Yet, we walked away from reading the article with a nagging sense that perhaps the most challenging part of capital budgeting for family businesses is not deciding “how” to decide so much as deciding “what” to decide. In other words, what types of capital projects should be going into your capital budgeting funnel? For example, before deciding whether to lease or build a new distribution facility, family business directors must first – whether explicitly or implicitly – decide that enhancing distribution is a more appropriate use of family capital than acquiring a competitor, or investing in research & development, or securing supply, or any of a host of other potential decisions having varying degrees of difficulty.
It is at this level of “meta” capital budgeting that we suspect family business directors could benefit from the decision classification scheme outlined by the authors of the HBR article. The “easy” capital budgeting decisions entail less risk, but also promise less return. Multi-generational business transformation arises from making “hard” capital budgeting decisions. What is the appropriate mix of “easy” and “hard” capital budgeting decisions for your family business? Net present value, internal rate of return, and the other traditional capital budgeting tools are not really equipped to answer this question.
We suspect that deciding “what” to decide is yet another manifestation of what your family business “means” to your family.
In our experience, there are four basic “meanings” a family business can have for a family. Knowing what your family business “means” may be the best path toward deciding “what” to decide.
- For some families, the business exists to drive economic growth for future generations. With this forward-looking perspective usually comes a desire for higher absolute returns and a willingness to accept more risk. For these families, the ideal mix of capital budgeting decisions is likely tilted more toward the types of transformational capital budgeting decisions having low degrees of familiarity and predictability.
- Other family businesses serve as a mechanism by which to preserve the family’s capital. A prominent concern for these families is that all their economic eggs are in a single basket, so they want to build a stout fence around that basket. As a result, they will be best served by focusing on capital budgeting decisions having a high degree of familiarity and predictability.
- In contrast, other families respond to the “single basket” problem by seeking to find more baskets. The focus for these families is maximizing the harvest from the family business to enable family shareholders to store some eggs in different, uncorrelated, baskets. These families may be more willing to accept risk once an acceptable number of other baskets have been filled. Making a large volume of “easy” capital budgeting decisions that serve only to increase the size of the existing basket is not a suitable meta-capital budgeting strategy for these families.
- Finally, some families view the business principally as a source of lifestyle. The primary concern for these families is maintaining the current level of real, per capita distributions. Depending on the biological growth of the family, doing so is likely to require making some capital budgeting decisions that are either less familiar or have less predictable outcomes.
How are you and your fellow directors deciding what to decide? Is there consensus around the economic meaning of your family business to your family? Gaining consensus around the meaning of your family business can be a crucial first step to making all the strategic finance decisions you make line up with one another.