Family businesses, governance and performance

I have previously written that family firms have differing challenges as they go from entrepreneurial start up to an established business run by siblings, cousins or a wider family network of managers and owners.  These governance challenges tend to correlate to levels of financial performance of family businesses.  Essentially there is a U shape.  High on the left are efficient, hardworking entrepreneurial owner managers who perform well if they have the self-knowledge to seek external expertise and plan their succession.  In the trough in the middle are sibling and cousin run enterprises risking voting gridlock, conflict and challenges around the distribution of management responsibilities if the owner manager and/or later generations have not properly prepared the succession.  Such preparation includes considering the use of some or all of: an appropriate shareholders agreement, proper board governance, a family business employment policy, a family charter and a family council.  On the top right of the U are efficient family businesses, which may be run by siblings or cousins if the owners and managers are effectively communicating and decision making.  The trough can be bridged (and thus avoided) by effective succession planning which involves governance planning.

Particular risks are faced in the trough.  As the gridlock, conflict and perhaps mismanagement occurs, family members face loyalty tests between their nuclear and extended families in a focus on the vertical distribution of ownership and income from the business.  A more constructive, horizontal family thinking may create a working compact thereby recharging the batteries of the business (Hughes 2004).  It is easier said than done to go from the trough to the top right corner of the U.  It requires some humility and tolerance as well as external advice.  As a result, there is a tendency for sibling and cousin owned businesses to find themselves in the trough, underperforming until the governance of the business is addressed.  Business governance has a strong long-term relationship to business performance.

When considering governance, the agreements, policies and rules relating to board, shareholder and family decision making need to be suitably engineered for the family and the business.  Not all aspects may be required initially.  Some features might be bolted on as the business develops.  The governance structure might be overhauled at a later date following a significant business or family event.  Nevertheless, the techniques should at least be considered as part of a thorough assessment of the family business’ governance.

In that assessment, participants should have in mind four areas of governance: corporate, ownership, family and (perhaps for larger, more established business families) wealth governance.  Each of the four has particular topics to consider, goals and participants.  It is the family and wealth governance that especially distinguish business governance from corporate governance generally, although this piece will only comment on the family governance. 

Corporate governance covers the efficient working of directors, managers and shareholders.  The power distribution of these 3 groups impacts the nature of decision making in the business.  In family businesses the lines between the three blur as family members may have more than one role and perhaps all three.  More tension and confusion can occur if family members are at different levels, such as manager and shareholder but not director.  Thus family businesses strain the conventional corporate governance levels of shareholders, directors, management and workforce.

Furthermore, the position of a family member in the family may not equate to their role in the business, yet their family position creates informal influence across the family members in the business.  Such use of influence may frustrate those family members with formal power, such as directors.  The larger the family, the greater and more complex is the governance challenge unless a specific family business approach is taken to resolve the challenge.

In larger businesses the approach may be to focus the family at the shareholder and board level, leaving management to non-family professionals.  The board is then the forum for family vision and strategy, and the ideas of management.  This forum then debates to produce a creative fusion for strategy and the monitoring of management.  The board may include family members and external professionals as non-executives, and senior managers as executive members.  It is important the team on the board have the knowledge, intelligence, skills and experience collectively to lead and control the wider management of the business.

Ownership governance covers many issues typically seen in shareholder agreements.  These include the use of equity voting rights, share transfer provisions, deadlock procedures and the dissolution process.  However, ownership governance has a particular flavour in family businesses better described as family governance.

Family governance is a concept of increasing importance to families as a family business matures and passes down the generations.  It is of planning importance to the entrepreneur whose business has become established and has grown.  It is of immediate importance to sibling and cousin owned and managed businesses.  Family governance aims to efficiently manage family matters as they relate to the family business.  It covers the vision and values of the family and their preferred method of consultation and decision making.  The values will underpin the whole architecture and be the foundation of continued family cohesion.  They are overarching values that inform the vision, define who the family are and thus the values and culture of the business (with the strategy and operational implications of that).

Under family governance is family involvement in management.  Does the family allow its members to work in the family business?  If so, in what positions?  Does family member entry into the business require particular experience or qualifications?  How will the remuneration of such family members be determined?  How is under performance by the employed family members to be managed?  Much of this can be dealt with by a family employment policy at a strategic level, with business regulations and policy dealing with some aspects, but in alignment with the family employment policy (and the wider law).

Family governance also includes its ownership strategy.  How much of the business equity will be in the family firm?  Will there be pruning of the family tree to keep equity ownership concentrated?  What will be the share transfer policy and process?  How will all of this be documented? Often a mix of family charter, shareholder agreement and company articles of association will set out family involvement in ownership.

Family governance also covers how to deal with the entrepreneurial activity of the next generation of the family which may not fit within the family business.  A family venture fund may be set up with its own policies and rules for the stewardship of the fund.  Properly implemented, initiatives like this provide valuable opportunities for entrepreneurial experimentation by younger family members without risking the family business or the overall family wealth.

My corporate and commercial law colleagues and I at Nexa are available for consultation on governance matters to help your family business be an efficient family businesses, well placed to perform well in the future.

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