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Addressing Issues of Family Businesses and Financial Advisory

By Rajiv Khaitan and Rohan Poddar

According to the Credit Suisse Research Institute’s (CSRI) latest “CS Family 1000” report, “Indian family-owned businesses appear to be more optimistic with regard to future revenue growth and have a slightly more conservative approach to funding that growth. Challenges seen as most prominent in India include succession planning.”

With the third highest publicly-listed family-owned businesses at a staggering 108, India is at number three when it comes to number of such businesses and fifth in terms of market capitalisation. This number indicates the sheer scale and importance of family owned businesses in our country. As several reports indicate that our country is entering yet another growth phase trajectory post demonetisation, it is imperative at this juncture to understand how a typical family owned business could benefit from tailor made financial advisory.

Appropriate Financial Advisory for Family Business

Family Businesses have peculiar requirements from Financial and wealth management advisory as their criteria for investment, asset allocation and management is quite different from other forms of business.

An entrepreneur and his family are individuals first with their own assets and annual income flows and their personal requirements for personal expenses, which needs to be optimized according to the principles of asset allocation and management and relevant financial advice is required to ensure on the one hand that income streaming from family business flows to the family appropriately as per their needs. On the other hand, the source of the income flows is inextricably linked to the management of the company and the needs for growth of the business and a major part of the promoter’s wealth is locked-in or required to be deployed back in the company itself.

These attributes raise problems of optimizing the promoter’s wealth and liquidity based on the personal needs as well as the needs of the Business. A streamlined and regular access to capital to help grow and evolve the business and ensure flow of wealth to the family for consumption.

Stages of Family Business and Effective Strategies

Family business needs appropriate legal and financial advisory depending on the stage of evolution of the business. Businesses having a market capitalisation of more than INR 1000 billion would be required to focus on strategies to protect the family estate and deploy resource fairly amongst various businesses managed by different family members as well as have an eye on the succession plan. Similarly, for a business which is at a medium scale, the focus of the promoter should be on creating support systems to leverage the existing wealth to create newer businesses and multiply the wealth.

While doing this, adequate caution must be exercised so that the existing wealth is not depleted. For smaller scale businesses, however, where the risk exposure is high, the role should be to find ways to incentivise to do more business for generation of more disposable income. In this case, most of the assets are locked initially which are employed to generate returns. Cash and credit management would be the key for the young, affluent new age entrepreneurs as they are comfortable spending considerable amount of money.

Family Businesses should look at structuring their finances in a manner such that individuals do not have to rely solely on their personal assets to run their day to day affairs. Most of these business owners’ wealth is heavily concentrated as part of the company’s wealth and there is little focus on management of the illiquid wealth and risk that they possess.

But the needs and prospects of every business and the needs and ambitions of every family is different and hence each family is required to develop its own strategies which is best suited for the family. Since, sizeable portion of family assets are tied up in running the company, it is incumbent on part of the business families to examine how corporate finance and corporate financial advisory services are integrated within the overall personalized financial management.

Multi-Disciplinary Approach

For any family business, it is necessary to address the concerns that affects their personal or family profiles of the various members from the perspectives of optimisation of the tax portfolios, strategic planning and allocation of the wealth derived from corporate assets as well as deal with succession planning initiatives as well as the transition of the leadership role to lead the family business of the company or group over time.

On the investment management front, the principles of allocation of the available wealth and income of the family needs to ensure fair distribution of the wealth amongst the family members and this requires expertise in finding the right balance between interests and ambitions of various family members and risk-reward combinations compatible to the risk profile of the family.

All the above complexities require advisors having experience of dealing with such complexities and having domain knowledge in setting up holding and governing structures which facilitate balanced growth of all businesses and equitable sharing amongst family members. Today, there is an increased interplay and co-existence between financial, tax and legal matters. It is vital to approach consultants who can advise a holistic plan to best suit the family, engineer investment, tax and estate planning strategies that considers both investment and business income sources and their legal, financial and tax implications. It becomes almost obligatory and necessary on part of the promoter to seek appropriate legal advice to steer clear of tax and regulatory hurdles.

The IBM Institute for Business Value analysis, PSI Global data and Putnam Lovell Research data shows that apart from the general financial advisory, “firms should also consider other types of customer characteristics such as behavioural or attitudinal characteristics as they create their own wealth management strategy.”

Rajiv Khaitan is Partner and Rohan Poddar, Associate, at Khaitan & Co.

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