According to studies, 95% of family-owned businesses don’t survive beyond their third generation of ownership. In most cases, this is a governance issue—either the lack of it or the failure to observe good governance in family-owned businesses.
On a positive note, though, more companies today are family-controlled. For instance, up to 74% of manufacturing companies in India are family-owned businesses. Moreover, these businesses contribute to up to 25% of the country’s GDP.
On the other hand, 49% of manufacturing companies in Germany are family-owned and contribute to up to 49% of the country’s total revenue. Meanwhile, the percentage represented in Indonesia is 48%, and the contribution to the country’s GDP is 10%.
But as good as such stats are for family-owned businesses, why do most not go beyond the third generation? Well, the challenges are clear. We’ve got to look at issues like family conflicts, lack of transparency, poor communication, succession planning failure, and lack of proper development, which result from poor governance.
Poor governance is also manifested through unclear roles and responsibilities of those taking the lead, an unclear decision-making process, and unclear future direction. Proper governance is urgently needed to overcome these challenges, and that’s where this guide comes in.
We’ll address how family-owned businesses can implement governance and its importance. We’ll also look at the best family governance structures, the elements to consider, and the challenges family-owned companies must overcome when adopting governance. Let’s dive in!
Key Takeaway:
- Family governance describes how a family-owned business is controlled. It’s a structured set of rules and principles that run a family-owned business.
- Family governance is essential in separating power, defining ownership, succession planning, enhancing accountability, transparency, proper financial management, decision-making consistency, conflict resolution, merit-based recruitment, cultural and social responsibility, and wealth protection.
- Common examples of modern-day family governance structures include family assembly, family council, board of directors, advisory board, and family office.
- Critical elements of an influential family governance structure include the family constitution, shareholders’ agreement, and family fund.
- The process of establishing family governance involves defining the mission and core values, creating the family constitution, instituting the board of directors, establishing a family council, and developing the shareholders’ agreement.
- Family governance may face challenges related to succession planning, balancing family and corporate interests, and casual governance structures.
- Family governance success depends on a family business’ ability to assess (its needs and goals), reflect (on its vision and values), align (its vision with its core values), discuss (the management of the family wealth), design (the governance structure), educate (members on corporate governance), engage (the next generation), and reassess (its governance framework).
- Sound family business governance principles include collaboration, competence, objectivity, integrity, diligence, transparency, professionalism, and independent oversight.
What is Family Governance?
Family governance refers to the processes and principles that govern how a family-owned business is run. It gives the family business a formal forum and framework for running its corporate affairs and separating them from family matters.
Family governance ensures transparency into the family business’s operations and performance, open communication among family members, and an increased level of accountability and responsibility by the members.
Furthermore, it helps to identify and groom suitable candidates from the family who can ensure a smooth succession planning process to foster business continuity across different generations.
Importance of Governance in Family-Owned Businesses
Good governance benefits family-owned businesses in several ways, which include the following:
1. Separation of Power
Governance structures clearly define the roles and responsibilities of all family members. There’s clarity on the powers that each has, and lines are drawn between the ownership and management so that each of them can do their job.
2. Defined Ownership
Governance establishes boundaries for family members’ control over the family business, stopping them from overstepping their limits. More importantly, everyone feels a sense of ownership as the shareholder’s agreement defines their ownership rights.
3. Succession Planning
Proper governance leads to adequate succession planning. Everyone is clear about who is in line to take up what position within the board, family assembly, and family council, ensuring the smooth continuity of the family business.
4. Enhanced Accountability
Good governance facilitates open communication, transparent reporting, and defined responsibilities, making family members more accountable.
5. Transparency
One reason most family-owned businesses fold up quickly is the lack of transparency. With corporate governance, however, there’s clarity on policies, employee benefits, committee membership, and stakeholders’ involvement, which bolsters the chances of the family business succeeding.
6. Proper Financial Management
Lack of governance is a major explanation for the lack of transparency in monetary reporting and misuse or misappropriation of funds in family-owned businesses. However, with proper governance, there is transparency, accountability, and responsibility regarding funds administration.
7. Decision-Making Consistency
When running a family business, it’s never easy to make consistent decisions regarding finances, succession planning, liquidity, investments, and partnerships. Nonetheless, a solid family governance structure ensures consistency in decision-making, as the family leadership consults widely before rendering a verdict.
8. Conflict Resolution
Governance promotes harmony among family members involved in the family business by promoting the separation of power and defining ownership. The shareholders’ agreement clearly outlines the policies for resolving disputes. At the same time, the family constitution defines all members’ roles and responsibilities to avoid conflict.
9. Merit-Based Recruitment
With governance, family members aren’t hired, promoted, or compensated based on familial relationships. They enjoy such privileges because they deserve them on merit. It’s about competence and qualification.
10. Cultural and Social Responsibility
Proper governance dictates that a family business observe the necessary ethical and cultural practices. There’s no room for noncompliance, and such a high level of cultural and social responsibility improves the business’s corporate image and stakeholder relationships.
11. Wealth Protection
Clear governance structures help manage the family’s wealth and boost its financial well-being. They also ensure that the family members in authority leave a lasting legacy to the next generation.
Modern-Day Examples of Family Governance Structure
Family-owned businesses employ different structures to govern their operations in today’s corporate world. Here are the most typical categories:
a) Family Assembly
A family assembly is a family-only governance body that focuses on and addresses issues that are core to the family and its business ownership and operations. The family assembly’s agenda may extend to familial-focused matters like family vacations and philanthropy or business-focused topics like employment policies, council members’ appointments, and membership rights.
b) Family Council
A family council offers a platform where family members can convey their needs, expectations, and values and develop policies and regulations that protect the family’s interests, culture, and key values.
The council makes decisions on policies relating to the convergence of the family and its business ownership rights, including succession planning, family employment, conflict resolution, and liquidity.
c) Board of Directors
The board of directors is the honest intermediary between the company’s ownership (the family) and management. It offers a disciplined forum for healthy corporate debates and effective decision-making. Overall, the board balances stakeholders’ interests and strategic planning.
d) Advisory Board
An advisory board is an external board that provides expert counsel to the board and the top management on business affairs. They’ve extensive knowledge in their area of expertise to offer objective-driven, independent oversight.
e) Family Office
The family office is a group of experts who administer and manage the family wealth. The group serves as an investment advisory entity and performs administrative duties like bookkeeping and travel arrangements.
Elements of an Effective Family Governance Structure
In addition to establishing the correct governance structure in place, family-owned businesses need to observe these elements:
a) Family Constitution
A family constitution is a structured document that outlines the family business’s core principles, values, and policies. It is usually the contact between the ownership and the family business and the foundation for making critical business decisions. Additionally, it’s the road map for the family members’ key roles and responsibilities.
b) Shareholders’ Agreement
The shareholders’ agreement defines the obligations and rights of individual shareholders, including their voting rights, ownership rights, and dividend policies. This document governs the relationship between individual family shareholders and the family business. Furthermore, it helps to settle disputes and facilitates smooth succession.
c) Family Fund
A family fund has a particular percentage allocation of the company’s dividend distribution. It is often established to promote financial equity among family members and support family charity initiatives.
How to Establish Governance in Family-Owned Businesses
Generally, here are five key steps instrumental in establishing good governance in family-owned businesses:
Step 1 – Define the mission and core values
What are the family company’s mission and core values? Answering this question helps underpin the family’s involvement in the business. It offers a shared vision for the members’ collective effort. The mission and core values should be well articulated and relayed among the family members.
Step 2 – Create the family constitution
Once the family’s mission and core values are articulated, the next step is to document them formally, and that’s where the family constitution comes in. The constitution also comes in handy in outlining key company policies and principles that run the company.
Step 3 – Form the board of directors
With the family constitution in place, the business should form an oversight body to look after the family’s interests and those of stakeholders. That’s where the board of directors comes in.
The board comprises family executive members, non-family executives, and outside/independent directors. Remember, however, that everyone on the board of directors should be there on merit.
Step 4 – Establish a family council
After the board of directors is established, the family council is established. This council represents the family’s interests in the business and offers a forum for communication, dispute resolution, and momentous decisions.
Step 5 – Develop the shareholders’ agreement
Lastly, the family company should draft its shareholders’ agreement outlining the business ownership structure. It should include dispute resolution mechanisms, define the company’s dividend policies, and specify distribution criteria. Moreover, it should indicate the dividend payout frequency and any restrictions.
Common Governance Challenges in Family-Owned Businesses and Solutions
Family governance can be challenging, and family-owned businesses should expect a few hiccups when implementing the correct governance structures. Here are the notable challenges:
a) Succession Planning
Sometimes, it’s never easy to pass power down to another person, even if they are part of the family. This happens to parents who might think their kids aren’t ready or responsible enough to take up critical responsibilities in the family business.
Some family members are not ready for change, and their resistance to change makes it hard to ensure smooth succession. In other cases, it’s a case of sibling rivalry or any other form of family conflict.
The Solution:
Whatever the reason behind the succession hiccups, it helps to identify successors early enough and make it known across the family. The potential successors should also be adequately groomed to take the mantle when the time is right. Additionally, it helps to seek external advisors who can help streamline the succession process.
b) Balancing Family and Corporate Interests
It’s never easy to balance the affairs of a family business with personal interests. Conflicts may stem from business strategy, resource management, and financial priorities. In the end, family members may find it hard to reach a consensus.
The Solution:
These challenges can be overcome by instituting a competent family council to handle internal conflicts or consulting an external mediator who can offer an unbiased assessment. Moreover, it helps to have clear policies inscribed in the family constitution.
c) Casual Governance Structures
Family businesses are less formal and, as a result, may find it challenging to adopt proper corporate governance frameworks. That’s unlike non-family-owned companies, which have formal structures for everyone to follow.
The Solution:
This problem is fixed by improving the family business’ governance structure by establishing outside boards, instituting reporting standards, and streamlining the decision-making process.
8 Must-Dos for Successful Family Governance
A family business can successfully establish a corporate governance framework if it does the following:
- Assess: The family should assess its needs and goals to tailor them to its corporate governance structure.
- Reflect: The family should reflect on its vision and values to understand what the family means to them, what they would love to do as a family, and what they should do separately.
- Align: Upon reflection, the family should align its vision with its core values. At this point, the family members are likely to have shared values that are likely to align with the vision.
- Discuss: Family members should talk to each other about managing the family’s wealth. This also means disclosing the family wealth to younger generations, who will eventually be expected to take up key positions in the family.
- Design: The family should develop a governance structure with clear roles and responsibilities and internal communication protocols that align with the vision.
- Educate: The family business should continually educate its members on corporate governance and business management.
- Engage: The family business should engage the next generation in its affairs. The next generation should be groomed early to be ready to take up leadership and corporate management responsibilities when the time is right.
- Reassess: Lastly, the family business should assess its governance framework to maintain its cohesiveness and ensure it incorporates new perspectives promptly.
Basic Principles of Good Governance in Family-Owned Businesses
Principles run every business, and family-owned businesses are no exemption. These principles are crucial to observing good governance, and they include the following:
- Collaboration: Family members should collaborate in all matters relating to the family business and wealth. They should consult each other in their capacities, depending on their roles in the business.
- Competence: Decision-makers in a family business should be well-informed, qualified, and proficient to render the right decision. In order to ensure that’s the case, the criteria for making key appointments, especially by the board, family assembly, or family council, should be clear.
- Objectivity: The family should apply facts and rational thinking when deliberating on anything that affects the family business. Doing so prevents emotional sway and cognitive biases that could impair decision-making.
- Integrity: Integrity is a core principle elemental to building trust among family members. It ensures that all family members observe the agreed ground rules and regulations and are more accountable for their actions.
- Diligence: All family members with responsibilities in the family business should work hard to fulfill their obligations and consistently demonstrate diligence whenever an issue touches the family business.
- Transparency: Family members must not have hidden agendas or prompt suspicion. They should observe honesty to encourage the seamless running of the business and decision-making process.
- Professionalism: Utmost professional conduct is highly advisable when observing governance in a family business. As much as it’s a family business, the family members should know how to separate work from family affairs.
- Independent oversight: The family needs an exterior eye to monitor its governance. Thus, the business must include independent directors to offer unbiased insights and hold the family executives accountable.
Where the Center of Corporate Governance Comes in
As a premier corporate governance institution, the Center for Corporate Governance understands the importance of good governance in family-owned businesses and how to marry the two worlds. We run a monthly corporate governance training that specifically addresses that.
Our corporate governance training is tailored to address issues such as emerging trends in corporate governance, practical corporate governance principles, effective board meetings, ESG, enterprise risk management, ethical leadership, strategic direction setting, board responsibility, and corporate governance reporting.
This training promises to deepen your understanding of corporate governance and sharpen your business leadership excellence. It’s educational and interactive, underscored by expert insights, future-ready frameworks, and massive networking opportunities. Check it out on our website!