Family Business Quarterly
by Michael Winter and Josh Gold
Relinquishing control of the family business that the owner has spent a lifetime building is both a complicated and painful affair. Part of what makes it difficult is deciding what to do with the proceeds from cashing out.
The principal of a family business typically has had the majority of his or her personal net worth invested in the company for many years. This individual hasn’t had either the time or the inclination to become well versed in the public financial markets.
Yet senior members of family businesses are often thrust into the position of having to provide both income and future financial security for themselves and their spouses. Ensuring personal financial security as the business is either passed to the next generation or transferred to outside sources demands thorough attention and due diligence, even for someone experienced in the ways of the public markets.
Senior family members should address personal financial planning issues as soon as possible after deciding to retire or sell the company. Choosing a succession plan and deciding how to divest from the company is the first step to personal financial independence.
Focus on Safety
Once the individual receives the proceeds of a stock sale or divestiture, new decisions are required. The financial markets, both fixed income and equity, provide a safe and diverse avenue for investors to garner income and realize significant capital appreciation, if used appropriately.
The family business executive’s choice of vehicles should be linked primarily to income needs, risk tolerance, and time frame (age). Individuals must determine their goals and lifestyle demands based on both present and future expectations.
In our experience, safety is the key concern in launching the investment process. Once a business owner relinquishes control of the company and attains self-sufficiency, he or she must be assured of a sufficient income while remaining confident that the money is being managed with a primary focus on capital preservation. The best way to ensure capital preservation is to focus on diversification.
The Best Portfolio
Carrying out an investment policy of diversification is easier said than done. Asset allocation is key. Determining proper asset allocation is essential when future financial considerations must be addressed and current financial demands must be met.
In our experience, a diversified fixed income portfolio consisting of both U.S. Treasury obligations and tax free municipal bonds, with a laddered approach throughout several maturity periods, provide a safe yet competitive avenue for portfolios requiring predictable income. Other vehicles that we employ are somewhat more speculative–international bond closed-end funds, preferred stocks, and investment grade corporate bonds.
The equity market should also be considered by individuals seeking a comprehensive investment portfolio. As witnessed over the last year, equities can provide tremendous returns. The key to successful equity investing, which performs well through generations, is diversity. The focus should be placed on blue chip stocks, particularly issues included in the Dow Jones Industrial Average and the Standard & Poor’s 500 index. We believe buying blue-chip growth stocks makes the most sense in the current market environment. With price-to-earnings ratios at seemingly high levels, growth stocks actually remain relatively inexpensive. By delivering consistently superior earnings, growth stocks will perform particularly well in an environment of decelerating earnings and lower interest rate movements.
The public markets aren’t the only appropriate real estate investment, of course. Other appropriately structured investments such as real estate and insurance also should be factored into the final equation, based on advice from professionals in their respective fields.
When the amount of money at stake essentially amounts to one’s life savings, professional assistance is advisable. The advice needn’t come from one individual.
The first step is to find someone you trust–ideally someone like a financial planner–to get you started in designing and plotting a path for determining investment objectives. For individuals with little investment experience, a financial planner or mutual fund company, with opportunities in a wide breadth of investment vehicles, is usually a good fit. For more seasoned individuals, the use of a money management firm and/or a brokerage firm can suffice, provided the individual wants to be actively involved in the decision-making process.
Aside from trust, a key consideration is matching the advice with your overall needs and objectives. Recently, a client of ours sold a family business to a large corporation for both cash and restricted stock. This individual required both income to support a pair of families and capital appreciation to secure a comfortable future for the younger generations. We suggested they meet with several municipal bond managers, who have demonstrated superior five-year track records, to secure a steady tax-free income stream. The family also met with several equity growth managers to plan a long-term portfolio through various trust accounts. The process worked, in large measure because we provided enough time for the client to meet a variety of money management professionals so as to obtain the right fit of both investment styles and personalities.
In conclusion, family members must realize that the financial security and comfort level that comes with control of your own business diminishes when one becomes dependent on outside sources of income. We suggest becoming familiar with terms, risks and instruments used commonly among the investment community. That way, you become an educated consumer focused on making successful investment decisions.
Michael Winter is a managing director and Josh Gold an account executiveat Bear Stearns.