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
