11.

How to Be Responsible with the Wealth of Your Family Business

As a thirty-eight-year-old family member working in her family furniture business, Judy knows that more than 90 percent of her personal wealth is tied up in the business. The company has had a great run, creating wealth for her entire family. But now, with people starting to whisper that Judy will be the company’s next leader, the wealth of the family may soon be her direct responsibility. How does she continue to build that wealth, ensuring that she doesn’t “mess up” what has been three generations of success? Should she focus on continuing to generate healthy dividends for the family rather than investing in innovation that may or may not pay off? Should she consider taking on debt to help grow the business or simply stay the course, maintaining the business’s conservative business model? Judy doesn’t want to ruin what the previous generations worked so hard to build. The responsibility weighs heavily on her shoulders.

Your family business has probably made, or will hopefully make, your family wealthy. The idea that the family may be successful enough to be financially independent, provide for multiple generations, and offer benefits to family members is part of the wonderful payoff of building a family enterprise.

This chapter will provide advice on a weighty question: how to be responsible with the wealth of your family business. While there are no one-size-fits-all formulas for success, business families grapple with the same three questions:

1. How do you protect the golden goose?
2. How do you build a portfolio to last for generations?
3. How do you prepare your family to be responsible with wealth?

Plenty of advice exists for dealing with wealth in general (see “Further Reading” for some of the best), but less clear is how to manage wealth specifically from a family business. We offer here some suggestions to navigate the key issues.

Protect the golden goose

Many family businesses refer to their core business as their golden goose. That is, whatever the family does, whatever feuds it has, whatever business decisions it makes, however the members “overexpress” their egos, the family’s overriding concern is to avoid hurting the business.

Less talked about, however, because it’s harder to see from the outside, is how family businesses responsibly protect their golden goose. Here are the patterns we often see in family businesses.

Survive, profit, then grow

Once, when we were helping a next-generation leader with a growth strategy for her construction company in Florida, her father, the patriarch, called us into his office, asked us to have a seat, and said, “Now, boys, I’m not against growth. But make sure you get our priorities right. They are, in order, one, survive; two, profit; and then, three, grow. If you put revenue growth first, my grandchildren may have no business at all. We don’t want that, do we?”

It was a great reminder that aggressive revenue growth always brings risks. If you want your family to own your business for multiple generations, you need to prioritize survival and profits instead of chasing risky revenue growth opportunities. Of course, you hope that your business will have periods of strong growth for many years. But unlike owners of a venture capital firm, which may invest in ten firms, betting that one, maybe two, survive more than five years, you may hope your one company will be “evergreen” and survive for a hundred years or more. (Recently, we have seen an increase in this evergreen philosophy, with such groups as the Tugboat Institute bringing together like-minded owners, many of whom are from family-owned businesses.)

Keep debt low

When we started working with family businesses, we were shocked by their low level of debt. It’s common for family businesses to have zero, or even negative, net debt, meaning their cash and cash equivalents on their balance sheet exceed all their debt. For example, one client keeps enough cash on its balance sheet so the business can survive two years with zero revenue. This policy flies in the face of what business schools teach and many private equity firms practice—that debt is both tax-efficient and a good way to increase return on equity. Family businesses that thrive across generations know that too much debt can lead to losing the company to the debt holders (i.e., bankruptcy) sometime in the medium to long term. A global study by Standard & Poor’s in 2011 showed that during a ten-year period, default rates are greater than 50 percent for companies with C to CCC bond ratings and about 30 percent for companies with B-rated bonds. In chapter 5, we pointed out that your level of debt is an explicit choice in your Owner Strategy. But too much debt can have existential consequences, as the Covid-19 economic crisis illustrated to many indebted firms.

Keep most of the wealth “in the cave”

If your business is concentrated in one industry, it will probably be more volatile than if you own a diversified portfolio of businesses. While it may seem more rational to diversify with liquid proceeds to weather this volatility, some owners keep their wealth, as they say, “in the cave”: they may be wealthy on paper, but their money is tied up in their business. The money might be invested in working capital, a factory, the land the factory sits on, or inventory on the shelf. The owners take this approach for two primary reasons. First, with their wealth in the cave, they can use it to invest in down cycles when other owners can’t, boosting their own competitive position. Second, many owners believe that the gold in the cave should stay in the cave. As one matriarch told us, “You have a choice: live rich or be rich.” Liquid wealth is easier to spend (or fritter away) than is money tied up in the business. Owners increase risk to the business with excess personal spending because their personal spending habits can become similar to fixed business expenses. For example, people can take out mortgages for expensive homes and then become dependent on distributions from the business for mortgage payments.

Diversifying your wealth out of the cave doesn’t automatically mean selling some of your assets so that you can enjoy spending that money (which you are fully entitled to do). Instead, diversifying for long-term wealth creation can mean investing in other businesses or investment vehicles but with a focus on investing for the long term.

Build a portfolio to last generations

Successful owners of multigenerational family businesses rarely rely on just a single company to generate and sustain their wealth. That’s in part because of the natural life cycle of any business. For ten years or even twenty, a single business may generate significant value, but seldom does this happen decade after decade. At some point, you will most likely need to build a portfolio. Here are tips for how to do so responsibly.

Be in business, not in a particular business

Evolving from your original legacy business can be tough because the owners often have a deep emotional connection to it. Multigenerational family wealth, however, is typically created via a portfolio of related businesses. A study by Shell about corporate longevity found that “many successful moves were made when companies did not see themselves locked into a particular business, but in business, with talents and resources that could be used profitably to meet a variety of consumer needs.”¹ This in business idea perfectly describes how most multigenerational business families work—they systematically, often over decades, extend into businesses adjacent to their current business. One of our clients, for example, began in local coal delivery but then over the decades added heating oil delivery, gas distribution, gas stations, convenience stores (with great fried chicken), and, most recently, real estate. Over time, each adjacency played an important role in diversifying and growing the family’s wealth. Successful portfolio creation comes in all sizes and types of family enterprises. For example, another of our clients became well known for a small but celebrated jewelry business in Milan in the 1960s. But the family actually made more money from a corporate-gift business and from real estate owned at the business’s primary location. That combination proved to be a responsible portfolio approach for the family in the long term.

Create a portfolio to fit the owners’ interests

In multigenerational family businesses, your portfolio approach needs to blend value creation and your family values. Invest in businesses that you want to own together. Each business family has to find its own blend as it balances its unique expression of growth, liquidity, and control.

We learned one of our favorite approaches to a family business portfolio from a highly entrepreneurial family that balanced its interest for longterm financial security, a desire to reward individual passions for building businesses, and its attachment to its core business. Table 11-1 shows the four investment categories the family uses for its collective wealth, listed from the highest risk–reward ratio to the lowest.

Each of the investment categories has a role—both economic and familial. The moonshot investments, for example, were created to both bet on high-risk, high-reward businesses and to let some of the entrepreneurial family members follow their passions. The “hurricane” fund recognized the family’s psychological need for highly conservative emergency and liquid funds, reflecting the family’s painful history as refugees.

Follow a dividend policy

Owners often keep most of their gold in the cave, but not all of it. Dividends can take several forms:

• Regular dividends: Payments from the company to shareholders in proportion to their economic ownership of the firm. Owners set guidelines, or a policy, for how the annual dividend is calculated. The board declares the exact amount annually.
• Share buybacks: Option to sell a predetermined number of shares at a calculated price per share to the company in a set time frame. This approach allows shareholders who want liquidity above and beyond regular dividends to access it (and can help prevent people from feeling trapped) into ownership. One seventy-five-year-old firm we worked with has never paid an annual dividend but instead offers an annual share buyback program. An owner told us, “We like it that dividends are not a right here; we think it should hurt a bit to get some money. Selling shares of our successful firm is painful.”
• Special distributions: Onetime payments to owners. Owners decide on these payments for various reasons, including situations when the company has more cash than it can invest wisely.
• Tax distributions: Payments to owners to cover their tax payments. These distributions reflect the corporate structure and are usually sent to the tax authorities rather than spent. Since they don’t end up in the hands of owners, we won’t consider them in our discussion of managing family wealth.

Decisions about dividends are among the most important in a family business. They affect the long-term viability of the business as well as the culture of the family. How you treat dividends reflects your values and can therefore be a significant source of conflict. Here’s what to consider as you navigate this critical choice:

• Agree to an annual dividend policy instead of negotiating the amount every year. Discussions about dividends are rife with conflict and can be financially and emotionally challenging. You’re better off not relitigating the dividend decision every year but rather deciding on a policy ahead of time and reconsidering it only when circumstances change or after several years. For example, you could decide on an annual dividend of 10 percent of your firm’s free cash flow.
• Set your dividend policy according to your Owner Strategy. More liquidity means either less growth or reduced control over your company. Create the policy in your Owner Room and communicate it to your board as part of your Owner Strategy statement. The board should base the annual dividend, which is usually expressed as a formula, on this policy.
• Treat your dividend like an equity rather than an annuity. The value of equities goes up and down, while annuities stay the same year after year. Most of the payment should be at risk and tied to the performance of the business instead of a set amount every year. A large set amount creates a dependency and disconnects the owners from the performance of the business. Family members should be prepared to live without dividends in case the company can’t afford to pay them without taking extraordinary measures, such as borrowing. Some owners set a floor dividend amount that “guarantees” a relatively small income.
• Have some level of dividends. Dividends are a valuable way to reward and encourage long-term ownership, especially when some owners are governors and investors. For example, if some family members work in the business as executives and are rewarded with generous compensation packages, nonoperating owners will question the fairness of zero dividends. Additionally, dividends can increase the financial independence of owners whose wealth is highly concentrated in their family business. As one spouse explained to us, “We want ‘emotional diversification’—which for us means our family branch wants to own some assets separately from the broader family. We sleep better at night knowing that not all of our wealth is tied to the collective decisions of our full family.”
• Use the dividend to set expectations of management. Management should treat your capital as valuable and scarce. Dividends are a valuable lever for owners to maintain discipline in the business. Special dividends should be considered when the business can’t make good use of the owners’ capital, using agreed-on metrics to measure the value of further reinvestment.

Prepare your family to be responsible with its wealth

Many family business owners worry intensely that their wealth will quickly dissipate with each generation. Several countries have some version of the three-generation rule, such as these three adages:

• “Shirtsleeves to shirtsleeves in three generations” (United States)
• “Pai Rico; Filho Nobre; Neto Pobre” (Brazil)
• “Dalle Stalle Alle Stelle Alle Stalle” (Italy)

Like the three-generation rule discussed in chapter 2, this claim is misleading. Certainly, some families go from rags to riches and back again, but on average, they do not. Gregory Clark, an economist at University of California, Davis, conducted extensive research on social mobility over generations and concluded, that in general, rich families stay rich and poor families stay poor.² He found that while there is some “regression to the mean, the process can take 10 to 15 generations (300 to 450 years).” ³ A study conducted by two economists from Bank of Italy looked at tax records in Florence in 1427 and 2011. They discovered that “the top earners among the current taxpayers were found to have already been at the top of the socioeconomic ladder six centuries ago.” ⁴ Though this research is not specific to business families, the findings apply to them as well. Wealth may dissipate over time, but it does not happen quickly. Those who climb to the top of the ladder tend to stay there.

If your business is creating significant wealth, you need to prepare your family for the responsibility of dealing with it, probably for many decades. The good news is that by owning a business, you have several ways to embed the idea that with wealth comes responsibility. We advise you to consider the following approaches taken by other successful multi-generational business families.

Expose your children to the business

Owners have an enormous and often underemphasized advantage in how and when to expose their children to the real heart of their wealth—the parents own a business and have a family narrative. Talking to your children about the business early on will help them understand the hard work that has generated your family wealth.

Top business families make a point to have their preteen and teenage children learn about the people who work in their business, what these people produce, and how they do it. Regina Helena Scripilliti Velloso is a fourth-generation owner of Brazil’s Votorantim Group. The family-owned company has operations in more than twenty countries in cement, mining, metallurgy, steelworks, banking, orange juice concentrate, and generation of electric power. Velloso recalled to us how powerfully her grandfather instilled in her the foundation of where the business started:

When I was a little girl, my grandfather would take us to visit the sugar cane mills. And I really didn’t like the taste of sugar cane juice. It’s terrible. But I didn’t have the courage to tell my grandfather that I hated this juice, because of what it meant to him. He’d say, “When you smell the sugar cane syrup, you are not going to forget it. This is going to enter your blood and your heart.” I didn’t understand it at the time, but as an adult, I understood he was sharing with me the passion for the business and the legacy of where we came from.

Youthful exposures—such as working in the company gift shop, stocking shelves, and walking your orchards—create a lasting appreciation for the craft of a family business. It’s an early and important lesson that it’s not all about money. Business can be fascinating, even beautiful. Many owners provide their children with a deep appreciation of their family business in age-appropriate ways such as visits to the factory floor and internships.

In some companies, college-aged members of the next generation participate in higher-level Owner Strategy discussions. In one such meeting, a family debated whether it should continue to own a business that made components for assault weapons. Both sides in the argument had deep convictions and respectfully listened to the other’s point of view. Seeing how thoughtfully the owners approached an important topic, the next-generation members in the room understood the depth of responsibility of ownership. Eventually, they found a compromise that, though imperfect, they could all live with. They decided to keep the business but pull it out of the main holding company to allow family members who didn’t want to participate in it to sell to those who supported it.

All these experiences can help your children appreciate your business instead of your wealth. Show them how the wealth embedded in the business is used: to create things of value for customers, to create jobs, to clarify and express what you value, to give back to the community. With these experiences, your next generation will better understand the responsibility of their family’s wealth.

Be open to a variety of stances on your business wealth

People in family businesses relate to their wealth in different ways, and there is no single right way. For this reason, you need to understand and recognize where family members stand on wealth. You don’t want each person’s relationship with wealth to be held against them, building resentment and creating difficult relationships. Most owners take one of seven stances on the wealth from the family business:

• Rebel: You reject wealth and actively speak and act out about the negative effects of wealth and social inequity.
• Avoid: You act as if the wealth does not exist; you refrain from actively engaging in its management (e.g., physically and emotionally separating yourself from your family and the family business).
• Give it away: You donate the wealth to worthy causes during your lifetime (e.g., Bill Gates as cochairman of the Bill & Melinda Gates Foundation).
• Steward: You care for the wealth for the benefit of future generations, your employees, and society. You broadly define wealth financially, psychologically, and socially.
• Create: You create more wealth so that you leave more than what you received; you find personal fulfillment in creating great wealth (e.g., Ian “the creator” in chapter 1).
• Enjoy: You enjoy the benefits of your wealth through personal spending and philanthropy, while not defining yourself by it.
• Self-define: Your wealth defines you. You don’t merely enjoy your wealth, but you revel in it. Spending your wealth makes life feel more rewarding.

Family owners as individuals can live happy and healthy lives with any of these stances, except the rebel and self-defining stances in their extreme forms, which can become destructive. Someone rebelling against wealth, for example, will cut themselves off from their wealth and their family, while someone who defines themselves by their wealth will lose sight of the values that created it.

Business families tend to glorify those who create wealth. But a family member is not a bad person for avoiding wealth, giving it away, or seeing themselves as a steward of that wealth. Those are all perfectly healthy relationships with family wealth. “Not all owners have the same financial interests and priorities,” observes Ben Persofsky, executive director of Brown Brothers Harriman Center for Family Business. “It could be for no other reason than differences in their stages of life. And that’s okay. What matters is not that there are differences, but that you find ways to be transparent about them.”

Once you identify where your family members stand, you should have insights for today and a roadmap for the future. If none of the next generation identify with the creating or stewarding stances, for example, you may be more open to selling the business. Or if you have a spread among the stances, you may find that the next generation will naturally fall into different, and important, roles in the future. Of course, a person’s relationship to wealth may change during their lifetime. Consider John D. Rockefeller, the founder of Standard Oil Company, who went from one of greatest wealth creators in the nineteenth century to one of its greatest philanthropists.

Avoid creating entitled kids

Want to know what keeps the owners of successful family businesses up at night? Across businesses of all sizes, geographic locations, and industries, these owners share one common fear: the dread that their kids will grow up to be entitled.

Most upper-class parents share this concern, but among family business owners, this anxiety is especially powerful. Will their children and grandchildren end up lazy good-for-nothings who are not contributing to society—trust-fund babies—and whose scandalous antics fill the pages of the tabloids and social media?

But wealth turns out to be a less important factor than you might think in the development of entitlement. Some very rich kids turn out to be highly motivated and engaged—we see people like this in our work every day. Our experience also suggests, however, that kids don’t mysteriously end up entitled; parents make choices that substantially increase the odds that the kids end up feeling that the world owes them a living.

Entitlement is not something that kids just fall into. It’s a trap—set for them, unintentionally, by well-meaning parents. Your number one instinct as a parent is to protect your children. Entitlement is the result of misguided protection. And family business provides fertile ground for parental protection.

How do you avoid the entitlement trap? There are not pat answers. But we have identified five practices that families have used to foster healthy relationships with wealth:

• Use your wealth to broaden your community. Parents who isolate their family in a social circle of similarly wealthy people can be enabling entitlement.
• Make sure your children have jobs. There are many ways to contribute to society but at some point every person should have the experience of having a boss, being responsible, and earning a paycheck.
• Help your children see a path to build a legitimate career. Parents who coddle their children’s careers in the family business are not preparing them to value the parents’ own hard work.
• Allow your children to have setbacks. When overly protective parents shelter their children from fate’s hard knocks, the parents fail to help the kids build resiliency.
• Instill an attitude of gratitude. Psychologist Jim Grubman suggests that fostering gratitude is one of the most important practices for parents with wealth. “Gratitude is the antidote to entitlement,” Grubman says.

A grateful attitude requires work on the parent’s part, however. You cannot simply expect your children to be grateful. Modeling gratitude and thinking out loud with your children about your financial decision-making can help foster appreciation. For example, Grubman points out that, yes, you can simply purchase a fancy new car and tell your children how much you love it. But you can also, instead, speak out loud about how deciding to make this expensive purchase reflects your values and your own thankfulness: “I’m really enjoying the new Porsche. I always feel very fortunate that my parents worked hard, we worked hard, and we have the kind of resources that let us have some of the finer things in life.” Without experiencing that explicit and repeated modeling of gratitude, your children may not pick up your values about never taking wealth for granted. Practice being thankful yourselves, and chances are that your children will end up thanking you for it. That’s a critical step out of the entitlement trap.

You can have a healthy approach to wealth, one that is neither fawning nor damning. You can start by thinking through the guidance we offer here to see if you are on track. “There’s no doubt you can raise incredibly sophisticated and responsible kids in a wealthy family,” San Orr, president of BDT Capital Partners, LLC, a merchant bank that advises and invests in family and founder-led companies, told us. “The key is preparing them to assume the mantle of responsibility being placed on them, a bedrock that will serve them well for the rest of their lives.”

Summing up

■Concerns about wealth are common in family businesses. On the one hand, owners worry about squandering what has been created. On the other hand, they are anxious about the impact that money will have on the family. Wealth can be an uncomfortable topic for families, but you can’t avoid it if you want a multigenerational family business.

■Think about the choices you are making to protect the golden goose. There is a difference between a strategy that maximizes financial value and one that fosters long-term resilience. If you want the latter, you should follow these practices:

−Prioritize survival and profitability over rapid growth.

−Use debt carefully, if at all.

−Reinvest most of your profits back in the business.

■Think about your business as a portfolio. Construct a portfolio that retains the spirit of innovation while still meeting the owners’ various needs, such as growth, entrepreneurialism, and security. And use a dividend policy to foster some financial independence from the family business.

■Prepare the next generation for what’s coming. Try to create children’s personal connection with the company so that they appreciate it rather than treat it as purely an investment. Recognize that there’s more than one healthy way to deal with wealth. Instead, encourage family members to find a way to mesh their attitude toward wealth with their personal values. And take actions to prevent the younger generation’s feelings of entitlement, especially by fostering an attitude of gratitude.