The majority of companies in every country are family owned. In the European Union for example around three quarters of all companies are family owned, accounting for on average 40%-50% of all employment in the private sector. The percentages in developing economies are likely to be higher.
A business owned or majority owned by a family brings special benefits and special challenges. The benefits of maintaining family values, culture and ethics in the business are considerable. Established family businesses tend to take the longer view and reinvest profits as equity rather than taking on more debt. They also feel more responsible towards their workforce, their supply chain and location. They have a family name to protect.
However, the challenge of keeping the family business together is significant and the success rate is low. The great majority of family businesses do not last three generations. Grandfather starts the business and works extremely hard to build it up. His son sees how hard he has worked and maintains the business and the grandson only sees the money and wastes it. In other cases the business does not survive the departure of the grandfather.
The objective of this short paper is to provide a framework of ideas for the governance of family business’s that will deliver continuity and the maintenance of family wealth in a successful and prosperous business flourishing long after the departure of the founding father.
“The founding father”:
Most family firms are either established and led by an entrepreneur who established them or have a dominant family member who takes the decisions and to whom the rest of the family defers. This places considerable pressure on the “founding father” and to maintain continuity and good decision making we would suggest:
- Once the business is established and moved beyond the start-up phase, the “founding father” should take a break from time to time to think what they are trying to do and want to achieve for the family in the longer term.
- If the dominant family member can’t leave the business for a few weeks then there is potentially a significant problem for all the family in the continuity of the business.
- It is important to separate the private and the business life, distinguish between company and family relationships, money and accounts. Don’t muddle the two, it will lead to confusion.
- Try experimenting with delegation on a step by step basis, it may work well. The founding father can’t take very decision all the time and starting with minor decisions confidence in other family members will grow.
- The aim is to reduce stress and prepare the next generation for running the business.
The “founding father” can’t lead for ever and if the business is to continue there needs to be in place an agreed and accepted succession plan:
- It is important to avoid intentional ambiguity and fudge the succession plan, it will only lead to disputes later on and these disputes tend to be destructive.
- Legal advice should be taken on any succession laws or death duties restricting transfer of family owned shares. A clearly expressed will needs to be prepared even if it is not legally binding as it provides an indication of intentions for the family to follow.
- Like almost all HR decisions, the family needs to accept that it is usually not possible to please everyone all the time. The family can’t be allowed to split into factions.
- The eldest male of the next generation might expect to be the automatic successor. This may not be optimum. It should be the person whom the family accept as the most competent and reliable to control and grow the business for the benefit of all.
Ownership is different from stewardship
Creating a business is different from leading and managing a business. Some would say that starting the business is the easy part, other issues arise when you have to manage an established and growing business. The family might consider:
- Retaining control by issuing a class of shares that carry “Super” voting rights. It may discourage outside shareholders to invest but if the business is a success they are not likely to complain.
- Establish a methodology for the buying and selling of family shares. The family will want to have pre-emption rights even if a third party offers a higher price. How do you establish in a shareholder agreement or family pact a fair selling price for a family member that may be below the price an outsider is willing to pay for a stake in the business?
- Outside independent talent needs to be brought into the business. The family is unlikely to have members with every skill set to successfully run a modern and dynamic business.
- Some dilution away from family ownership is inevitable if the business is to thrive: non-family executives will need an incentive, substantial funding may be required for plant and machinery, bond issues , private equity funds or long term loans may require equity kickers.
- Ultimately as the business grows it may be the best interests of the whole family to relinquish control, otherwise the business might just stagnate and go nowhere. Think of the large vehicle manufacturers such as Ford and Peugeot or food manufacturers like Cadbury which are now international firms where the families have gained enormous wealth.
Family relationships do matter
In a family it is all about the family:
- Some family members will be considered more able and better educated in management and business than others, it is inevitable.
- Just because you are a family member it doesn’t mean you can disobey the rules on how the business is run. There has to be discipline in every business, in particular in a family business.
- Avoid the dangers of “entitlement”, there needs to be a methodology on dealing with the disruptive family member who believes he or she has been unfairly treated by not being given a senior job or say in the business?
- Family loyalty cannot take precedence over business competence.
Formalising family governance
To survive a family business, like any other business, needs a formal structure. However, being a family firm adds an additional layer of complexity to running that business:
- It is important to maintain all the formalities and the structures of a company.
- Build an Environmental Social and Governance Code that sets the values, ethics and culture of the family so it can be transmitted throughout the business.
- Hold, as with every company, an Annual General Meeting, maintain accurate accounting records, prepare a full set of accounts. Hold regular formal meetings of the Board and prepare minutes.
- Establish a formal written family Constitution or Family Pact. Who owns what? Who within the family is responsible for what? How can the family constitution be changed?
- Hold semi-formal quarterly “Family Council” meetings to settle any disputes, air grievances and share family values. Nobody should be left out, problems can be aired and the family stays together.
Whilst this may be more common in advanced markets it applies equally to family owned firms in developing economies. The temptation to assume that everybody understands and agrees so nothing needs to be written down should be avoided, in all probability not all will agree with everything wholeheartedly and it is probable that future generations or outsiders might well take a different view.
The business will naturally employ members of the family who wish to be involved:
- Establish who are members of the family? There may be a need for a definition, otherwise it might just grow and grow.
- Decide who are family salary-earners or dividend receivers or both? Fairness needs to be extended to those not in the business.
- Identity family members who can be trained and fast tracked to management. They have to prove themselves, especially in the eyes of non-family management and staff. This could be by working for some years in other firms that may be in the same sector as the family firm.
- The family should never exploit members of the family as cheap labour for the business.
- Identify and control potential conflicts of interest, for example between family who are shareholders and the family at large.
Incentivizing talented non-family members
In a growing and thriving business, it is unlikely that the family will be able to provide sufficient competent family members to fill every top job. Outside talent and expertise will need to be hired:
- The hired executive will need to accept that as a non-family member he or she is not likely to be slotted for the top job.
- Non-family directors and executives cannot take sides. They are hired for their experience and independent expertise.
- They are there for their experience and expertise and should be generously rewarded.
- Consider the possibility of Employee Stock Options or a mechanism where all staff can share in the profits of the business.
When things go wrong
As in very business there will be issues and challenges but in a family business there will be another layer:
- Consider a mechanism for regaining control of the business should the family find itself in a minority position and unhappy with the way the business is being run and possibly bringing the family legacy and name into disrepute. A buy-back agreement may be possible or possibly a mechanism enabling the payment of a premium for shares.
- Limit the temptations of the next generation by controlling their ability to get their hands on the cash.
- Establish an exit strategy for family members who want to get out and have their own life outside the family. This may not always work “The family – that dear octopus from whose tentacles we never quite escape” Dodie Smith 1898-1990.
Owning and running a family business is more complicated and challenging that running a business with a range of independent and mostly anonymous shareholders who are seeking an increase in the value of their shares and a regular dividend.
The members of the family will usually want more and their demands and rivalry, sometimes extending through the generations, will need to be considered. This is best achieved within an open and agreed framework which is additional to the mechanisms and methodologies of a non-family company.
Each family will need to find its own structure but without a controlling mechanism the business is liable to fall apart or at best ownership and control will be transferred to non-family entities.