Only 40% of family-owned businesses reach the second generation, 13% get to the third, and just 3% are passed down to a fourth generation and beyond. To build legacy, It’s critical to create an effective governance structure that serves the family and the business. Conflict around who makes the decisions in a family-owned business can destroy that legacy before it gets started.
For owners of a family business, “Governance” is a dirty word. For many founders and G2 owners, their biggest fear is the mistaken belief that governance means an outsider is going to start telling them what to do. Or, worse, someone else in the family will be looking over their shoulder second-guessing everything.
This article will discover:
What Governance really is
Generational Phases and how they impact governance structures
How to build a governance structure that serves the business and the family
What Governance really is:
Have you, or any members of your family ownership team, ever held any of these beliefs?
“I don’t need someone else to tell me what to do.”
“This is our business, we’ll run it our way.”
“Our company is too small to need a board of directors.”
“An outsider will just steal our business secrets and go somewhere else.”
“Governance” simply means “Decision making.”
It’s an accepted legal and business term for the processes you put in place to make sure things get done properly within your given range. Those processes are critical for the long-term survival and growth of your business, and they’ll get done even when you’re not involved in every decision.
Within an effective governance structure, owners are free to concentrate on the actual path of the business. You get to answer the questions: Where are we now? Where are we going? How are we going to get there? What are our next steps? Who’s going to do what? And Who will be in charge in the event of [fill in the blank]?
Creating this structure is no different from writing a new-employee manual. Governance helps family members, owners, investors, and employees understand how to run your business. Most importantly, whether you as a family member are involved as an owner, manager, or board member, or if you’re part of the operational team, you control the process of governance. That’s the watershed moment, when an owner understands that they’re already doing governance.
Governance provides the framework so owners and managers can navigate the different phases of their business: starting, managing, owning, and investing. More on phases later. Frameworks include approval levels, strategic discussions, and business reviews. It means understanding what you should do going forward, regardless of whether you do it yourself or someone else does it for you.
Governance is about helping you manage the business, so things get done correctly. For example, when there’s an approval required to make an expenditure, it’s usually a matrix. If it’s this much, it goes to so-and-so; if it’s that much, it goes to so-and-so. If it’s above a certain dollar amount, then it’s always communicated to so-and-so for approval. Maybe you have a rule about pricing, the way car salespeople must “get my manager's approval” on the deal. Or the rule says you can’t make a capital acquisition, buy a building, or buy a company, without approval.
Generational Phases and how they impact governance structures:
Family businesses evolve through phases that are shaped by generations of the family and their role in the business. The phases of generational evolution and their impact:
Starting a business – In the beginning, the founder(s) drives the Governance structure. It’s “My way or the highway!” There is no need for an elaborate structure for governance since the management, ownership, and approval authority are one in the same.
Managing or joining the business - The Governance structure can include a management team. It can also include an operating Board to oversee the business. This phase may involve a small or large number of family members, both shareholders and non-shareholders, depending on the number of generations. It’s important that the governance structure includes the authority designations, rules and communication processes to get things done properly.
Ownership – This phase is when the family members have stepped out of the business and merely provide oversight to the professional management. It typically includes a Board of Directors, with both family and non-family members. There may also be a family “board” or family council, to oversee the operational Board. So, there is a structure for the family, and a structure for the business. Trust and communication between the two are critical.
Investing/Divesting – This phase is when the family is even further removed from the role of oversight of a single asset and engages in the investment decisions of the family wealth in a number of companies or ventures. This is frequently known as a “Family Office.” The governance structure for this would be very much like the ownership phase of a single company.
Throughout that evolution, there is a potential for conflict between generations. Putting the business first can create tension between family members. That’s why it’s so important to pay attention to the family architecture and engage as many generations as possible. Consider the impact it should have on both succession planning and developing the family governance structure that fits best.
How can you apply this?
It starts with evaluating what phase you are in, and where you’re headed. Ask yourself:
What phase do you believe you’re in?
Are you ready to move to the next phase?
When will you be ready, and who will take over your old role?
What skill(s) do you have to add or let go of to move to the next phase?
Who can help you do that?
Keep in mind that the phase of the business drastically impacts governance structure. It can affect the overall point of view, individual roles, and long-term expectations of all of the stakeholders.
Entrepreneurial, first-generation owners need reassurance that “governance” won’t mean someone else is telling them what to do. Founders should understand that they will be shaping the initial governance and maintaining its form and application. The evolution of good governance is a continuous journey, even in a 100-year-old family business.
How to build a governance structure that serves the business and the family.
This process of developing an effective governance structure that positively serves both the business and family can be challenging. Family governance structure, business governance structure, and the intersection of the two must be considered when building the next phase of your legacy. The Board of Directors, management, and shareholders will also be vital components in this process.
How do you build a governance structure?
It starts with building trust through respect and communication through generational engagement. Frequent updates on company progress foster transparency and build trust.
Family Values (these are defined by the Founder. Is the family aligned?)
Purpose
Direction
The process will evolve into a set of rules for oversight and processes for decision making, which ultimately create the approval matrix. To apply this process to your family and business, consider these critical questions about communication:
How does the family communicate its desires or expectations to the management of your company?
Do you feel that the communication between the family and the business is open and respectful?
Do you believe that members of the family feel that they have an opportunity for their voice to be heard?
Do you have effective family employment and development policies and processes?
To protect the family business, make sure your governance structure remains relevant. Establish a cadence for frequent reviews of the documents necessary for business continuity.
Merely having the documents isn’t enough. If a shareholder agreement says one thing, and wills and trusts say another, that’s a problem. It’s critical to continually evaluate agreements among stakeholders for consistency. Families and boards must act in concert.
Structures, like family ownership councils, can move a business without a board in the right direction. But don’t wait until the business has become overly complex to define and document your governance frameworks.
Finally, keep in mind that ultimately, the quality of decisions equals the quality of data.
About the Author: For more than 40 years, Charlie Leichtweis has been helping family businesses establish best in class governance as an executive, advisor, and board member. He's the author of two books, The Power of Respect, and The Power of Legacy. Also, he hosts the Power of Respect in Business podcast, which explores various topics about the dynamics and challenges of family businesses.
If your family is struggling with how to remain in control through generational changes, please contact charlie@expertsinhow.com to set up a free consultation.
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