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A fish-and-chip shop or an ASX-listed giant - businesses owned by families span the economy. They are often innovative but must look outside their expertise to grow. For Robyn Langsford, who is a partner ... A fish-and-chip shop or an ASX-listed giant - businesses owned by families span the economy. They are often innovative but must look outside their expertise to grow. For Robyn Langsford, who is a partner in KPMG's family business enterprise division, most of her family-business clients operate in property, construction, retail and hospitality. Many of them are from Western Sydney, including Parramatta and Penrith where KPMG keeps offices. The firm traditionally offered them accounting and tax services, before moving into an advisory role in recent years. "Businesses typically come to Big Four when they are looking for finance from the banks and need an audit, have a complex tax problem, or are looking to expand overseas in a multi-jurisdiction market and need someone with an international network," she says. "Interestingly, when businesses come to us with their primary concerns, they are not necessarily what they actually need." Langsford says, the trigger for them is usually a particular piece of regulatory action, like the Australian Taxation Office's expansion of its scrutiny on private groups from the top 500 to the top 5000. "When we look at their business, we often find that the smaller accountants have been unable to keep up with all the legislative changes at an ATO level and often a number of tax risks are identified." Among common findings are outdated back-office systems, with little heed to cyber risks. "It's not uncommon, for family businesses that may have grown through acquisition for example, to have a whole mix of IT systems and inefficiency in procedures." she says. "By the time you get to a certain level of revenue, you really need to be taking investment in technology quite seriously, and often these businesses also haven't looked at cyber risk properly." Skill and governance A 2008 survey from Family Business Australia found only one in three family businesses had a formal board structure. When it came to succession planning for the chief executive role, only one in five had a plan. On the family level, 28% had a family council [turn to pg. 16 on how the Hammon family does this] while 12% had a family constitution. "The reason to bring in external talent ranges widely," Langsford says. "Whether there's a more formal board governance aspect to it, where you get external directors onto your family board to bring you extra insights and knowledge. Or we see businesses growing to a point where they need to engage somebody like a non-family chief executive officer." Businesses may not cede key positions until they look to list via an Initial Public Offering. On the other side of the table, working in a family-owned business can be tricky for an outsider, with its deeply entrenched relationships. And so rewarding them is important for retention. "Just paying a salary is one thing. But if as a family you are willing to share some equity or a bonus scheme [with an employee] if they can then drive the business growth to a particular level, they can get the recognition the individual deserves and that can be quite successful," she says. Langsford says her clients often create a different class of shares for employees that may entitle them to proceeds on the eventual disposal of the company or dividends over a time period. Meanwhile voting rights are often kept within the company. "The family members then perceive that they retain ultimate control of the company. They're not giving away everything, but they're giving away enough that the person who's receiving the incentivised." Readying your children Some family-owned businesses involve heirs early, others ask them to complete university and work externally before coming in. How do you know your child is ready to step up in the business? HLB Mann Judd's Tom Roberts offers a handy two-point criteria: ability and credibility. "Ability means they need to be objectively capable of fulfilling the role: What type of experience do they have, what type of education, do they have the skills required," Roberts says. "Then there is credibility. You see in family businesses all the time, the heir apparent jumps to the top of the queue and that can be perceived as a free ride by others in the business." He says good succession takes years, and the current generation should make sure they help the next generation build both their capability and credibility before they are allowed to step into positions of power. Among Roberts' suggestions are making sure performance reviews of family employees are done by an outsider, and that when they make mistakes, they are dealt with via clear processes to avoid nepotism. Embrace technology Technology is not just about getting your house in order and ready to scale, it can also provide a significant edge. Roberts cites an example. One of his clients, a family-owned construction business, started tracking all their tender data which can have a lead-time of up to 12 months from when the tender is requested until the start of construction. "They started to see that the value and number of tenders was declining nearly six months before their competitors, and that allowed them to act swiftly," he says. As a result, the business was able to expand its market share during the period. "Even in the COVID environment, you will be surprised how many businesses don't have forecasts. Businesses that have the insights and visibility over their key performance metrics can take well-informed, decisive action quickly and stay ahead of the game," he says. Watch the cash High cash burn rates are often associated with newer companies. Names that spring to mind are Uber and the other investment-intensive startups. But watching the till is important for family-owned businesses too; more so because they can't fall back on another series of funding from venture capital or private equity backers. EY Oceania private clients leader Justin Howse says the biggest risk that ambitious family-owned businesses face is to ensure they enough cash both for legacy business, and the future one. "One of the biggest risks that I find is understanding that difference between profit and cash. There is a phrase profit is like food - you can live without food for three days but cash is like oxygen - you can't live without it," Howse says. He says family businesses have to be mindful to not overinvest in an opportunity to the detriment of the remainder of their business. "Make sure you've done your research on the new product that the market is ready for. Understanding production costs and supply chain costs if you are ramping up production in some area. "It can become a cash strain if the opportunity doesn't live up to your expectations, it can take the oxygen out of the remainder of your otherwise very successful business." Lastly, put it in action Everything the interviewee mention is easier listed than done. How do you make a stubborn owner consider advice outside their experience? According to Langsford the key to bending them to the business's benefit is this. "The point is selling them the dream and the vision, rather than focusing on talking about the family having limited experience," she says. "What works is rather than focusing on the potential deficiency, focusing on the vision of where they could get to."Read more

Lessons for endowments from COVID-19

KANIKA SOOD

... pandemic and accompanying volatility is forcing endowments to rethink how they invest, govern and grant. Kanika Sood reports on the latest in the sector. Sue Dahn is one of Australia's best known ... The COVID-19 pandemic and accompanying volatility is forcing endowments to rethink how they invest, govern and grant. Kanika Sood reports on the latest in the sector. Sue Dahn is one of Australia's best known financial advisers. She also wears many hats in the philanthropic world. To count a few, she advises private endowment clients at Pitcher Partners, acts as the responsible person for multiple private ancillary funds and is a director for a public ancillary fund. She also sits on their investment committees. Dahn says her endowment clients had returned about -8% in FY20 to March end. By April end, the number sat at -5%. She expected them to finish FY20 with about -2% in returns. The mayhem of last few months does not need much exposition. But to recap -- equities markets were down over 20% before rebounding strongly, credit markets faced a liquidity squeeze in March, oil futures traded in the negative territory for the first time in history in April, property and infrastructure asset values were revised down and ASX-listed companies reigned in dividends. On a panel in early July organised by Philanthropy Australia Dahn was one of the four panelists offering some pointers for endowments in future crises. Among the issues that came up were: Best policy for rebalancing investment portfolios during extreme volatility, the most effective way of making grants (out of income, as is traditionally done, or via total return), considerations for using balance sheet for granting, the future role of franking credits and whether governments' COVID-19 specific incentives for distributions out of public ancillary funds are good enough. To rebalance or not to rebalance Dahn said the big question is - how disciplined the endowments need to be about rebalancing back to their strategic asset allocation after drifting away from it during the March volatility. "Because on some of those days, you could have been churning through a lot of transactions costs, if you rebalanced one day back up from a big market fall, when the market might have done that for you all on its own," she said. "So the governance model was tested. Investment policies were tested to see whether the ranges around rebalancing were, in fact too tight." Dahn saids some endowments decided to suspend rebalancing completely in March to avoid the higher transaction costs. Perpetual Private partner Daniel Tome's clients fell in both camps - who rebalanced intensively and those who didn't. "The more aggressive foundations or particularly those with founders still alive and still contributing looked to rebalance a little bit more aggressively. And those that perhaps have been around for a long time with co-trustees looked at being prudent," he says. For Jenny Wheatley, the chief executive of Vincent Fairfax Family Foundation and Cambooya, the conversation with trustees had to go from short-term performance to long-term returns. Meanwhile the investment team rebalanced cautiously. What's the best way to grant: income or total return Endowments have traditionally made grants out of the income they generate. But, Dahn thinks that approach is "somewhat outdated" and the sector needs to shift to taking a total return approach, especially as income sources dry up in a world of reduced dividends and low interest rates. "And that's been a really useful philosophical and intentionality conversation with endowments. If the policy is we can grant 4%, we have 1% to run the show...we have 1% to maybe grow the capital base," She said. "If we think about the last five years, we've actually been making an average of 6%...and it's very likely that the next five years will be much the same. And we can continue with those granting levels to run each of our operations and still grow the capital base. " Perpetual's Tome and Fairfax's Wheatley agreed with Dahn's comments. Tome added that legacy trusts may have restrictions that only allow them to distribute income. "There's a case to be made [for] skewing portfolios towards Australian equities, most definitely, but certainly [in] a more diversified approach. And a total return approach is going to provide a better risk adjusted return over time. And so having those discussions with co trustees and founder about how they're investing these funds for total return approach is critical," he said. New ways endowments donated in COVID-19 Tome says Perpetual's philanthropic clients became more flexible in their giving during the pandemic. This included untying grants, paying them sooner, using their own capital or even lending them money - all of which must be linked to investment and governance response, he says. "From an investment perspective, it has forced a reevaluation of risk tolerances in investment as well as the giving side -- clients have been willing to push the envelope a bit more on the investment side and on their spending policies in the face of this unprecedented need," he said "Ultimately my counsel is that the purpose of the funds should drive the investment decision making. If that shifts to the circumstances, then the investment policy should be reviewed and shifted as well." Balance sheet philanthropy A May 2019 survey from Philanthropy Australia asked endowment decision makers if they would consider using their balance sheets to offer non-grant financial support to an organisation? Less than 10% said yes, about 25% said they were considering it and the majority at just under 70% said no. Wheatley revived the question to the panel. Dahn was in favor, citing Ford Foundation which used its balance sheet to raise capital via a bond issue. "They've used their balance sheet to leverage their balance sheet to raise to raise bond capital, at obviously historically low levels...They can effectively, with a reasonable to higher degree of conviction, make more money on the equity side of their balance sheet that will more than cover the repayment of the debt," she said. JBWere director of philanthropic services Luke Branagan said while he supports similar endeavors in Australia, they might be hard to come by. "We hear discussions of people [in Australia] wanting to do it or explore it, but they're not really sure how to achieve it...but I just don't think there's a provider to come in and assist foundations -- the foundation of your sophistication [Fairfax] I think can enter into this world -- but many don't have that capability," he said. Franking credits: where do they add? Wheatley also asked the panelists what value franking credits added to their portfolios. Dahn suggested between 70 and 90bps, depending on the asset allocation, but she noted that was subject to tax changes. Branagan and Tome said they have tilted towards international equities in recent times, seeking growth. "It really is a material amount of the of the total return, which is, of course received in cash after a lag [when tax returns are processed]... think trustees need to be [aware], this isn't the end of the change or the end of what we need to adapt to," Dahn said, referring to potential changes in the tax system arising from stimulus debt. "Definitely skewed towards alternative asset classes, as well as towards international equities, which inherently have a bit of a buffer as well, with the currency differential and our currency is it's a pleasant buffer when markets go into volatility mode because of how our currency reacts to the sort of risk off risk off events," Tome said. Lastly, on the subject of whether government's increased distribution permission guidelines for private ancillary funds in FY20 are good or bad, the panel was split. Dahn said the credit could have been more or better aligned. "It's not a restriction on freedom, but it is a bit of a dictation as to, you should be giving now versus you should be giving later," Tome said. "And that might be a little bit dangerous in terms of providing incentives for people to actually create these foundations in the first place...I think that's absolutely useful, but certainly shouldn't be mandated in my opinion."Read more

A boat of one's own

KANIKA SOOD | In Investment

With close to 60,000 kilometres of coastline and spots such as the Whitsundays and Hamilton Island, it's hard to fault an Aussie who has made some money and now wants to buy a boat. Over two million Australians ... With close to 60,000 kilometres of coastline and spots such as the Whitsundays and Hamilton Island, it's hard to fault an Aussie who has made some money and now wants to buy a boat. Over two million Australians hold a boating licence. Each year brings 14,500 new boat registrations, according to July 2018 data compiled by the Boating Industry Association. "Usually we see people who have been financially successful or when they have just sold a business, decide to buy a boat to achieve another life goal," says Roger Perrett, an executive adviser at Viridian Advisory and former competitive sailor. "They want to have an on-water experience for a period of time or even for the rest of their life." His clients' purchases can range from small sailboats, to powerboats which don't have sails but an engine, to yachts to go racing. The prices for such boats can be anywhere from $15,000 to $5 million. Boats are fun but they are depreciating assets. And they can rack up significant maintenance costs each year. Therefore, buying one is not a decision that should be taken lightly. "What I generally think of, as a rule of thumb, is that you should not spend over 10% of your overall net worth on [it]," says Perrett. However, this 10% is a very general rule, he warns. "If someone really wants to create wealth and not have that lossmaking experience, they wouldn't go anywhere near that 10% range," he says. "On the other hand, there are people who go above that. For example, they might say, 'I've just had someone in my family die and I don't know how much longer I have, I want to enjoy life and my money'." Boat ownership There are many ways to own a boat: you can buy outright, join others in buying shares in a boat, buy a charter for a longer period of time like a year, or just the usual hourly charter. Getting into a shared arrangement brings down the cost and takes off some burden of the maintenance, Perrett says. However, it's limited in that you have to go through a booking arrangement, and you may not be able to take it outside a certain area or personalise the decor. "Some people might think if I am going to spend that much on a boat, I want to be able to take it out to Hamilton Island or the Barrier Reef and the other owners may not want that," he says. He adds that usually at the end of such an arrangement (which can be with friends or a random group) people go their own ways, the boat gets sold, and they get some money back. More to some people's taste might be a rental with a boating company, where they can hop on and off for an agreed period of time through the year. "Usually they have a lot of boats and you might be able to say I want to take out a 40 footer this weekend but next month I have a special occasion like a birthday so I'll take the 60 footer," he says. Maintenance costs Congratulations, you've bought a boat. The real expense starts now. "This is often the case with lifestyle assets. They buy an expensive asset, and it looks like it's cheap, much cheaper than they expected," says Ian Gillies, who is a partner and adviser at Melbourne-based high-net-worth advice firm Hamilton Wealth. "But often the actual annual cost of ownership, which can be significant particularly if it's not a new boat, is [overlooked]." Boating is a booming business in Australia. The industry reported an annual turnover of $8.47 billion in the 2018 financial year, according to data from AMIAG State of the Industry Survey. It has grown steadily over the past three years - recovering from a slump in 2015 - and 70% of the industry's participants expected it to continue over the 12 months to June 2019. There are more than 2250 businesses in the marine industry, including new and used boat sales, boat builders, charter operators, marinas, engine sales, and other professionals. And you will need their services once you own a boat. Gillies, who has worked as a sailing instructor and coach, has an exhaustive list of the actual purchase cost and the subsequent ongoing expenses of owning a boat. It starts with a survey to determine the state of the general boat (about $30 per foot) and engine inspections (up to $180 an hour). There's an initial boat registration fee, which is usually calculated by the length of the boat. In New South Wales, for example, this is capped at $676. Then you will have to buy berth lines, ropes to tie the boat to a wharf or a mooring. And a tender, a smaller inflatable boat to put on the side. There is currently no stamp duty on boat sales, unlike cars. In last year's state elections, NSW Labor proposed to extend stamp duty starting at $7600 to all boat sales valued at $200,000 or more with the view of raising $96 million over four years. However, it did not win the election. Then there are the ongoing annual costs. This includes things like annual registration renewals that don't cost much and biggerticket spends like insurance, berthing fees, yacht club membership and labour for maintenance. "Insurance can be a bit pricey, depending on where you store the boat. Usually about 1-2% of the purchase price is the ballpark to start," Gillies says. Maintenance costs include pulling the boat out of water at least once a year, scrubbing the areas in contact with the water and servicing the engine. And the ongoing fuel costs for motorboats. There's costs for the covers, sails, carpet, freshwater pumps, sanitation system, propellers, refrigeration systems and batteries that may need replacing in part or full every couple of years. Gillies says all of this may add up to a package of $16,000 to $25,000 for just a small tinny. Fortunately most of his clients don't want to buy big boats, they are happy with something they can entertain their family and friends on. Still, as a rule, Gillies doesn't make recommendations around how much a client should spend. "It's very much a discretionary purchase, not one I would suggest to people as it's very rarely that they would realise their purchase price on upon resale," he says. "You've got to think, where am I going to berth it, how much do I have to spend on it, who am I going to use the boat with, do I know how to operate the boat and who's going to maintain it." And for those who can't be bothered with the research, Gillies has a tale narrated to him by an accountant a few years ago. The accountant had a tradie client who had done exceptionally well in business. He turned up on his quarterly uptake of his business and said, "I've just bought a [second-hand] helicopter!" The accountant said, "Oh, I didn't know you could fly." He said, "I can't. I am going to get lessons." When the tradie met with the accountant nine months later, the accountant asked him how he was going with the lessons. He said, "Oh no, I didn't take the lessons. I sold the helicopter. I found that you had to maintain the engine on an hourly basis." When he bought it, he didn't think to check the maintenance program or when next services on various components were scheduled. And with only 15 hours to go on the engine before a major overhaul, he realised the continued cost of ownership was way higher than the purchase price. Generating a return If the ongoing costs of keeping your boat are too much, you can charter it out in through a company when you are not using it, much like an Airbnb. Such companies have their own requirements about the kind of boats they are willing to take. "If you are thinking about putting your boat into charter, it makes sense to talk to them first about what types of boats they are looking for and whether they are actually looking for anything," Gillies says. The first option is to operate it as a small business model, as laid out in ATO taxation ruling 2003/4 on income tax and boat hire arrangements. "It basically means if you meet a certain criteria in operating your charter boat, you may be able to make tax deductions," Gillies says. "The boat owner has to have a commercial plan for the rental, which sets out the expectation of profits over the life of the agreement or the life of the boat. They have to demonstrate that they are involved in the actual running of the business. "You can't just say I am renting it out and do nothing." If these conditions are met, the boat owner may be able eligible for a GST rebate if it's a new boat, and claim depreciation or losses. "They can use the boat privately, provided they make the appropriate adjustments on the tax returns - much like a holiday house," Gillies says. The other option is the passive business model.Read more

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