Besides helping family members bond as a business family, a clear definition of purpose will also help you make concrete choices about, and see the trade-offs in, how and where to create value. We call these choices owner goals.
Owners must balance their goals when deciding how fast to grow, how much liquidity to take out of the company, and how much control to retain. If you take money from the company’s profits and distribute it, less is available to invest in growth. If you maintain control by avoiding outside debt or equity, you have less money available either to invest in growth or to provide liquidity to the owners.
Owners might pursue only one of these three goals (growth, liquidity, and control) or some mix of the three. There are trade-offs to all the combinations. In the Owner Strategy triangle depicted above in figure 5-1, we have found that most family businesses prioritize a two-goal approach (the circled goals) at the expense of the remaining goal. Which of these three dual choices best describes the goals of your family business? Let’s look at them in detail.
Growth and Control
If you value growth and control, you primarily grow through retained earnings, paying low (or no) dividends. You also have low (or no) external equity or debt, since answering either to outside investors or to borrowers requires surrendering some autonomy. When outside equity is taken on, it is often done on a limited basis or through dual-class shares to ensure that the initial owners maintain control.
The owners of a company we know in the construction industry in Asia reinvest the vast majority of their profits back into the company every year, growing through retained earnings. They pay minimal distributions beyond what is required for taxes and have little debt. This approach works for these owners, as they live relatively modestly and want the business to continue on its current path. The board—and especially the nonfamily directors—have sometimes pushed the owners to lever up the company and acquire other businesses in their sector. The owners have been willing to do that to some minimal degree, but they don’t want to lose control by being beholden to banks. They’re quite happy to limit growth to a level at which they retain control. “Slower and steadier” is their motto.
Growth and Liquidity
If you value growth and liquidity, you are still focused on expanding but also on paying out money to the owners. You use other people’s money (equity or debt or both) to keep the engine going, giving up some control as a result.
We worked with a business in the fuel industry in Latin America. Ever since its founding almost fifty years ago, the business had grown by reinvesting the majority of its profits into new facilities and stations (the growth-and-control strategy). The owners continued to see much growth potential but were concerned about the long-term threat of disruption in their industry by emission regulations, electric cars, and ride services like Uber. Recently they decided to sell 30 percent of their company to an outside investor. Beyond gaining the benefits of the partner’s expertise, a primary rationale for this move was to take some money off the table to reinvest outside the company. To accomplish these goals of growth and liquidity, the owners sacrificed some control by bringing an outsider into their close-knit family. They have had to contend with a new reality in which their decisions are constrained by the rights they gave to the partner. But the family doesn’t regret the decision, because it agrees that growth and liquidity are the priorities.
Liquidity and Control
If you value liquidity and control, you are not as concerned with how rapidly you grow. Instead, you want to produce significant liquidity while maintaining control over decision-making. You probably have moderate to high dividends, low to no debt, and relatively low capital expenditures. A good example of prioritizing liquidity and control is a family-owned surfing business. Three sisters started the business together as a passion project several decades ago. Growing the business had never been a priority for them. Instead, they have long prioritized a culture of innovation – and the financial success that allowed them to enjoy the fruits of their labor. This is an example of “liquidity and control”.
We know highly successful family businesses that define their goals in each of these three ways. These are broad strategies, and companies can find a space in between. In defining your goals, you need to understand what you explicitly or implicitly value as owners. Though purpose will remain your high-level statement of intent, revisit how you achieve that purpose through these trade-offs as things change because of external factors like the economy, industry consolidation, and government policies or internal factors like a generational transition, family conflict, and a transition in senior management.
To start refining your owner goals, look at your previous decisions as an owner group. Which of the three approaches best describes how you have acted: growth and control, growth and liquidity, or liquidity and control? Embedded in the decisions that you have made is your current Owner Strategy, which may provide insights into whether you want to change your goals.
Each of the three approaches brings its own issues to be managed. You should make sure that these issues find a place on the agenda in the appropriate room:
- The owners of growth-control companies need to manage the expectations of family members about distributions, since the distributions can only be paid at a level that does not deprive the business of growth capital. We have also seen that these companies often fail to make good use of the owners’ equity. Since most, or all, of the profits are retained in the business, some management teams will pursue new projects simply because capital is available, not because the ventures are a great investment.
- The owners of growth-liquidity companies need to manage the extent to which they are losing control of decision-making to equity partners or lenders. They can do that by paying careful attention to loan and deal terms and by designing governance structures to maximize the owners’ remaining influence.
- The owners of liquidity-control companies need to manage the firm’s rate of growth. If growth is too fast, it will require additional investment, which may not be available, to maintain its pace. If it is too slow, the business’s momentum will be undermined, employees might leave, and the company’s competitive position may erode.
*Adapted from the Harvard Business Review Family Business Handbook by Josh Baron and Rob Lachenauer. Pages 84-88.
Summary: Family business owners have the right to choose what value they want their business to provide. They can choose between growth, liquidity, and control, but they can’t choose to have all three. Family owner must make trade-offs to prioritize the options that most align with their values and what they want from the business.