The power of governance in family business

Aug 28, 2020

Sustaining a family business can be complicated. Liam Lynch considers how good governance can achieve the right balance between family and business.

Like any enterprise, a family business needs governance to ensure that its family and business strategies are aligned and achieved. This governance must protect the business from the normal and predictable challenges that family involvement brings. However, formalising ownership structures, power and processes can create resistance and (often healthy) conflict as the management of a family business transitions from an ‘autocracy’ to ‘democracy’.

The benefits of governance far outweigh the challenges of developing it. As more generations become involved, and the demands of people in the business increase, the need for more a formalised governance structure is vital.

Governance means education and pre-agreed rules about management and how strategies will be implemented. These rules must apply to everyone involved in the enterprise, from directors to shareholders, managers and staff.

There typically needs to be two separate but related sets of rules (governance). One regarding how the family will behave and relate to the business – a family constitution, even if not formalised as such – and the other regarding how the family will behave and relate in the business – a Shareholders’ Agreement and sometimes a Board Charter.

Discussions must start now

Building a sustainable family business means starting early to communicate about plans for growth and future succession. Unlike a regular enterprise, a family business is usually built on a level of trust and informality by the founder family members. However, if a business is to grow and employ more people, including family, it needs a level of structure to help the business ‘scale-up’.

To minimise distraction to the business and tension within the family when formalising governance structures, it is important to recognise that these issues are completely normal and predictable. It can be helpful to work with an independent party who can facilitate conversations, share proven frameworks and use their experience to navigate the process. Invariably this will lead to a better outcome.

Four pillars of governance

Governance is broken down into four pillars: management, income, control and equity.

Management

A common trigger of problems is when the founder brings children into management roles who have not gained the experience to perform the roles. This not only creates tension, but it can stunt the business’ performance. Having pre-agreed rules regarding how family members can join the business, and the required experience, involvement, development and output – just like any other employee – will help alleviate this.

The pre-agreed rules will consider reporting lines, and establish performance expectations and review processes, as well as how issues are communicated and resolved. Ideally, family members should report to someone outside the family, but if it is a family member, their performance review should happen with an independent advisor as well. These rules help prevent disagreements later and spill-over between business and family relationships.

Income

There must be clarity around how family members, in and out of the business, will be recognised and rewarded, and how they can develop and progress. Part of achieving the balance of a sustainable business will mean adopting rules that reflect the different roles family members can play in relation to the business as employees, directors and/or owners.

Think about it like employees earning a market-based salary, family members who contribute as non-executive directors earning directors’ fees, and owners receiving dividends or repayments of capital in accordance with the pre-agreed plan.

Control

There also must be clearly defined rules in relation to the decisions that managers, directors and owners make in each of these roles. An important distinction to remember is that family members are ‘equals as members of a family’ but not ‘equals as managers, directors or owners of a business’.

Some of these rules may reside in a family constitution, business policy or shareholders’ agreements.  The important thing is that they are clear, agreed, communicated and respected.

Equity

Like any business relationship where there is more than one owner, there needs to be agreement and communication on how people will behave as owners. This includes defining who can appoint directors, the payment of dividends, how decisions will be made, how and when ownership interests can be sold or transferred, and how the business will be funded.

Respect the separation of powers

Finally, the creation of a governance structure is all about clearly defining and respecting the separation of powers. Focusing on the above four pillars ensures that each area has clear governance, helping family business members avoid arguments and ensure the success of their strategy.

At the end of the day, a lot of this comes down to ‘best fit’ rather than ‘best practice’.

Families and the businesses they own need to do what’s right for them in their own context. Making sure a governance structure is in place that is tailored to the specific history and needs of the family will mean they manage and avoid arguments and problems down the road to a sustainable future.

Liam Lynch is a Partner and Head of Private Clients in KPMG.