Reducing the Risks of Family-Business Growth

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We’ve heard financial strategies in family businesses expressed in many ways, ranging from “I just want to get out of debt” to “I’ll take every dollar anyone will lend me.” Our experience suggests that more family businesses would make the first statement; they don’t like debt and the risks that it causes.

Unwillingness to use debt, however, can restrict a company’s ability to grow. Professionals in corporate finance, develop strategies that blend debt and equity to maximize return on investment and support business growth. Our research has shown that companies with debt expect more and faster growth than do those without debt.

We do not suggest that every family business should run out and borrow money for growth. But in a recent survey, over half of business owners said they feel they have excellent access to capital. Besides capital, growth requires market opportunities, managerial ability to take advantage of opportunity, and the desire and motivation to grow.

In our experience, family business owners realize that growth, debt, and risk can further complicate family relationships. Aggressive growth strategies require more-sophisticated management practices and better communication with family owners. Communication, management controls, and accountability help reduce risk from growth and greatly reduce stress and perceptions of undue risk among family members.

In analyzing data, we found that old, multiple-generation family businesses tend to have three things in common: a strategic plan, a board of directors, and family meetings.

Each of these characteristics seems to be associated with business growth and the ability to manage growth and economic downturns well.

Growth, particularly rapid growth, requires strategic planning. Families that are conflicted over business direction, become much more supportive when management develops and expresses a clear direction and a plan to get there.

For family businesses embarking on growth strategies that require greater risk, having an active board of directors becomes even more important. Boards can provide oversight, ideas, and experience to help companies manage risk responsibly.

Our research shows that three-fourths of businesses that hold regular family meetings expect significant growth, compared with 60 percent of those that do not meet. Family meetings are an important way to build consensus for growth.

Here are some things we believe growing family businesses should do in their family meetings:

• Clarify family goals. Discuss how business growth can help achieve those goals. Examples include providing employment opportunities for more family members, remaining competitive in a changing industry, and building wealth.
• Make sure that the family understands the use of debt in business. Talk about corporate-finance concepts, principles, and ratios.
• Develop clear policies on debt levels, expected return on investment, and rewards to owners. The family should understand that business leaders are taking a responsible and disciplined approach to risk and that family owners can expect rewards for the risks they are asked to assume.
• Share financial reports with family owners on a regular basis – at the end of each quarter often makes sense. Emphasize results; of course, but also discuss key ratios that indicate how well risk is being managed.
• Discuss estate plans with the family. Careful planning is required to assure that the benefits of risk and growth remain with the business and the family. Unless estate planning is accomplished and understood, growth will simply cause estate taxes to be higher and harder to pay.

From the perspective of Wall Street or a graduate business-school classroom, the goodness of growth is seen as a given. In family businesses, growth cannot be taken for granted. The research shows that one-third of family businesses do not expect to grow – many because they choose not to.

Many families want businesses of a size that they can control, not larger. Many families prefer to minimize risk. Some families fear family conflict that may come from growth.

But the main resistance to growth, family leaders tell us, is that once a business has been built that provides a comfortable life, there is little incentive to grow. The biggest disincentives to growth, according to our surveys, are income taxes (identified by 38 percent of respondents), estate taxes (28 percent), and capital-gains taxes (14 percent).

Research shows us that the financial capacity for expansion exists. Our experience shows us that many family businesses have market opportunities and capable management available to achieve growth, and we have seen that family commitment to growth can be built. The means and method for growth are available.

What’s often lacking is the motivation.

That may very well require further changes in the tax codes.

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