As a family business advisor, I often provide consultations on maintaining family harmony as the family successfully transitions the business from one generation to the next.

Various research has found that only 30% of family businesses transition successfully to the 2nd generation, 12% to the 3rd generation and 3% to the 4th generation. Further, 60% of transition failures were caused by a breakdown of communication and trust within the family unit. With these statistics in mind, how can you safeguard the long-term interest of your family business?

How Family Roles Affect Business

Why do communication and trust breakdowns often occur within a family that’s operating a business? The greatest challenge family businesses face is the multiple roles each individual plays: management, ownership, and family.

Depending on which roles an individual plays, their viewpoint about the business may be different. For example, in the management role, an individual may be focused on achieving business growth.

Those in an ownership role, however, may demand a certain level of return through dividends. Further, a family member who is not actively engaged in the business may value family harmony and fairness at all costs.

These different—and sometimes overlapping—roles may contradict at times and add greater risk to the family business’s continued success—especially during leadership transition.

Governance Structure for Family Businesses

Governance is the system of rules, practices, and processes by which a company is directed and controlled. Your family business should implement a governance structure for three reasons:

  1. To effectively balance the interests of the many stakeholders—owners, management, and family members;
  2. To ensure the continuity of the business; and
  3. To promote family harmony.

Many business owners understand governance as the board of director’s fiduciary responsibility to represent the interests of shareholders. In a family business, however, the family is a key stakeholder and should not be ignored.

Good governance provides clarity on roles, rights, and responsibilities for all stakeholders; encourages family members, business management, and owners to act responsibly; and regulates appropriate family-and-owner inclusion in business discussions.

Who Should Implement a Governance System?

Businesses that rely on any of the three following business structures should implement a governance system. The structures include:

1. Board of Directors

The board of directors is a group of individuals with the fiduciary responsibility to protect the interests of the shareholders. They do this by working with management to set the strategic direction of the company and oversee the operations of the business.

In a family-owned business, the board also has the important responsibility of ensuring that management is directed by values and principles the family deems important.

The board’s duties include monitoring performance of the business, approving major acquisitions, approving the strategic plan and operating budgets, guiding succession planning, and advising the CEO.

The board of directors is governed by the bylaws of the company. The bylaws include policies describing the size and composition of the board, term limits, addition of independent directors, and family versus non-family board members.

2. Stockholders

Stockholders hold one or more shares in the company and have a right to vote on certain company matters. They are invested in protecting their ownership interest and focus on a return on investment, liquidity needs of the company, risk management, business acquisitions, and company growth plans.

The stockholders are governed by the stockholder’s agreement, which is an agreement amongst the stockholders of a company. The agreement should document restrictions on transferring shares and rights of first refusal in relation to shares issued by the company—often called a buy-sell agreement.

The agreement should also include specific rights for control and management of the company. For example, it should designate certain individuals to the board. The agreement should also include provisions for managing dispute resolutions.

3. Family Constitution

The family doesn’t just include those active in the business as managers or owners; it includes others who are impacted by the family business operations, but who don’t own stock.

Who is considered family? Does family include spouses, step-children, second cousins, estranged siblings? This answer is different for every family and should be defined in the family constitution.

The family constitution is a valuable governance document that addresses the human and emotional side of operating a family business.

The process of developing a family constitution can strengthen the family by helping them see a vision for the future. It also helps each family member understand their role in assuring family and business continuity.

A family constitution should address policies such as employment and interpersonal relationships. Some questions to consider include:

  • What qualifications, if any, does a family member need to meet before they can work in the business?
  • What is the decision-making process and how are conflicts resolved?
  • What are the family values and what is the vision for the future?

The constitution is a living document and should be reviewed and revised as needed to meet the needs of the changing family, ownership group, and business.

Bottom Line

All businesses have challenges that need to be addressed to ensure continued growth and sustainability. When you add the complexity of family dynamics to the mix, however, the risks are higher.

Anticipating these challenges before they arise and proactively developing written guidance, or procedures to resolve them, sets a family business up for success.

As you navigate those challenges, we are here to operate as an experienced, trusted advisor. Could your family business benefit from assistance in safeguarding its assets while maintaining family harmony? Please contact our professionals to get the process started.

© Clark Nuber PS, 2019. All Rights Reserved

This article contains general information only and should not be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services. Before making any decision or taking any action, you should engage a qualified professional advisor.