Family businesses often outperform their counterparts in terms of growth, but only 30% survive the transition from first to second-generation ownership. Do you manage a family business? Are you following the best financial strategy?
While a high growth rate may stem from a more cautious approach to risk, your decisions around investments – and when to cash out, can contribute to friction among family members.
As family business accountants, we understand that handling profits is a significant source of tension. While some may favor reinvesting for future growth, others may prefer a more frequent share in profits.
Understanding both perspectives not only maintains harmony but secures a healthy growth strategy.
Differing Financial Goals
Different family members have varying financial priorities. Our CPAs find that generations managing inherited wealth may be more inclined to take risks and make less considered financial decisions.
Reinvesting profits has clear advantages, such as increasing resilience during economic downturns. However, the benefits of reinvestment take time to materialize, which can frustrate family members seeking quicker returns. On the other hand, dividends provide immediate financial rewards that boost morale. But excessive payouts can hinder growth in the long term.
Striking the right balance between reinvesting profits and distributing dividends – or, getting your reinvestment rate right – is key to success.
A healthy reinvestment rate typically falls between 75% and 90%. This ensures enough capital to support long-term growth while still allowing owners to enjoy some of the wealth generated.
Financial Best Practices
While some family businesses don’t survive, many are thriving. We’ve found that the most successful family businesses often have the following in common:
- They implement a transparent financial plan. Establishing clear financial policies, including dividend payout schedules and capital reserve goals helps to manage expectations and facilitate conflict resolution.
- They take a long-term stance on investment. Prioritizing long-term growth over short-term profits positions you for sustainable success.
- They take a conservative approach to financial management. Carefully managing debt and maintaining lower leverage ratios allows you to weather economic crises more effectively.
- They ensure everyone has a voice. Involving family members in the financial strategy early on reduces resistance and encourages collaboration.
- They are in sync when it comes to decision-making. Using centralized but flexible decision-making processes allows you to act quickly when needed.
- They regularly review the reinvestment rate. This is essential to maintaining balance as family dynamics and business needs evolve.
Ensuring Transparency
Transparency is the foundation of effective financial decision-making in family businesses. It reduces misunderstandings and ensures decisions are based on facts, not assumptions. To foster a culture of transparency and keep everyone on the same page, consider the following:
- Release financial results regularly. Providing access to up-to-date financial information helps family members understand key decisions, such as the timing of dividend payouts or delays in challenging times.
- Adopt reliable accounting software. Using cloud-based tools like NetSuite or QuickBooks ensures real-time access to financial data. These tools also help automate protocols, creating an organized, open financial environment that aligns with everyone’s expectations.
- Partner with independent experts. Engaging CPAs or business integrators provides an impartial perspective, ensuring fairness and transparency while guiding the business in making balanced, informed decisions.
At Fusion, our CPAs specialize in family business accounting. From managing financial goals to ensuring operational efficiency, our team can help you implement processes to achieve success. Contact us today!
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This blog article is not intended to be the rendering of legal, accounting, tax advice, or other professional services. We base articles on current or proposed tax rules at the time of writing and do not update older posts for tax rule changes. We expressly disclaim all liability regarding actions taken or not taken based on the contents of this blog. The same applies to the use or interpretation of this information. Information provided on this website is not all-inclusive and such information should not be relied upon as being all-inclusive.
