By: Arif Zaman

Edited by: Meenakshi Rezdan


Family business 2A family business refers to a company where the voting majority is in the hands of the controlling family. Several studies have shown that family owned companies out perform their non-family counterparts in terms of sales, profits and other growth measures.1  Some of their strengths include commitment from family as business owners, willingness to pass knowledge and experience, willingness to work harder and reinvest in the business, family name and pride associated with the business. 2

 

It is also a fact that most family businesses have a very short life span beyond their founder’s stage and that 95% of the family businesses do not survive the third generation of ownership. 3 Main reason for this being complexity, informality due to absence of articulated practices and procedures and lack of discipline.4

 

The evolution of family business can be projected into three stages; the founder stage, the sibling partnership stage and the cousin confederation stage.5 In the founder stage, the business is entirely owned and managed by the founder. In the sibling partnership stage, management and ownership is transferred to the children of the founder. In the cousin confederation stage, the business governance becomes more complex as more family members are directly or indirectly involved in the business, including children of the siblings, cousins, and in laws.

 

Each stage brings with it unique governance challenges. The following table summarizes the key family governance issues faced by family businesses during their development cycle: 6

 

Stage Issues
The founder stage
  • Leadership transition
  • Succession
  • Estate planning
The sibling partnership
  • Maintaining team work and harmony
  • Sustaining family ownership
  • Succession
The cousin confederation
  • Allocation of corporate capital; dividends, debt and profit levels
  • Shareholder liquidity
  • Family conflict resolution
  • Family participation and role
  • Family vision and mission
  • Family linkage with the business

 

Six steps that can help family businesses to attain business continuity are-

 

Step 1: Establishment of Family Constitution

The family constitution is a statement of the principles that outline its commitment to core values, vision and mission of the business. It’s a living document that evolves as the family and its business continue to grow. A typical family constitution will cover the following elements:

  • Family values, mission statement and vision
  • Family institutions such as family assembly, family council, education committee and family office
  • Authority, responsibility and relationship among the family, the board and the senior management etc.

 

Step 2: Forming Family Governance Institutions

Family governance institutions help strengthen the family harmony and relationship with its business. Deciding what type of institution to establish will depend on the size of the business, the family’s stage of development, the number of existing family members and the degree of involvement of family members in their business.

  • Family Assembly; It is a formal forum, which meets 1 or 2 times in a year, to discuss business and family issues. Family assembly is open to all family members, with some restriction such as minimum age, participation of in-laws and voting rights. Its role is to approve family vision, values, family related policies, election of committee’s member etc.
  • Family Council; It is the governance body for the assembly. Family council comprises of 5 to 9 members elected by the family assembly and meets 2 to 6 times in a year. Its role is to act as bridge between family, the board and senior management, suggest name for board candidate and formulate family polices etc.
  • Family Office; It is an investment and administrative center that is organized and overseen by the family council. It looks after family member’s personal investment, taxes, insurance coverage, estate planning, career counseling and other areas of interest to individual family members. This is managed by professionals.
  • Other Family Institutions; Depending on size, the family business can have education, share redemption, career planning, family reunion and recreation committees.

 

Step 3: Establishment of Advisory Board and Board of Directors

As the family business gets more complex, it becomes necessary to establish two boards, the Advisory Board and the Board of Directors. This allows the family business to become more organized and well-focused.

  • Advisory Board; the advisory board is a group of experienced and respected individuals outside the family. The members of the advisory board are usually experts in the family business industry and market or in other areas such as finance, marketing and international markets. Over a period of time and once the family sees the added value of the advisory board, some of its members are often invited to join the Company’s BoDs.
  • Board of Directors; in family business, BoD constitutes of family members and company senior managers. The BoD look in to the matters of strategy, succession planning, finances, internal controls, risk management and reporting to the owners and other interested parties. The presence of independent directors in the Board can play a vital role in the board meetings. Independent directors can bring an outside perspective on strategy and control.

 

Step 4: Developing Family Member Employment Policy

Many family businesses that didn’t set up clear employment policies for their members end up with more employees from the family than the company needs. As the family business reaches the sibling partnership stage of growth, it becomes necessary to formalize the family members’ employment policies. This would require setting up clear rules about the conditions of entry, staying, and exit from the business. The policy should also cover the treatment of family member employees in comparison with non-family employees.

 

Step 5: Succession Planning

Many family businesses put off the succession planning of their senior managers until the last minute, which leads to crisis. This could indeed be one of the reasons most family businesses disappear before they reach their third generation.

Effective succession plan should allow for the selection of the most competent person, whether it is a family member or not. In addition, it is crucial to involve all family members, the board, key senior managers and other important external stakeholders in the selection process and make sure they agree on the next choice.

 

Step 6: Exit Strategy of Family Member

There should be clarity over the mechanisms that allow family members to sell their shares if they prefer to exit from the family business. Preparing an exit strategy well in advance helps avoid many conflicts and increases chances of business continuity.  Some family businesses establish a “Shares Redemption Fund” in order to buy back any shares that family members would like to liquidate. The Fund is usually financed by contributing a small percentage of profits to it every year.

 

Conclusion

These initiatives are not exhaustive but are some of the fundamental factors crucial for business sustainability. Studies suggest that family businesses that demonstrate good corporate governance not only enjoy greater longevity, but improve efficiency, effective risk management and greater rewards for all stakeholders.

 

References:

  1. Denis Leach and John Leahy, “Ownership Structures, Control and the Performance of Large British Companies”, Economic Journal,
  2. Sir Adrian Cadbury, Family Firms and Their Governance: Creating Tomorrow’s Company from Today’s (Egon Zehnder International, 2000); John Ward, “The Family Business Advantage: Unconventional Strategy”, Families in Business,
  3. The Family Business Network, www.fbn-i.org/fbn/main.nsf/doclu/facts.
  4. “IFC Famaily Bsuiness Governance Handbook”, Third Edition, 2011.
  5. John Ward, Creating Effective Boards for Private Enterprises (Family Enterprise Publishers, 1991); Kelin E. Gersick, John A. Davis, Marion McCollom Hampton, Ivan Lansberg, Generation to Generation: Life Cycles of the Family Business (Harvard University Press, 1997).
  6. John Ward, Creating Effective Boards for Private Enterprises (Family Enterprise Publishers, 1991).

 


ARIF ZAMAN ACCA, CIA, CISA, CPA, CFE, CCSA, CRBA, CRMA is a Group Senior Internal Auditor at HSA Group based in Dubai, UAE.

To comment: arifzaman786@yahoo.com