Morton Brown featured in Family Business magazine

I had the opportunity to write for the most recent edition of Family Business magazine on how financial planning for each member of a family business can help bring clarity to strategic decisions. Clarity on the personal impact of decisions is critical for closely held businesses. I hope you enjoy…

Developing Confidence and Clarity in Family Business Decision Making

As published in Family Business, March/April 2019

Our family relationships and our feelings about money bear some interesting similarities. A lifetime of interactions with relatives, especially in a business environment can create complex relationships with a range of strong emotions. We have all heard siblings talk about their childhood in ways that would make us think that they were raised under separate roofs. Each individual is affected in unique ways by their interpretations of childhood events and the inevitable drama of youth.

Our relationship with money can also be influenced by what we witnessed growing up. The risks we saw others take and the impressions that our environment left on us can guide the way we make financial decisions. The desire for gains and the fear of losses when it comes to wealth often emerge under stressful situations. When we combine the emotions of financial success or failure with the close, complicated relationships indecision and confusion can be the result.

When making strategic decisions, family business owners need clarity around the overarching goals of the business, the values it represents, and the roles that each member plays in future success. Each decision maker, however, brings a unique set of traits and experiences to the table.  Outside of their common experience in the business, their family situations, personal priorities, and experiences with wealth can be quite different. Those differences can bring added stress when business decisions have very personal implications.

Personal financial planning can help provide clarity and confidence. That confidence can help diffuse some of the emotions that can arise when deciding to innovate, transition, or scale. Each family member should be able to understand how the levers pulled within the business affect their personal financial situation.

The family business can provide a sense of identity for individual family members as well as the family collectively. There is a strong sense of belonging to something greater than oneself, sharing values and accomplishments while also pursuing personal goals.  However, balancing what is best for the senior members of the business and those who are preparing to take the next step forward can be challenging. Each party will consider, “How does this work manifest as wealth for me and my beneficiaries?” Each generation’s judgement might be influenced by their personal relationship with money. 

In one family business we advised, a generational transfer was just about ready to proceed. The next generation was prepared to assume the mantle of leadership, and there was clarity on the strategic goals of the enterprise. Yet the current leader struggled to embrace his personal financial plan. The wealth created by the business was what he knew and trusted most. He believed the business was the safest part of his balance sheet.  Because of that perception of safety, the wealth that they managed outside of the business was invested in risky, illiquid assets.

That approach to risk management worked for him, but it hindered the transfer of the business to the next generation. The majority owner could not bring himself to leave the family business because he did not trust that he would be financially secure if he retired.  While the family had sufficient wealth to provide for security, the owner preferred to maintain the current balance of risks because they were what he knew.  

Family business and money are both personal and complex.  There is no silver bullet solution that will work for everyone. The best way to manage the process is to begin wealth management conversations early on, so there is understanding well before critical decisions like this. 

The goal is to have all business owners come to the table with the highest confidence in how they define financial success and what role the business will play in that success.

Establish priorities.

When the source of family wealth is being discussed, uncertainty feeds emotion. If the business has provided a sense of identity for a family over many years, the way each generation responds to change is likely to vary. A member of the business may have a clear sense of who they are as part of the larger organization and in the wealth picture of the family but may have less clarity on the opportunities and challenges that role creates for them. The priorities of the business must be clear to all involved in order to achieve alignment, but each individual would also benefit from identifying priorities for their own family and wealth plan. Income, wealth accumulation, and even status within the business community and social circles must be balanced delicately. 

It helps to create a framework of priorities that recognizes that business goals will be collective but financial goals are very personal. The common priorities could be broad and typically long-term, like passing on the family values through the business across multiple generations. A more personal priority might be to understand how different sources of income, both active and passive, are supporting a lifestyle. That way, if courses change or timelines are adjusted, the impact on the highest priority goals would be understood.

Know your individual biases.

Behavioral economics is a field that is quickly making its way into advisor’s day-to-day conversations with clients. Insights from the field can help us understand why we think the way we do and under what conditions we might be prone to failure. 

Family business owners are particularly subject to several types of bias. One is the “endowment effect,” the belief that what we already own is more valuable than all alternative options. This phenomenon was at play in the previous example of the business owner who was unwilling to relinquish the reins because of fear of the unknown.

By assigning a higher value to our current status, are we creating paralysis for the business? Each member of the business must understand the range of possibilities for both their wealth, their profession, and their family. Evaluating how each option would affect their unique circumstances will build confidence that they are making an informed decision.

Another behavioral economics concept is the “illusion of control,” the mistaken belief that we can influence the outcomes of situations that are actually not under our influence.

Consider a senior-generation  member who owns a stake in the family business, but also has real estate holdings, interests in other closely held businesses and brokerage accounts scattered about. The only unifying factor in this complex balance sheet is the hand of the owner coordinating it all. From the outside these holdings look disjointed, but the owner feels the assets are under control.

At some point – perhaps for the benefit of a surviving spouse or to achieve transition of the business to the next generation – the owner must shift focus away from control. Instead, the goal should be creating a unified purpose for all assets. What is the role of each asset in providing income, growth, or stability? If the owner were no longer around to manage it all, would the heirs be left in a chaotic situation?

A team that includes a financial advisor, an accountant, and an attorney can teach business owners how to understand and master their biases. 

Clarity about our circumstances allows us to calmly assess the changes and understand their impact. In the dynamic environment of a family business, an understanding of money and wealth can help alleviate the strain and emotions that can emerge when key decisions are on the table. Confidence in business strategy and personal financial clarity make generational transitions more comfortable.

Contact Dennis

Important Disclosures

The Found Decade

The first decade of the 21st century has been called a “Lost Decade” for investors because during that time the U.S. stock market went through two bear markets before ending up flat for the ten-year period.  This month marks the anniversary of a robust rebound, a regression to the mean, or a “Found Decade.”  In early March 2009 the financial crisis hit its bottom, at least as far as the stock market was concerned.  From that time until March 7, 2019, the total return of the S&P 500 has been 408%. 

These two contrasting periods have me thinking about a question that faces investors when they look to invest in a fund or index:  How do I select the right fund?  The obvious answer might be to look at its past performance, but that can be deceiving.  In the scenario I just mentioned, in March of 2009 the Vanguard Total Stock Market Index Fund had returned an abysmal -32% over the ten years prior.  This assumed you had invested into the heights of dot-com mania and held into the troughs of bad mortgage debt.  The trailing returns were terrible, but did that make it a bad investment?  By contrast, over the same time period, the Vanguard Total Bond Market Index grew over 70%.  Did that make it a better investment in March of 2009?

No.  Because that is making forward decision with a focus on the rear-view mirror.  What we can learn from this chart is that during a period where stocks left much to be desired, bonds did their job.  They preserved principal and paid income steadily.  An investor in 2009 had a choice to make, though.  Do the  last ten years tell me anything decisive about the years to come?  Here is the chart of the next ten years for stocks and bonds:

Bond performance has been positive, and reasonable, but stocks have been on a meteoric run for ten years.  So many people lost faith at the lows, sold their stocks, and missed out on the years to come. This tells us some very important things about making decisions on past performance:

  • Past performance, while interesting to look at, is as out of our control as the future.
  • The past can’t tell us how an investment will perform in the future, but it can tell us what is possible.  Stocks can be volatile.  Bonds can underperform in a bull market.  Behave accordingly.
  • Market cycles can last a long, long time.  Patience can be tested, but that is why investing is a “get rich slowly” exercise.

I bring all of this to the foreground because rest assured, there will be mutual funds and investment managers touting their performance over the last ten years hoping that we investors will make decisions based on this advantageous snapshot.  Instead of focusing on trailing returns, you should instead weigh these aspects of an investment:

  • Cost
  • Comparison to similar assets
  • Risk levels

None of them will predict your returns, but these three features are in an investment manager’s control. Not so with the performance of the markets.  Be wary of looking backwards, you may miss the opportunity to come.

Contact Dennis

Important Disclosures