Split decision: how to deal with profits - without causing a family feud - Family Business

Entrepreneur, Sept, 1996 by Patricia Schiff Estess

YOU MIGHT SCOFF at an entrepreneur who laments that deciding what to do with profits, especially sizable ones, is his or her biggest problem. But in some family businesses, it is. That's because shareholders in a family business often see profits differently. Some see them as a return on investment; some see them as the family's gold mine; others see them as an investment in the company's future.

The contention is usually between shareholders who are active in the business and those who are not (the passive shareholders). Shareholders might be siblings who all received shares in the family's company for their birthdays, confirmations, bar mitzvahs or weddings. Now, years later, two of the siblings might have challenging jobs in the family business and two have challenging careers elsewhere. But because of mom and dad's largess, they all have stock.

"People who are active in the business are less likely to want to distribute profits," observes David Geller, president of Geller Financial Advisors Inc., a family business in Atlanta that advises other family businesses. "More often, they want to plow the money back into the company to stimulate growth." And because they are around for daily operations, they feel they should control how the money is distributed.

Passive shareholders, on the other hand, may be depending on these profits for anything from basic living expenses to financing a new car.

Much of the potential conflict lies in each member's answer to the question, What's the purpose of the family business? If they all see it the same way-as a way tO support family members, as an entity to be nurtured and kept in the family, or even as an asset to be built and sold--then the conflict is minimal.

Is it possible to develop an environment that fosters the family's shared visions for the business? Yes, say the experts. But it's essential to find ways to effectively communicate with and regularly educate passive shareholders. They should know, for example, how insiders see the value of the business increasing, what the important issues on the horizon are, why money may be tight at times (profits vs. cash flow), and what is needed to fund new growth--from working capital to money for purchasing fixed assets. These discussions help develop a sense of shared interests, values and pride among all shareholders.

Communication takes effort, says Neil Christman, president and founder of Christ Volvo in Marietta, Georgia. Although he's the company's majority stockholder, his daughters, nieces and nephews also own stock. Christman says he hasn't had much of a problem with stock dividend distribution, but he admits there could be. "Children may not be critical of the way a father operates a business, so they may not ask too many questions. But in-laws, especially sons-in-law, may feel they need to exercise their rights as the 'men of the house' and question operations."

While that might stir up some furor, in the long run, Christman feels questioning is important. "It forces you to do a better job in reporting to shareholders-something [many] small family businesses don't do too well."

SETTING GOALS

Suppose a shareholder doesn't like the direction in which the company is heading or needs a return on investment that the family stock is not providing. Tempers will flare at profit-distribution time if there is no way for the person to sell the shares, says James Lea, a communications specialist and expert on family business decision-making at the University of North Carolina in Chapel Hill. Increasing liquidity through such things as an annual redemption program or a loan program, Lea says, has a direct bearing on how shareholders view their investment and whether they are willing to wait for long-term strategies to pay off.

Creating different classifications of stock is another way to prevent passive shareholders from limiting the business's growth potential. Class A stockholders have voting rights; Class B stockholders do not. "If you have particularly restless passive shareholders, you could even provide them with preferential distribution of dividends," says Geller. Passive shareholders would get the first dividends up to a certain amount; in exchange, they'd give up some of their equity should the stock be sold later.

Another way to increase inactive shareholders' participation in the company is to ask them to join the board of directors, suggests Lea. Even if they have no official voting power because they are Class B shareholders, they'll develop a better understanding of the business. In addition, many companies pay board members for carrying out their responsibilities--another way to distribute money to inactive family members.

"In the final analysis, if the business can afford it. it should Drovide at least a modest dividend [1.5 percent to 2.5 percent] to all its shareholders," says Geller. His rationale is simple: It doesn't look as if the active shareholders are trying to squeeze out the inactive ones. It also allows inactive family members to share in the benefits of the business without having to sell their shares. And it builds family harmony.