Let’s talk spending; specifically distribution policies.

I have noticed that distribution policies are the battle line of family wealth strategy. To whatever degree that cash flow is reinvested in historical family investments, most commonly the family business, the decision is always seen as sound.

This is the root discipline of financially successful families (foreshadowing warning!)

Multiple activities converged this month to make distribution policies top-of-mind for me. It started with my work on the Family Bank; I’m excited that in the near future Daniel Trimarchi and I will have a STEP Journal article on the topic published.

The Family Bank establishes a formal distribution policy for families that desire governance discipline for their investment decisions in their human and relational capital pools. Going from an informal ad-hoc “bank of mum and dad” to a formal Family Bank is my favourite governance tactic as it combines family values, family goals, policy/procedure and strategy all towards my favourite aim; family flourishing.

Here are my Family Bank articles for Canadian Family Offices.

Another recent distribution task: I was asked about ownership strategy and how it relates to family wealth strategy. Family wealth strategy covers spending at all levels of the family enterprise. Ownership strategy is the shareholders of the holding company that must balance the business’ capital reinvestment strategy with dividends.

All owners are wealth stewards but not all wealth stewards are owners.

Once the complication of reinvestment versus dividends is settled, the use of the dividends requires some consensus: what is the budget for family-centric spending from the dividends? How will the family spend on matters like family retreat and shared property expenses before the owners receive money for their independent spending plans.

Lastly, a podcast interview of John Warwick included a story of a family with a remarkable distribution strategy: none! Over three generations, not a single dividend had been paid from this real estate family. Everyone lived within the means that their employment could support… and the cash flow of the business was entirely reinvested for decades!

The role modelling that each successive generation of this family showed within their stewardship is certainly admirable. Although I would not recommend it to any families myself, at least now I had a perfect example for an important metaphor in distribution policy:

The oak tree metaphor: when families focus on building the strongest of trees with the deepest of roots.

I love using trees as metaphors in distribution policy design, going back to the beginning of my trust law courses from law school.

In trust law, there is a distinction between income and capital beneficiaries. When we explain the difference, we use the “fruit and tree” analogy: income beneficiaries receive the fruit of the trust’s property and capital beneficiaries are entitled to cut down parts (or all) of the tree.

That real estate family with no distributions? They represent the deepest of roots. They invest in whatever it takes to make that tree stronger and stronger. They do not even have to consider seeds at this point; they are entirely focused on one big tree. Certainly no fruit!

But what happens when, despite the strength of that tree and it’s roots, it comes falling down? Where is the family then? There are always tradeoffs in family wealth strategy.

Families that diversify and invest in multiple areas address this risk by caring about populating the future of the family with new seeds. This diversification is valuable to the family long-term. Innovation (which begets family enterprise resilience) arises from the highs and lows of investing in new ideas. This carries more risk in the short term but as noted by Nassim Taleb, an anti-fragile goal requires these exposures to risks to grow stronger long-term.

Taking the tree metaphor to it’s anti-fragile extreme, a family might make their distribution policy metaphor to be that of a dandelion! They invest entirely in the distribution of the seeds and don’t set roots down anywhere. Now, that would be some chaotic capital investment strategy indeed!

I’m still waiting to hear of the family deploying the dandelion metaphor in their distribution policy; please let me know if you’ve heard of one marvellous Reader!