A lot has been written about the generational differences between baby boomers and members of younger generations like Generations X, Y, and Z. Not surprisingly, members of each generation tend to look at the world differently and think about things in different ways.
This includes their approach to managing a family business. Unfortunately, these varying mindsets can sometimes threaten the continuity of a family business.
Different Generations, Different Mindsets
Many baby boomer family business owners—let’s call them Generation 1, or G1—have had the mindset of reinvesting most, if not all, of the company’s profits back into the business. Their thinking tends to be that it’s more important to reinvest profits for growth than it is to take profits out of the business to support their lifestyle.
This has been a successful strategy for many family businesses that have grown exponentially over the years. By leaving profits in the business to fund growth initiatives and living modest lifestyles, many of these owners are in a position to pass on highly successful and profitable businesses to the next generation.
Problems sometimes occur when members of Generation 2, or G2, take over a successful family business. For years, they have watched their parents put most of the company profits back into the business instead of taking out dividends to support a more lavish lifestyle.
Of course, they’re thankful that their parents have built a thriving, successful business to pass on to them. But they also want to enjoy some of the fruits of their labor by taking some money out of the business to support a lifestyle that, while not necessarily lavish, might be a little bit more expensive than the one their parents lived.
Facing this dilemma, some members of G2 decide that the only way they can monetize their business interest is to sell the family business. And this is certainly a viable monetization strategy: They could end up with millions of dollars of “walking away” money after the transaction is complete.
But at what cost? This strategy may effectively end the family business that might have been in the family for decades. More often than not, the G2 owners who sell the business end up with some degree of seller’s remorse.
A Better Way
Many G2 family business owners don’t realize that they don’t have to sell the business in order to monetize their interest. Instead, they can take more of the profits out of the business by paying themselves a regular dividend.
However, doing so requires a shift in mindset—from thinking like a family member or employee to thinking like a business owner or investor After all, what smart investor doesn’t expect return on his or her investment? In the same way, owners usually shouldn’t feel guilty about reaping regular dividends from the investment they’re making in their own business.
This is not dissimilar to the strategies behind growth and income stocks. Growth stocks don’t pay dividends but instead reinvest earnings back into the business to fund growth initiatives. Conversely, income stocks pay dividends to shareholders, which inhibits growth but provides regular income to shareholders who need it.
How Much Cash?
If you’re a G2 family business owner, how much cash should you take out of the business to support your lifestyle? The answer depends on your goals for the future of the company.
Let’s say your goal is to increase profits by 25 percent over the next five years. Based on projections, you determine that you’ll need to reinvest 80 percent of profits back into the business to achieve this goal. In this case, you could distribute 20 percent of profits as dividends.
But what if you determine that you’ll need to reinvest 100 percent of profits back into the business to achieve your profit goal? In this case, you’ll need to adjust your profit goal downward in order to take out any dividends.
Open and Honest Discussion
Family business members of both G1 and G2 should openly and honestly discuss these issues during the business succession planning process. This is the best way to avoid misunderstandings that can lead to the premature end of a family business legacy.