Investment decisions are normally driven by data analysis and objective criteria, but when an adult child asks parents to invest in their start-up venture, subjectivity can take the wheel.
Although most parents are hardwired to help their children, making an emotionally driven investment can lead to poor outcomes both financially and in terms of family dynamics. Advisors can play an important role in helping clients decide whether to assist their child’s entrepreneurial venture and how best to support them in the process if they decide to go forward.
Before any in-depth discussions between parent and child about funding the start-up, the client should require a business plan—in writing—detailing, among other things, the nature of the proposed business, the near- and long-term prospects of the industry it will be operating in, where the company will be based, and regulatory concerns that could affect the start-up. The plan should also include a projected timetable for achieving positive cash flow.
Parents should also factor in wider family dynamics and estate-planning ramifications. For instance, if the client has multiple children and invests in one child’s business, does that set a precedent for others? How might a failed investment or a new thriving business affect a family’s financial or estate plan? Such an analysis could apply to the financial components of an estate plan such as gifting a child assets during life to mitigate potential federal and/or state estate taxes at death.
Financial advisors can prepare the client for meaningful family conversations and work to take emotion out of the equation in the service of working toward a shared financial goal. Whatever the parent’s conclusion about funding their child’s venture—and especially if it’s a “no”—they should be prepared to fully explain their reasoning and the perspectives, experiences, and accumulated wisdom that factored into it.
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If the answer is “yes,” it’s time to make a plan. From the parent’s point of view, an equity interest (ownership of a stake or shares in the company) offers the potential for significant profits if the business prospers. But it also comes with the risk of losing the entire investment, potential dilution, and strained relationships.
Alternatively, if parents choose to become creditors, they significantly increase their chances of recovering some or all of their investment in the event of business bankruptcy as creditors are usually paid before shareholders. It’s possible to offer a personal loan to one’s child, but in a personal bankruptcy situation, they would recover against their own child, which may lead to a fraught scenario.
Financial advisors should emphasize the importance of business insurance, as well as directors and officers liability insurance, especially if your client will serve on the board of the new company. Financial advisors can bring in additional resources, such as insurance specialists, to determine whether adequate coverage is in place.
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As with any situation dealing with two parties, even when they are close relatives, advisors should have an advance conference with their client to make a game plan. When the parent and child meet—preferably with the financial advisor in attendance—there should be an open discussion about ownership percentages, decision-making authority, measures of success, and potential exit strategies for all parties. This will help avoid misunderstandings that could strain the financial, and more importantly the personal relationships, between family members.
Done properly, the entire process gives parents the opportunity to educate their children about making sound strategic decisions in the business world. It can also give the child the opportunity to gain firsthand experience in developing, refining, and pitching ideas for current or future endeavors. A financial advisor’s guidance can thus create a meaningful impact on the family’s financial health and strengthen relationships for everyone involved.
Angelo Loumbas is Morgan Stanley’s Family Office Resources generalist covering the New York metro area and Northeast region. With more than 25 years of experience, he provides specialized expertise to ultrahigh-net-worth clients and their Morgan Stanley financial advisors across a broad range of family wealth management issues.
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