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Bringing the family business community together

Creating Governance Structures

2nd March 2015 Mike Walls

Establishing and maintaining a governance structure can help provide for the future stability of the family and the business.

Starting a family business is easy, relatively speaking; sustaining it beyond a couple of generations is more challenging. It’s often said that the typical family business goes from rags to riches and back to rags in three generations.

Research locally and internationally confirms the truth of this old saying. The reasons for this failure are complex.

However, it’s increasingly recognised that family issues rather than business issues determine the outcome of generational change in family businesses.  

Establishing and maintaining a governance structure, through the creation of a family constitution, provides a framework and mechanism to manage such that arise in family businesses that, left unchecked, can threaten the stability and long term future of the business.

So what is a family constitution? A family constitution is sometimes called a family creed, family charter or family agreement. The family constitution has three purposes:  

  1. It documents the values and principles that will underpin the conduct of the family business.
  2. It defines the strategic objectives of the business. 
  3. It sets out the way in which the family will make decisions affecting the ownership and management of the business.

It’s vital that each family constitution reflects the unique characteristics of both the business and the family to which it relates. It can either be short and concise, or long and complicated.

Does every family business need a constitution?

While not every family business will have a constitution, all of those who develop and maintain one will reap the benefits through greater clarity of how the business handles particular situations and issues.

Some people imagine that the creation of a family constitution will avoid family conflict in a family business. Of course, having a family constitution won’t prevent conflict.

However it provides a mechanism by which conflict can be successfully managed and resolved. Going through the process of creating a constitution also forces the family to consider important issues about the future of the family business that might otherwise be put aside.

Family to business mechanisms, such as a constitution, provide a formal link between business matters and family affairs.

The value of formal governance mechanisms is that it facilitates communication between the family, the owners and business managers.

As the family business evolves and successive generations enter the business, several changes typically occur.

  • The number of individuals with an ownership interest in the business increases. 
  • The expectations of the business held by these individuals begin to diverge. 
  • As the business expands, it makes increasing financial and management demands on its owners.

A family constitution helps the family deal with these changes constructively. It requires the family to think about important decisions before they have to be made and to find agreement on important family and business goals.

The importance of shared values and goals in sibling business partnerships has been explored at some length by family business authority John L. Ward . Professor Ward likens a successful family partnership to the bunch of sticks in Aesop’s fable.

“If you take a bunch of sticks together, you can’t break them. But if you take the sticks one at a time, they snap.” Shared values and common goals bind the business owners and sharpen their business focus. A family constitution should articulate these shared vision and goals.

What does a family constitution typically contain?

Just as each family business is unique, so each family constitution needs to reflect the unique characteristics of both the business and the family to which it relates. However there are many matters that are commonly covered in family constitutions:

  • Strategic business objectives reflecting agreed family values and aspirations for the business. 
  • The process for hiring, assessing and remunerating family members employed in the business.
  • The rules for nominating, training, assessing and appointing management successors. 
  • Processes for nominating and assessing individuals for appointment to the family company’s board of directors and/or the family council (or equivalent) if one exists. 
  • The composition and rules of conduct for a family council or equivalent body. 
  • Communication and disclosure policies between company and family. 
  • The process for resolving conflicts about the business between members of the family. 
  • The rights and obligations of shareholders in the family company. 
  • Recommended or compulsory retirement age for family directors and managers. 
  • Processes for buying out family shareholders in the business. 
  • Policies concerning external, non-family ownership and management of the business. 
  • Procedures for amendments to the constitution.

A family constitution should be able to accommodate growth and change in the family business. For example, the business might reach a point where external management and independent, external representation on the board are considered desirable.

How will this best be achieved? Or growth in the business can create financial demands that can only be satisfied through access to external capital, either in the form of equity or debt. The family has to make several trade-offs here involving its appetite for risk (debt) and the extent to which it wants to maximise family ownership and control.

When should we adopt a constitution?

The quick answer is as soon as possible. In practice, a family constitution is most likely to be adopted or revised at the time of generational change within the business. It can often be considered when the business is about to be passed on from the founder to his or her children.

Suddenly two or more branches of the family can find themselves in charge of the business and unsure of where to go next. The transition from the second to third generation can further increase both the number of owners and the diversity of their ambitions for the business.

Generational change can be unplanned, typically as the result of the unexpected death or disablement of the existing proprietor. This possibility strongly suggests that the constitution should be drafted and agreed well ahead of the expected transition.

Formulating a family constitution will take time to develop and may require a number of family meetings. Even if there isn’t agreement on all issues, it will form a good basis for the family to work from when issues arise.

 

This article has been reproduced with permission from Mike Walls, Publisher and Editor of Western Sydney Business Access in Australia.  For more information please visit their website here

 

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