Compounding Family Capital
Compounding small gains into something big takes time, by definition. The financial writer Morgan Housel tells a story of the power of compounding using Warren Buffett as an example. He explains that $78 billion of Buffett’s $81 billion net worth was accumulated after his 60th birthday. Housel’s point is simple: Buffett’s success comes from his early base (he started young) of capital and extraordinarily long run (and kept going) even more than his investing skill.
The same math can be applied to family businesses, but not only in a financial sense. In a recent family meeting, a new addition to the family via marriage asked, “Where are the big topics on our meeting agenda? Seems a little fluffy.”
In some ways, he was right. The family wasn’t making big capital allocation decisions that day or deciding who was going to be the next CEO. But he was also missing the point. The family spent the meeting learning about each other, learning how to communicate better with one another, and deciding together how to donate relatively small sums of money in the local community. They were working together and engaging in the family enterprise while the stakes were low.
The gains earned from this family meeting may feel negligible, but they will compound on the work from the last meeting – and the next meeting will build on this one. Over time, the collective experiences the family goes through at these meetings will make them stronger. They will be able to take on harder and harder topics. They will know how to work together to move the enterprise forward. Just like it takes time and consistency at the gym to build muscle, the output of these family meetings is hard to measure in the moment but is invaluable over time. That’s really what the family was doing; building muscles they will need in the future.
The most important muscle they are building is engagement. Family businesses can be destroyed by traditional means such as too much debt or product obsolescence, and there plenty of ways to build financial and strategic resilience into a business. But failure to due to disengaged family owners is a company killer unique to family businesses.
Disengagement is especially dangerous because it exudes exponential power. In a family business with 30 individual owners, it just takes one disengaged family member to blow the whole thing up with accusations, distractions, and even litigation. Sometimes families try to encourage engagement by issuing dividends to dissatisfied shareholders. When that is the only solution, it is often too late. Money may quell things for a while, but money is not a long-term solution. It usually just leads to demands for more money.
The first step to engaged owners is simply to start the process. The best time to plant a tree was 50 years ago. The next best time is today. Charlie Munger frequently uses a mental model called inversion, which helps him think about how to avoid a negative outcome as opposed to how to achieve a positive one. It is a helpful framework in this case. Inversion would have a family ask: “How do we avoid disengagement?” as opposed to asking, “How do we ensure engagement?”.
Avoiding disengagement will look different for different families, but there are commonalities across families that do it well. Sharing information is critical. It is hard to care about something that you don’t know about. Clarity on roles also helps. Family members want to know how they fit in and what is expected of them. Speaking of expectations, there must be some. A free ride does not engender engagement. Whether it is making owner-level decisions or attending a family meeting, a mutual commitment drives engagement. And finally, this all works best when the broader family is involved in designing how engagement works. We are all more likely to buy into something we had a hand in building.
Preventing disengagement of family owners should be at the top of every family’s risk matrix. But there’s a catch. Engagement takes time. It takes effort. But it is possible, and it compounds.