Family Governance – how to turn the success of your family business into a family
tradition
1. Successful generational transfer of a family business – the best option for the family members’ long-term wealth
Contrary to common perception, family businesses create an estimated 70 to 90% of global annual GDP in all countries. Studies show that the long-term returns of family-owned businesses with good corporate governance considerably outperform those of public, non-family controlled businesses. Amongst other reasons this has to do with the long-term approach of entrepreneurs, whereas CEOs of public companies are measured by the analysts, shareholders and the public on a quarterly basis.
One of the major risks that family businesses face is the generational transfer of ownership: Only roughly 30% of family-owned businesses survive into the second generation, 12% survive into the third generation and only 3% into the fourth generation. Interestingly enough this development often goes in parallel with the generational wealth development of the members of an entrepreneurial family. This is for example reflected by the proverbs “Father merchant, son gentleman, grandson beggar.” and “From shirtsleeves to shirtsleeves in three generations”. Given that this is a global phenomenon, similar proverbs exist in many other languages.
Over continents and time there is a strong correlation between the survival of the family business and the wealth development of the individual family members, which is one of several strong indicators that a successful generational transfer of a family business is the best guarantee for continued wealth of the individual family members.
2. Why exactly do a majority of generational transfers fail?
Given the importance of family businesses for the global economy, in recent years an increasing research effort has been directed to the topic of family businesses. Both surviving multigenerational family businesses and family businesses which disappeared have been analyzed. Some of the main findings why generational transfer fails are:
• Many founders (but often also subsequent generations) focus considerably more on creating wealth than on preparing a successful transfer of the business to the next generation(s). This often comes with a stronger focus towards short-term tactics rather than long-term strategies.
• Whereas many founders have a succession plan for the ownership of the business in place, a lack of the commitment required to achieve long-term survival and success of the family wealth results in few families enacting and subsequently implementing governance tools and processes (including education) to ensure a smooth generational transition during the founder’s lifetime.
• Only relatively few families implement their visions, tools and processes, but do so with a top down process and often plan for financial wealth but not with and around the existing social, human and intellectual capital of the family. The lack of involvement of and communication geared towards the future generation(s) results in considerably lower commitment of left out family members towards the joint long-term success of the family and its business.
3. Family Governance Tools
a) Family Protocol (also called family constitution)
The overriding family governance tool is the family protocol, a non-legally binding set of rules to which members of a family agree voluntarily. The family protocol outlines the principles of the family members to certain core values of the family, it defines the roles, composition and powers of governance bodies of the family and the business and the relationship between the family members and those governance bodies.
Whereas the family protocol itself is not legally binding, it often co-ordinates certain tools with legal enforceability such a wills, prenuptial agreements, trusts, shareholder agreements, etc., which are all legally binding in nature. Given the complexity and emotional nature of families, it will however not be possible to organize and cover each and every angle of a family with legally binding documents. Nor may it in many cases even be useful to try to cover them with unilateral legally binding documents, given that most of these documents by nature are not designed towards obtaining consensus of the family members, which however will be in one form or another the key to future cohesion and success of the family and its business. Therefore, in order to ensure commitment beyond the decease of the founder of the family business, it is crucial that all family members be involved in the process of the family protocol and subsequently consent to the final document. Typically upon completion a family protocol is signed by all members which generates additional (non-legally binding) commitment. The family protocol is dynamic and can be adjusted to the ongoing changing needs of the changing family.
Apart from topics specific to the family or its business a family protocol will typically address the following topics:
• Joint family values, mission statement, and vision.
• Family governance bodies, including the family assembly, the family council, the education committee, the family office, etc., which among others define how the family takes its decisions.
• Board of directors of the business (and possibly board of advisors).
• Senior management of the business.
• Authority, responsibility, and relationship among the family members, the family governance bodies, the board, and the senior management.
• Policies regarding important family issues such as family members’ employment, remuneration, transfer of shares, CEO succession, etc.
• Conflict-resolving protocols between family members.
• Process to amend the family protocol.
It is crucial that the family governance bodies be not only set-up, but also implemented and applied during the lifetime of the founder. This because trying to implement a new governance system from zero at a time of emotional and organizational stress and without guidance of the founder is a highly challenging undertaking which – even if it is finally implemented effectively – will create highly disruptive effects on the business.
b) Family Assembly
The function of the family assembly (sometimes also called family retreat) will usually consist of discussing, debating and issuing guidance and instructions to the family council on any financial or non-financial matters relevant to a family. It also elects the members of the family council. The exact role, function and process of family assembly meetings will normally be defined in the family protocol. The family protocol will usually also contain a definition as to which members of the family qualify to participate in a family assembly and in what role (for example: are in-laws considered part of the family and if so in a voting or non-voting capacity?). Family assemblies are normally held in an offsite format, and will normally be held at least once a year. An important part of the family assembly is no only the communication within the family but also between the members of the family and the family council, and often educational topics mainly targeted at younger generations will play an important role. Having said that, because the overall purpose of the family assembly is to create cohesion and bonds between the family members, there will normally also be a strong social element to them, which can include dinners, sporting events and others, with the aim of developing mutual, cross-generational understanding, stronger relationships, and better teamwork between family members. Members of the family assembly will often have their expenses covered in order to attend the meeting.
c) Family Council
The family council normally consists of an elected subgroup of the family assembly. It is the governing body of the family, it represents the family towards the outside world and serves as a communication link between the family and third parties, including the family business. The family protocol or the family assembly may also mandate the family council to be in charge of preserving order among the family members, to be in charge of a budget which may include a budget for the prevention or managing of externalities, for helping family members in need and/or education of amily members.
The family council may oversee committees of the family assembly and the chairperson of the family council may often serve on the family business’ board of directors. The family council will also often co-ordinate the family shareholders of the family business. Sometimes members of the family council can be compensated for their services.
d) Board of Directors
The members of the board of directors of a business are elected by the shareholders and owners and take decisions on behalf of the company, thereby owing fiduciary duties to the business and its shareholders. The functions of the board of directors are to recruit, supervise, retain, evaluate and compensate the senior management of the company. The board will provide the long-term vision and goals of the business together with a policy-based governance system. The board also has a monitoring and control function. Directors of the board may be held liable for the consequences of the business’ actions or inaction.
Family businesses will also often have an advisory board normally consisting of external, non-family member advisors. The advisory board and its members do not have legally binding decision-making authority on behalf of the company. The board of advisors normally provides strategic advice to the management team including the board members of a business. Businesses generally choose to have a board of advisors so they can benefit from the knowledge, network and advice of experienced outside professionals.
e) Chief Executive Officer and Senior Management
A company’s Chief Executive Officer (CEO) and senior management team run the day-to-day operations of the business. They implement the ideas of the owners and shareholders as well as the board under the direction of the board of directors. Often members of the family will be part of the staff or senior management of the family business. The general conditions for family members to be employed by the family business will normally be fixed in the family protocol.
4. Conclusion
Owners of family businesses should consider the following:
• Commit to and prepare for a successful transfer of the business to the next generation sufficiently early in order to prepare the next generation adequately.
• Jointly set-up and implement governance tools and processes ensuring a smooth generational transfer during the founder’s lifetime which plans with and around the existing social, human and intellectual capital of the family. Governance of a family business is an evolving process. The governance structure at all levels has to be adjusted regularly to the changing environment and needs of the family.
Governance of a family business is an evolving process. The governance structure at all levels has to be adjusted regularly to the changing environment and needs of the family. The proper governance structure for a family business must be adjusted to the needs of the family, the family business as well as to their mission and vision.
Copyright by René M. La Barre, Global Wealth Management Consulting GmbH, www.gwmc.ch, January 2021. All rights reserved.
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