Liquidity problems: a successor’s nightmare

“Family businesses are constantly walking a tightrope. On one side is the need for capital to grow the family business. On the other side is a need to make family members happy via shareholder liquidity. As a family business matures, balancing the competing needs of capital and liquidity becomes a greater challenge.”

AS business matures, so does the number of shareholders.

Family businesses encounter specific problems that come along with growing and aging; not just of the business, but also of the shareholder base. Often these are liquidity problems originating from structural or incidental conflict of shareholder and business interests.

What is “liquidity”?

It is speed at which an asset may be converted to cash; being “in cash” or easily convertible to cash; debt paying ability; and distribution of dividends.

A liquidity problem in family business is a situation in which: a) one or more family business shareholders, with a significant influence in the family business, demand the business to change its policy on providing liquidity for shareholders, or b) the family business is unable to meet “outside” liquidity demands (like estate taxes) that are necessary to keep the business in the family.

The need for capital is the recurring problem of generating liquidity and dividing between growth for the firm and payouts for the family in the context of shareholder control. Family firms are reluctant to raise capital that might dilute their shareholder control. Some family firms are hesitant to take on debt. The result is a predictable cash problem that usually occurs in the Philippines and in Asia around Christmas time or Chinese New Year.

As defined in the “Family Business Liquidity” authored by M. Bruel in August 1994, liquidity in this context is not a measure of a company’s financial position, but cash or cash equivalents. The possibility for shareholders to obtain cash with the help of the company if they so desire is the liquidity flexibility.

The ability of the company to deal with financial emergencies is financial mobility. The kind of liquidity needs that arise (continuous or incidental, triggered by business performance or family affairs) will determine the kind of options that are needed and thus the nature of the problem.

There are many possible liquidity options, ranging from stock redemption plans to going public, from raising dividends to company-sponsored loan programs. Every option has a different effect on capital and control structure, so the willingness and possibilities to change those structures will determine how easily the problem can be solved.

Can an Estate Plan prevent my siblings from selling their shares to outsiders?

The estate plan can include provisions to deal with family members who wish to sell his or her shares. The board of directors (or family leader) may require the mandatory buyout of the shareholder’s interest, probably through share redemption when a triggering event occurs. In some family businesses where the majority of owners are not employed in the enterprise, an internal market of minority shareholders is established to facilitate independence and a prudent exit strategy, and there is often an annual sale/purchase event.

If a family-owned company is to endure and provide the maximum potential opportunity for future generations, it must plan for provision of both adequate shareholder liquidity and sufficient business capital. Many believe their options are limited: restrict money available to the family; sell the business; or go public.

There should be a clear blueprint (a shareholder agreement) in case of the separation (forced or by choice), retirement, disability or death of any shareholder, whether a minority or significant owner. This includes foreseeable expenditures such as taxes on the estate. In some situations, insuring for the value of the preference shares, rather than just for the tax, is a prudent option. Some people use permanent insurance policies.

The most critical step in preserving the assets of the principals is to avoid the forced sale of the company.

The departure, through whatever means, of a principal in a small, family-owned business can create sudden demands for cash to pay income taxes, family support or retirement income. Effective planning requires estimates of the family’s future needs, the means to provide for them, and the necessary liquidity to pay personal taxes. Rather than allowing financial pressures to destroy the family business, careful planning and sophisticated use of the growing collection of financial techniques can help the family retain business control and make wise choices among many available alternatives.

Three days to go before the Family Business Workshop in Cebu! Prof. Enrique Soriano is an ASEAN Family Business Coach, book author and Marketing Cluster Chair of the Ateneo Graduate School of Business. He will be conducting a one-day workshop, “Securing the Future of Your Family Business”, on April 24 in Cebu and April 30 in Makati at the AIM Conference Center. These workshops are organized by Octopus Strategic Branding and Family Business Asia. For inquiries, please contact the organizer, John 0947-5070869 (Makati) and Prof. Danny Wong at +639178900063 (Cebu) for details. Slots are very limited.

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