Family Businesses and Governance

Governance of family businesses covers structures, rights and obligations of individuals and legal entities. This includes at the level of board of directors and the shareholder level. In general, it covers the rules and procedures adhered to in coming to a recognised decision. It is the structure through which business strategy is pursued. It is partly determined by law and by the agreement of the parties. Like other businesses, family businesses need governance. Traditional assumptions of stewardship associated with family businesses do not always occur without careful design of the governance of the family business.

The governance must address the motivations of family members, issues particular to family businesses and the shortcoming of general governance mechanisms as applied to family businesses. Part of this is to recognise any additional family goals besides financial wealth. Goals may include social reputation, intergenerational succession, family cohesion and interests of other stakeholders such as a workforce which may include multiple generations of families whose commitment to the business parallels that of the founding family. Proper governance will factor in these considerations.

An important point is that family shareholders are not a group of united actors forming a monolithic power block. Whilst wealth concentration in the family business may be cautious to preserve wealth in later generations, this is not automatic. Concentrated wealth in a shareholding does not always result in careful, prudent selection of professional managers in medium to large family businesses to whom significant managerial power is delegated and whom are carefully monitored by the family for good performance. Family members fall out due to differing interests. Differing views may be taken on risk, affinity to the business and dividend rates. Personal issues may bleed into the business sphere. Such battles can become very intense.

Even if a family act in unison as a bloc, this may cause tension with minority (non-family) shareholders through the acceptance of practices to extract private benefit from their majority control such as very generous benefits to employment packages, filling positions with family members, high levels of risk aversion impacting strategy and operations management.

Family management is not always competent management. A successful entrepreneur does not necessarily beget talented manager(s) to lead the more established, perhaps larger business bequeathed to the next generation. Consequently, an untrammelled family transition may be an adverse selection system. Governance is required to remove or minimise the adverse selection risk from the shop floor through the boardroom to the control of shareholder power.

Once the entrepreneur has established their business and has aspirations to pass on ownership within the family, governance becomes an important matter for discussion with their advisers. It is important to consider this early on as family businesses often overlook the benefits of governance mechanisms at the early, owner-manager stage which instil discipline into the business’ culture in good time as they become larger, more complex businesses. For example, there may be directors of the early stage business, but the functioning of the board of directors may be hazy or haphazard. Board membership may not be carefully considered for the quality of the members. Furthermore, family businesses often decline to use performance pay to incentivise management. Whilst a clubbable atmosphere in itself is not harmful, it may block meritocratic family or non-family talent. If so, it damages the business’ future prospects. As share ownership widens to other family members, family shareholders may disagree on issues. In that scenario, the problem of a badly run board with inappropriate members may remain an unaddressed problem, or at least unsuccessfully resolved.

The product or service market and the labour market do not discipline family businesses. Poor sales do not necessarily result in management changes or training of such underperforming managers, or changing the product or service. The business may be unwilling to address underperforming managers due to kinship ties and by the level of shareholding of that particular manager. The family may sentimentally hold to the product or service which built up the business.

A family business that does not address governance carefully risks these scenarios in a way that a car is a risk without functioning steering or brakes. The governance challenges of family businesses vary with the maturity and complexity of the business. Therefore, governance arrangements need to be different between businesses and the stages of the development of each business.

An owner manager needs to talk with external professional advisers. This requires openness in the dialogue with the advisers. The owner manager has the opportunity to plan ahead for more smooth business growth by addressing such ownership and management issues.

A business in sibling or cousin ownership has a more immediate need for governance awareness and implementation. At the least, such a business needs a shareholder agreement to cover the transfer of shares amongst other issues. In addition, it is helpful to define family values and vision for the business, have a written policy on employment of family members in the business, have methods to foster continued family interest in the business and implement policies to educate and prepare family members for entry into the family business.

A family may launch other businesses following the success of the first ones. This moves them from family business to a business family in mindset. However, it is less clear what there is for family members to identify with. At this stage a family council mechanism may assist. Of course, a family may remain at an earlier stage if the business does not grow further or the family does not want to diversify its business interests.

Nevertheless, across the family business governance scenarios, three principles are important in shaping the governance solutions. The family must be competent as owners and managers to make good decisions for the family business and stakeholders. The family must be cohesive to provide the necessary leadership and long-term strategic vision. The effect of the governance set up must include control so that owners can hold management to account, with control remaining with the family. At the same time, the control measures must not hinder delegated decision making so innovation and responsive business performance is not sacrificed.

My colleagues and I at Nexa deal with corporate governance matters and would be happy to talk with readers whose family businesses may require some governance advice and/or implementation.

For more information please contact Henry Clarke using henry.clarke@nexa.law