a real risk. If you want the incremental return associated with that risk, you have to bear that risk.
Family shareholders bear the risk of illiquidity. On the one hand, that can be an attractive feature so long as the incremental risk is rewarded with incremental return. On the other hand, as we can see in the secondary market for private equity interests, shareholder liquidity needs don’t always align with corporate liquidity opportunities. Investors accessing liquidity “ahead” of schedule pay the price in the form of selling at a discount.
So what can family businesses and family shareholders do to manage the burden of illiquidity? Five things come to mind.
Earlier this year, we wrote about the Connelly case heading to the Supreme Court for final adjudication. The Court handed down its ruling in June, siding with the IRS in a unanimous decision. While the Supreme Court’s economic reasoning in its Connelly decision is impeccable, the need to redeem shares to fund eventual estate tax obligations of significant shareholders can disrupt, or at least complicate, the best-laid plans of growing family businesses. The Supreme Court’s Connelly decision is a timely reminder that family businesses and their shareholders need to work together to prepare for possible redemptions.
The good news – or maybe it’s the bad news, depending on your perspective – is that overly optimistic projections are not necessarily the result of intentional errors on the part of your family business managers. Rather, behavioral economists tell us that humans are prone to overconfidence as a result of what they refer to as cognitive biases. In this week’s post, we address five cognitive biases contributing to overly optimistic forecasts.
A recent Wall Street Journal article noted that, while the effects of the pandemic have receded from many aspects of American life in mid-2024, investors continue to deal with dividend disruptions. According to the article, of the 187 U.S. companies that suspended dividend payments during the pandemic, all but 47 have resumed payouts. With the competing claims on operating cash flow from the perspectives of the family business and family shareholders, managing dividend expectations can be a delicate dance. Finding and forging consensus on what the family business means to the family can help make sure that everyone is at least dancing to the same tune.
This week we look at recent economic data and the implications of this data regarding the Fed’s upcoming monetary policy actions. GDP growth in the U.S. economy slowed to 1.6% in the first quarter of 2024, lagging measures of 4.9% and 3.4% recorded in the final two quarters of 2023. Leading economic indicators point to a further slowdown on the horizon in 2024, as The Conference Board’s Leading Economic Index, fell 2.2% in the six months ended March 2024. We take a brief look at these trends and more.
Consistent investment in research and development is at the heart of many family business breakthroughs. Like any investment, R&D spending consumes family capital today in the expectation of generating more cash flow in the future, and for many years, companies deducted R&D costs from taxable income as those dollars were spent. However, a little-heralded provision of the Tax Cut & Jobs Act of 2017 upended the status quo for tax treatment of R&D expenditures. Taxpayers are now required to capitalize R&D costs, deducting them from taxable income over a period of five years rather than in the period the costs were incurred. With this in mind, we present a brief case study to help family businesses visualize this change and better prepare for capital budgeting decisions in the future.
The 2024 NFL Draft occurred this past weekend, and while a family business director might not be sitting 8th on the clock in next year’s NFL Draft, there are certainly draft day themes that can be applied within your family business. NFL Draft “assets” may look different than those of the family business, but the themes of considering shareholder & owner preferences, allocating capital, and preparing for next-generation leadership mirror many of the responsibilities of a family business director. Read more in this week’s post.
Successful enterprising families are careful and deliberate consumers of family capital. In specific circumstances, Section 6166 of the Internal Revenue Code can provide a capital planning alternative family business directors should consider when facing large contingent liabilities for shareholder estate tax obligations.
This week’s blog centers around the challenges of asset allocation and investment decisions for family businesses, touching upon the importance of understanding a family’s appetite for risk and growth. We explore how the meaning assigned to the family business influences investment choices options and the necessity of balancing risk and expected returns. While there may not be a perfect answer for deciding how to invest, reevaluating what your family business needs and what it means to you will help you decide more wisely.
Capital budgeting can’t be avoided — the only question is whether your family business has a consistent and disciplined process for evaluating potential investments or instead makes significant capital commitments in a more haphazard way. In this video, we describe the key elements of the capital budgeting cycle and identify some common potholes along the way.
Your family business may likely be one of your largest assets, but not the only asset. Thinking holistically about your family’s complete balance sheet, not just the operating of the business, is a good mindset for fostering longevity, family harmony, and shareholder engagement.
In this post, we discuss three key financial areas that family businesses generally focus on. Having an accurate picture of the complete family balance sheet will help inform the ultimate decisions made at the family business level that optimize shareholder returns and maximize total family wealth.
Warren Buffett is regarded as one of the world’s preeminent investors and most shrewd businessmen. Buffett and his partner, Charlie Munger recently drew thousands to Berkshire Hathaway’s annual meeting in Omaha. Buffett’s 2022 shareholder letter analyzes the company’s strategy, performance, and vision for the company going forward. This year’s letter provides several lessons for investors and family businesses alike.
How do you approach your family business budget? Do you ask your managers to “reach” or to create targets you expect to meet? Do you measure your forecasting accuracy? What is your process? In our post this week we share three forecast reminders that may help you make better budgets: Measure yourself regularly, remember the law of averages, and adapt your roadmaps when needed.
Capital budgeting tools are ideal for answering the question: Is the proposed capital project financially feasible? Too often, however, we see these tools being used to answer what seems to be a related question, but one that the tools are simply not designed to answer: Should we undertake the proposed capital project? The first question opens the door to the second, but the tools of capital budgeting – no matter how sophisticated or quantitatively precise – cannot answer the second. To answer the second question, family business directors need to consider three qualitative questions identified in this post.
How are you and your fellow directors deciding what to decide? Is there consensus around the economic meaning of your family business to your family? Gaining consensus around the meaning of your family business can be a crucial first step to making all the strategic finance decisions you make line up with one another.
Despite our best efforts, having four kids in the house means that we are a net candy importer over the Halloween weekend. Staring at the piles of candy in our house this morning brought to mind several recent conversations we’ve had with clients and prospects. The topic of those conversations was “lazy” capital. In this post we discuss where lazy capital comes from, what its consequences are, and how to get rid of it.
Family business directors generally take the long view relative to their publicly traded counterparts, providing a reprieve to constant market updates and daily market volatility. Successful family businesses plan for the next generation, not just the next quarter. However, family businesses cannot simply put their heads down and ignore economic trends outside their family’s industry.
It is harvest time in rural America. Farmers are working long hours gathering the crops that have been planted, fertilized, watered and worried over since springtime. While the cycle of planting and harvesting is an annual one on the farm, for family businesses, the cycle can span decades or even generations. There are many different ways to classify family businesses, but one simple distinction that we find ourselves coming back to often is that between planters and harvesters. So what time is it for your family business? Is it planting season or harvesting season?
Family Business Director was recently whiling away the hours scrolling through the archives of the Harvard Business Review when an article caught our eye. “What You Can Learn from Family Business” was written by Nicolas Kachaner, George Stalk, Jr. and Alain Bloch, and appeared in the November 2012 issue. The authors describe an empirical study they undertook to discern the ways family businesses are different from their non-family owned peers. In a series of posts over the next several weeks, we’ll take a closer look at some of the attributes identified by the authors, particularly from the perspective of privately-held family businesses. This week, we’ll consider how family businesses make capital expenditure decisions.
