Family businesses tend to be conservatively run, and it is not uncommon for them to accumulate excess working capital over time. We often see that excess accumulate in the form of cash and a portfolio of marketable securities that sit on the company’s balance sheet.
The Problems with Excess Cash in Family Businesses
There are two potential problems with this scenario. First, the excess capital becomes a balance sheet asset that is subject to general creditor exposure. A second unintended consequence is getting too comfortable with the cash. Companies with ample amounts of cash often don’t feel the need to give themselves stretch growth and innovation goals, which can lead to a lower competitive advantage over time.
Another alternative is to simply distribute excess cash directly to shareholders. While there are pros and cons to this approach, the biggest con is that once the cash is distributed, it may not be accessible again.
Setting Up a Family Investment Company
One solution that I have seen work very well, particularly with multi-generational family businesses, is to set up a family investment company which holds and invests the excess working capital of the operating business.
Creating a family investment company can be fairly easy to do, particularly when the business is already structured with a holding company sitting atop the operating business. If there is not a holding company already in place, it may be worth considering a restructure to create one.
These liquid assets can be transferred from the operating company to the investment entity, which achieves several objectives:
- Moves some liquidity away from the operating company’s general creditors
- Forces the operating company to be disciplined and strategic about replenishing the excess cash
- Allows the family to set up parameters for how to deploy the liquidity, creating opportunities for the next generation to be involved in the business’s affairs
There are some additional benefits. First, if cash is needed for the operating company, it is still accessible from the family investment company. Plus, the entity can serve as a family bank that lends to family members to buy a home, further their education, or even start a new business.
Next Steps if Your Company is Considering a Family Investment Structure
If you find you are being tempted to invest your business’s excess cash in marketable securities, now might be the time to consider a family investment structure. If you have any questions about this approach or would like to discuss next steps for this structure, please check out our Family-Owed Business Services or contact us.