How a Dividend Policy Helps Ensure Family Business Harmony

A sound dividend policy is an essential part of the governance structure of any business.

But like many situations in a family business, when you add family to the mix, things can get emotional and complicated. This can make it tempting to skip developing policies like these.

Yet…the truth is that you can create more family harmony by creating a dividend policy.

While you may not relish the thought of developing one, having a clearly articulated dividend policy in place helps avoid turmoil, confusion, and misaligned expectations among shareholders and family members.

In this article, we’re going to look at:

  • What is a dividend policy?
  • The key elements of a dividend policy.
  • How your dividend policy can promote family harmony.
  • Key questions to answer when developing your dividend policy.

Let’s dive in.

What is a dividend policy?

A dividend policy is simply a document that outlines your family’s philosophy around distributing a portion of profits to company shareholders.

This includes both the method by which distributions are shared, and according to what schedule or under what specific circumstances.

While a dividend policy generally isn’t a legal document, it does provide essential guidance to family business leaders, while also allowing for the flexibility of human judgment in cases like dramatic market fluctuations, changing business priorities, or increased investment in capital projects.

The word “policy” strikes fear into the hearts of some business owners, but a dividend policy doesn’t have to be complex or lengthy.

In fact, the simpler it is, the more useful it’s likely to be.

Key elements of a dividend policy

A clear and successful dividend policy will include the following elements:

Your family’s overarching dividend philosophy

What do you collectively believe about who should benefit from the company’s success?

Defining your philosophy is something you can undertake at an annual family meeting.

As family business advisors, we recommend that you sum up your philosophy in just a couple of sentences.

Dividend timing

Will dividends be paid quarterly? Annually? At other regular intervals based on business performance?

There’s no one correct way to time your distributions, but everyone involved needs to be clear on what to expect.

Dividend method

How will your family business issue dividends?

You can choose from paying a constant amount, paying a percentage of cash flow or net income, paying an amount based on the most common tax rate, or paying based on another specific metric that you develop.

How does a dividend policy promote harmony in a family business?

Where there is confusion, it’s hard to find harmony.

The same is true for unspoken competing interests.

That’s the chief benefit of a dividend policy: limiting confusion and making your overall position clear.

With a dividend policy in place, all business and family leaders should be clear on the process for making cash distributions – including their timing and their method of distribution.

Many family businesses feature several different family members – and multiple generations – both involved directly in the business and benefiting from its success.

And most of the time, each of those family members brings to the mix their unique viewpoint about how and when distributions should be made.

In addition, each shareholder has different needs and interests, and such a policy provides clarity to everyone.

Key questions to answer when developing your dividend policy

How will you allocate profits?

Your dividend policy helps define how you will prioritize spending your family business’ profits.

Will you first pay bonuses or other incentives to your employees?

Will you reinvest in your business – maybe in technology upgrades, new ventures, or debt service?

And, finally, will you pay distributions to company owners?

These are the three major ways you can allocate your company’s profits.

How will your dividend policy impact your family business culture?

It’s important for your leadership to consider how your dividend policy both reflects and influences your culture.

When making decisions about your policy, you’ll need to balance the needs of the business with the needs of shareholders.

Prioritizing distributions to company owners over incentives to employees and investing in the business can have profound influence over your culture.

If, for example, you tell your employees that they are your greatest asset, your dividend policy should reflect this.

How will your dividend policy affect your family business finances?

Your dividends represent a cash distribution, so a key question is whether your business’ annual budgeting process calculates cash flow and balance sheet leverage, in addition to profits and losses.

Your leadership should address the question of whether there is consensus on the prudent amount of liquidity you’re committed to maintaining – based on your specific business and your industry’s economic volatility.

You should also factor in additional risks such as litigation.

Consider also:

  • Does company management annually assess the remaining useful life of all critical capital assets needed to sustain and/or improve business revenue at a reasonable cost?
  • Do you routinely develop a forward forecast for two to five years, and does it include all calculations we’ve mentioned above?
  • Does your management team follow a documented policy – issued by your board of directors or shareholders’ group – that specifies a minimum return on equity and return on assets?
  • Does it also specify the maximum debt-to-equity ratio that must be achieved before any dividend distribution may be approved?

These questions are sometimes tough to answer – but you’re wise to insist that your family business only pays dividends when the answers to these important questions reflect the sound financial health of your organization.

Developing a sound dividend policy is crucial for family businesses, not just for financial reasons but also for ensuring family harmony.

A well-articulated dividend policy acts as a guiding document for profit distribution among shareholders.

It addresses key aspects like the family’s dividend philosophy, timing, and method of distribution, helping to avoid confusion and misaligned expectations.

Such a policy is especially helpful in family businesses where emotional and complicated dynamics can play a significant role.

Your dividend policy reflects and influences your business culture and finances, posing critical questions about profit allocation, culture impact, and financial health.

Understanding these elements can be challenging, but is essential for the stability and success of a family business.

If you’d like to create a harmonious and financially sound environment in your family business, booking a call with an advisor could be a valuable next step. An advisor can provide tailored guidance to develop a dividend policy that suits your unique family and business needs, ensuring clarity, fairness, and success for all involved.

If you’d like some support, we invite you to reach out today to set up a consultation with one of our family business advisors: Book a Call

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