Establishing a dividend policy for a family-owned business: What your approach says to shareholders

November 10, 2025

Different dividend policies send different signals, which is why shareholder communication is critical. Here, we examine the different ways business owners are thinking through their approach – and what each says to shareholders

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Family business owners often ask us about the best formula to use in a dividend policy. Unfortunately, there’s no single answer to that question.

That’s because dividends play an important role in defining the financial relationship between a private company and its shareholders. Good dividend policies protect the health of the business while also recognizing shareholders’ broader capital interests. These decisions – whether to pay dividends, how much, and how often to pay them – send signals to shareholders about the magnitude, consistency, and reliability of those payments. But the structures chosen don’t always align with all shareholders’ preferences. Therefore, how these interests are managed can ultimately affect shareholder satisfaction. The “right” answer regarding how to do this depends on many factors.

In our third annual Private Business Owner Survey, we asked participants about their dividend practices and determinations. The results provide useful insights into how owners today think about their dividend policies. It also highlights the importance of aligning dividend policies with both business and owner needs in order to be sustainable.

Here, we review the survey results and outline some common dividend policy approaches and their implications.

For the purposes of this article, “dividends” refer to cash returned to shareholders. In the context of a family-owned business and for the purpose of this article, this is further qualified as distributions above and beyond required to cover taxes in pass-through entities.

Dividend structures and their indications to shareholders

Dividend policies are a central component of ownership strategy. Overall, 64% of private business owners reported paying annual dividends to shareholders – and this jumped to 73% among larger firms (those with $100 million or more in revenues); however, their methods for doing so varied widely. The most-cited approaches included a cash sweep method, a discretionary approach, and fixed amounts and/or formulas.

  • 64%

    of private business owners surveyed pay annual dividends to shareholders

Cash sweep

Forty-one percent of private business owners’ dividend policies involved distributing a variable amount above tax liabilities, based on profits and other factors. Also called a cash sweep or “residual” cash approach, in this method the distribution is equal to the amount of excess cash (if any) that is left after taking care of the business’s capital needs.

  • 41%

    distribute a variable amount above tax liabilities

This approach is a business-friendly policy that prioritizes reinvestment over short-term shareholder liquidity. It is good for companies that want to grow or pay off debt. When investment opportunities for the business are not available, the cash is returned to shareholders.

A cash sweep policy allows a company to sidestep having to pay dividends in down years but also avoids the accumulation of funds during good years. This policy tends to work best for more concentrated shareholder groups who are aligned on prioritizing business needs over providing liquidity to shareholders.

Consequently, dividends may vary greatly depending on annual free cash flow generation and business needs. As near-term shareholder needs are given the lowest priority, shareholders might have to wait for an extended period before they receive a dividend payment.

Indications to shareholders

  • There is a hierarchy; the business’s cash flow needs take priority over shareholders’ desire for autonomy or diversification. 
  • Shareholders shouldn’t rely on the amount or frequency of dividends. While there is a formula, the embedded subjectivity that can be applied by business leaders may cause dividend payments to lack correlation with business results. 

No scheduled payments/special dividends only

Under this structure, no scheduled dividend payments are made, but one-off payments may be made to shareholders as deemed necessary. Among survey respondents, 23% of owners reported using this discretionary approach.

  • 23%

    determine dividend amounts on a discretionary basis

Indications to shareholders

  • We are in growth mode. All available capital should be reinvested into the business so we can hire additional staff, buy more equipment, or acquire companies. Our focus is on increasing the enterprise value. At present, growing enterprise value is a higher priority than returning capital.
  • We want to reduce our cost of capital with our excess cash or reduce undesirable capital positions (debt, junior capital, shareholders). This is currently a higher priority than returning capital to shareholders for the foreseeable future.
  • If we were to return capital to shareholders, it would be difficult (or impossible) to get it recontributed back into the business. Therefore, until we gain greater clarity on the best use of this capital, we plan to leave it in the business so we can maintain optionality.
  • We don’t rely on the business as a source of cash flow. If a dividend is paid, it will be due to an exceptional circumstance. No timeline for payment or amount can be committed. 

This approach provides the most optionality for business leaders. For growth-minded shareholders, the delayed realization of value may also be expected. For shareholders who aren’t growth-minded, this approach can create frustration or apathy given that the only pathway to extract value is to sell their shares (assuming there is a well-designed buy-sell agreement in place).

Fixed payout ratio

Nearly one in five private business owners said they used a formula to calculate dividends. One way this formula can be implemented is through a fixed payout ratio. Under a fixed or constant payout ratio policy, the business chooses a metric, such as percentage of earnings or free cash flow, which drives the amount of the dividend. The interval is typically scheduled (such as quarterly or annually). The percentage is set after considering broader capital strategy objectives, such as the annual reinvestment rate desired to support business plans.

  • 19%

    use a formula to calculate dividends

This policy is most responsive to cyclical businesses, rewarding shareholders with a larger dollar amount in strong years and constraining payouts in more challenging years.

While this policy is dynamic and responsive, particularly in years or periods of underperformance, it can lead to inconsistent or irregular dividends. Because of this, a fixed payout ratio approach is ill-suited for shareholders that require more predictable liquidity streams. Additionally, this approach can cause some challenges for business leaders who use cash generated in periods of strong performance to build cash reserves or invest in large capital projects if there aren’t adjustments in the formula that allow for them to do so.

Indications to shareholders

  • The business will distribute cash periodically as it is generated. While the amount may vary, the frequency of payments is reliable.
  • The owners will participate alongside the business in both the upsides and the downsides of performance.
  • Because downturns can occur, shareholders should be prepared for wild swings and plan accordingly.
  • If applicable, during periods of outsized performance, expect that payments will be larger. However, it may not result in a payout of excess capital in all cases – some excess capital may be retained for reinvestment. 

Fixed dollar amount

Fifteen percent of owners’ dividend policies involved distributing a fixed amount above tax liabilities each year. Fixed dollar approaches pay shareholders on a predetermined schedule (such as quarterly or annually). When used, they are most common in mature companies that have stable earnings and steady cash flow. Given the implied predictability of payments, they are favored by shareholders who don’t have other sources of income (e.g., employment) to support living needs.

  • 15%

    distribute a fixed amount each year

In some cases, a reserve is created to support payments even when earnings are low or if there are losses. Some companies may even borrow in a market downturn to further assure the dividend payments. As a mitigant, some business owners also set the dividend at a modest amount relative to cash flow generated. This reduces the risk that business performance will affect whether dividends can be paid.

In theory, fixed payments may be adjusted, but tend to be “sticky upward” because of shareholder pressure to maintain dividends at or above the set fixed amount. Commitments to maintaining payments may become even stronger if owners had, at some point, agreed to relinquish some decision rights in exchange for guaranteeing the security of these payments.

Indications to shareholders

  • Nonoperator shareholders may see some financial benefit from ownership, tied directly to the amount of dividends received.
  • It’s OK to view the payments as an annuity, which has implicit reliability (or volatility) based on how long the payments have been made without interruption. The amount paid and the frequency will be predictable.
  • The business is healthy enough to support these payments. If weakness occurs and changes need to be made, it will be a hard pill to swallow. Be prepared for upheaval, as the implications of reducing the amount or frequency will likely be problematic for some. 

Smoothing

Another dividend method not mentioned in the survey but still relevant is called smoothing. Smoothing is similar to the fixed payout ratio, but it also incorporates an averaging feature of the selected metric over time. For example, a company sets its annual dividend contribution ratio at 10% of that year’s free cash flow. The actual payment made in that year is an average of the last three years’ earnings.

Using an averaging approach removes the extremes of outlier years, either positive or negative. This makes payouts more consistent year over year while generally trending with business performance.

The strength of this approach is also one of its weaknesses. Shareholders may be upset by the lagged connection between business growth and dividend payouts. The smoothing method is also more difficult to change once implemented, given its dependence on the company’s past performance. Tenured shareholders who have had to exercise patience may not be as willing to appease newer, more impatient shareholders. In addition, shareholders of companies with large earnings swings will naturally experience more dividend volatility than firms with more consistent cash flow.

Indications to shareholders

  • The business will distribute cash periodically as it is generated. The amount may vary, but the frequency of payments is reliable.
  • Both the business leaders and the owners will participate in the upsides and the downsides of performance, but the volatility will be more muted compared with some of the other approaches.   

Conclusion

A business’s dividend policy both implicitly and explicitly communicates expectations to shareholders regarding whether, how, and when cash flow generated will be distributed. The policy also reflects goals and priorities as they relate to owners’ capital. Whose goals and priorities they represent is driven by the people who designed the policy.

It’s also important to note that a policy exists for every business regardless of whether it is documented – the documentation is simply a formality. How businesses manage this issue in practice tells shareholders their specific approach to dividends.

There are numerous ways to set policies. Some policies have transparent and formulaic aspects, while others are more opaque and discretionary. One is not better than another. The best approach for a shareholder group and its business considers both shareholder interests and the needs of the business supporting them. Well-informed shareholders who are aligned on the business’s overarching capital allocation policy will be able to unite around a dividend policy that best meets the owners’ goals and enables the business to thrive long term.

The best approach for a shareholder group and its business considers both shareholder interests and the needs of the business supporting them."

Another important consideration is a policy’s short- and long-term sustainability. In our survey, 83% of owners said their dividend formula or approach was sustainable, yet answers revealed this confidence was nuanced and conditional. Respondents said a dividend policy’s sustainability depends on business growth, profitability, ongoing review, and generational dynamics. Like design, a dividend approach’s long-term success is context-dependent.

  • 83%

    believe their dividend policy is sustainable

Finally, even with the “right” policy in place, friction may still exist. A business may not be right for some shareholders the same way that some shareholders may not be right for a business. In this case, having a viable pathway to exit can help those who have differing interests from the larger ownership group. The existence of that pathway can also keep shareholder relations calm during times of uncertainty.

Regardless of what an ownership group decides to do about cash flow and its dividend policies, communication (or lack thereof) between business leaders and owners can largely determine how well any particular strategy is accepted.

Reach out to our Corporate Advisory & Banking team or Center for Family Business if you are interested in discussing this topic or the results of the survey further.

An earlier version of this article originally appeared in Family Business Magazine; the article has since been modified.

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1 Dividends refer to cash returned to shareholders. In the context of a family-owned business and for the purpose of this article, this is further qualified as distributions above and beyond that required to cover taxes in pass-through entities.

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