Governing Your Family Business

Every family business, no matter its size or age, needs a system of governance that ensures its success, prosperity, and continuity from generation to generation.

Without a clear and consistent method of governing your family business, you run the risk of becoming a statistic – currently, only 40 percent of family-owned businesses make it through the end of their second leadership generation.

Plus – a mere 12 percent survive to the third generation, only 3 percent last through the fourth, and less than 1 percent of family businesses actually make it to a fifth generation of family leadership.

We don’t want you to be a statistic. Instead, with a strong governance structure in place, we want to see your family business succeed for generations to come.

A good system of governing your family business will address the following areas:

  • Decision-making and control
  • Types of boards
  • Inclusion of independent board members
  • Communications
  • Formal agreements

Here’s how.

Decision-making and control

A sound governance system will address who makes decisions and by what process.

For example, your ownership structure can be inclusive or exclusive – in an inclusive ownership model, you have shared ownership, while exclusive ownership typically concentrates ownership to one or two individuals.

In an exclusive ownership model, decision-making usually rests with the owners or partners.

In a sole ownership, the one family owner typically makes all decisions, without necessarily conferring with the rest of the family. This model isn’t uncommon for family businesses that are fairly young.

But as a family business matures, it’s not unusual to see ownership distributed among family members, which means a different decision-making model is necessary.

In this case, we often see family businesses with full boards of directors and shareholders with voting power, which spreads out the responsibility for decision-making.

There’s no one-size-fits all model for decision-making: you’ll need to identify the most effective model for your family business.

But whatever you choose, it’s essential to make sure everyone is clear on which decisions are made by the family, which are made by the board, which decisions are the responsibility of shareholders and which ones rest with your management team.

Types of boards

When it comes to implementing board governance, we typically see four different kinds of boards associated with family businesses.

First, there’s the informal advisory board – this is an advisory group that provides informal advice to management and business owners, usually on an as-needed basis. This entity has no legal authority over business operations and holds limited liability. You’ll find that this type of board is easy to implement and flexible.

Next, there’s the formal advisory board – this advisory team meets regularly to provide advice to both shareholders and executives, and is usually made up of subject matter experts in areas like marketing, technology or finance. Like the informal advisory board, a more formal board holds no legal authority over business decisions.

Third, you have more formal fiduciary boards. This group of directors is legally empowered to make board-level decisions about your family business. This kind of group often is called upon to make tough business decisions. They also have a legal responsibility to pursue shareholders’ best interests, and if needed, they can step in to provide interim organizational leadership.

In some cases, we also see boards that function as an advisory/fiduciary hybrid, offering guidance and advice while also operating with the best interests of shareholders in mind.

Why you need independent board members

We find that sometimes family business owners balk at the idea of appointing board members from outside the family. And that’s understandable – it can be hard to open up your family’s legacy to outsiders.

But if you’re playing the long game, there’s some pretty compelling research indicating that the more independent board members you have, the more effective their governance is likely to be. In fact, effectiveness ratings improve from just 50 percent with all-family boards to 96 percent for boards with a majority of independent members.

If you think about it, this makes sense. If you include only family members on your board, you’re more likely to create an echo chamber. Instead, it behooves you to add outside subject matter experts who bring different perspectives, new ideas, new methodologies, and different points of view.

Communications

Throughout the governance process, good communication is essential.

As early as possible, define how you’d like communication to flow among the family, the board, the shareholders, and the management team.

The more you transparently communicate, the higher your level of trust and accountability will be. And as your business grows, it becomes even more important to include different modes of communication to ensure that everyone is clear on expectations and goals. Eventually, your business may have the need for a full communication plan that supports your strategic plan.

Formal agreements 

We generally recommend two types of formal agreements for family businesses.

First is the family constitution. This document outlines the legacy of the business, providing alignment with the overall company vision. This agreement highlights important values and ethics that the family holds for the business and provides a sense of responsibility for the family to uphold its brand.

In addition, you’ll need formal, legally enforceable documentation that codifies the mechanics of business ownership. These types of documents include bylaws, formation documents and shareholder agreements.

Governing a family business can be simple, but it’s never easy.

If you’d like to learn more about how our experienced family business advisors can help, please set up a consultation call today. We’d love to help.

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