Crafting dividend policies early can avoid conflict

ONE of the most important aspects of any business continuity planning is to have pre-agreed rules on to how to deal with predictable issues, particularly control and ownership of the business, before they come up. In many family firms, the lack of a dividend policy is a serious omission at best, and a recipe for shareholder relations disaster.

Conflict in a family business stems from how best to recognize and reward family members for their efforts. By the second or third generation, not every family member will work in the family business. Some have higher financial needs than others. For some, their personal lives are too dependent on some form of family business rewards.

In a Business Spectator article written by Dominic Pelligana, he resonates, “All too often families seek to aggregate remuneration and keep it equal, particularly in the second generation. The next generation wants certainty of amount and level of financial independence. The senior generation does not want to create expectations or create incentives to the next generation’s ‘entitled lifestyle’.”

A suggested solution is to have a form of pre-determined compensation model. Others refer to the model as a pre-agreed dividend policy.

Paying dividends will discourage family members from trying to join the family business for the wrong reasons. Policies should define criteria for dividend distributions, such as linking them to profitability levels, to keep potential competition among family factions from harming the business.

Rather than being a source of conflict, a reasonable dividend policy can reinforce a family’s values and goals for the business.

Pelligana further opines, “The reality is that individuals are equal as family members but may not be equal in terms of position in the company. So in order to promote transparency and fair process, best practice suggests that we separate these roles, as well as the remuneration.”

All too often, senior generation leaders mix and match payouts and, in the process, confuse family members.

The article further cites clear examples on classifying the different forms of remuneration. Below is a handy reference guide for family business leaders:

Managers – market value remuneration and, where appropriate, bonuses for exceeding goals

Directors – a set amount per meeting and effort

Shareholders – an annual dividend based on ownership interests

By doing it this way, family members are clear on what they are being remunerated for.

So what is a dividend policy?

At its simplest, a dividend reflects the portion of earnings that is not reinvested in a business in a given year, but paid out to owners in the form of current returns. It is the decision to pay out earnings versus retaining and reinvesting them. It includes the following elements:

1. Form of Payout? High or low?

2. Stable or irregular dividends?

3. How frequent?

4. Do we announce the policy?

Setting dividend policy in the family business

Family business practices for dividends or distributions range broadly. In my coaching work in the ASEAN region, I have encountered many family businesses that simply do not have policies for dividend payments. Others distribute all available cash. And for some, they have a pre-determined value at the onset making releases predictable so family members can forecast their family cash flow for the year. There is really no “rule of thumb” to speak of. Ultimately, it all boils down to the financial health of the business.

So what’s a desirable dividend sharing?

What’s right for your family business depends on many factors.

Securing cash and extracting it out of the business in a tax-efficient manner is a function of your accountant and finance people managing the cash flow affairs of the business. But first, cash must be available for distribution. To set a dividend policy, there must be a relatively consistent, level of cash flow.

Once the availability of cash is determined, the question of what to do with that cash arises. Should the money be reinvested in the business? Should it be allocated to make family members/shareholders happy. Is it the CEO/family members’ carrot to shareholders so he/she can stay in the job as head of the family business?

So what is really the formula for dividend payout? During family business conferences where I am invited to share my insights about dividend policies, I am always incessantly bombarded with questions after questions asking me or pleading for a “perfect” dividend model.

Part 2 will cover the best practices in creating a dividend policy.

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