Building the Best Strategy to Drive Cash Allocation

Managing Cash on Hand Challenges Businesses

For most businesses, cash allocation is a challenge. Margin pressure, seasonality, credit risk, and bank covenants make it a constant chore. Cash on hand is the oxygen of business. You can’t run low and survive.

For successful businesses, the opposite is true. They have too much cash on hand. Apple is a well-discussed example. The public markets will force a resolution to Apple’s cash hoard. Cash is the oxygen of business. You can’t run low and survive.

For the successful private companies, however, having no access to public markets creates a complex strategic problem.

The Value of Smart Cash Allocation

Here’s an example: a client has built a successful business over two generations and has accumulated significant cash. The client does not need this cash on hand for operations. Being conservative, they have always saved for the future, and unless they find a major acquisition, this cash is not a productive asset for the family.

Frankly, they should find a better use for it or return the cash to shareholders.

These funds can be used to:

• Fund strategic growth initiatives
• Invest in diversifying strategies
• Pay down debt
• Increase compensation
• Provide peace of mind
• Support charitable causes

This  family had achieved substantial success without having a formal strategic planning process. What worked well for them was remaining tightly focused on their niche and being excellent operators. That is why the cash accumulated over decades.

But as the competitive landscape changed, there were concerns that the future would not be as kind to them as the past had been. New regulations were causing concern. The next generation of leaders had different views than the founder. Some wanted to diversify revenue streams to reduce their risk, while others wanted to take more cash out of the business for personal use.

Furthermore, some were more aggressive than others in pursuing growth opportunities. Boards are stewards of the owners’ capital. They should avoid both under-utilizing assets and taking unwarranted risks, while sound business strategy and ownership priorities should be driving cash allocation.

Creating a Strategy

The outside directors organized two parallel processes to help the family manage the issues. First, a traditional strategic planning process was started to help set priorities. Simply put, the family needed to set long-term priorities for the business. Fortunately, the Family Council was effective at this task.

Second, the board formed an investment committee to find top, professional money managers that could manage the large sum of money. Personal chemistry was as much a part of the process as the mechanics of investing.

The board then connected the strategic priorities to the investment management program, so that the investment policy (risk levels, distributions, volatility) supported those strategic priorities.

Good acquisition opportunities are few and far between in this industry. So, having ample cash on hand to be able to move quickly was important. This was included in developing the investment program – they could move to cash quickly if needed, with no strings attached.

The younger generation was in their 40’s, so they had a lot of time to worry about cash allocation. But this is where being too conservative may become a liability. Since lost opportunities compound as the market grows, not taking enough risk can become very expensive over long periods of time.

Educating the family on market dynamics allowed decision-makers to define an investment strategy which:

• Supported the strategic priorities of the business
• Provided ample cash flow
• Allowed the older generation to sleep easy
• Excited the younger generation about future potential

The money managers also provided financial planning for the family members. Since each family executive now had a good idea of their personal situation, the transition between generations eased. The guesswork was removed, and the executives could focus on the business. This also took some stress out of family relations.

This example demonstrates how outside directors can help successful owners maximize opportunities and manage risk. Remember, too much cash is a good problem to have, but a problem nonetheless.

[Editor’s Note: To learn more about this and related topics, you may want to attend the following webinars: Negotiating and Drafting Cash Collateral/DIP Financing Orders 2020 and Where Did All My Profits Go? Mastering the Concept of Working Capital 2019. This is an updated version of an article that was first published May 11, 2018.]

©All Rights Reserved. June, 2020.  DailyDAC™, LLC d/b/a/ Financial Poise™