By: Hossam Amin Fahmi, Founder&Managing Director,HA Consulting

shutterstock_641258596

Family Businesses have been the traditional way of doing private projects in most countries of the world; and have acquired a great consideration in recent years as one of the means and forms of doing private projects. There are several reasons to attract attention to Family Businesses, including the following:
• The role of socialist systems in political and economic life has diminished in most countries of the world. These systems were not only non-conducive to the growth of private investment, especially Family Businesses, but it has also led to the nationalization of some of these projects in several countries in the world.
• Reducing the role of the public sector in economic life and the growth of the privatization trend led in turn to the entry of multinational companies and some Family Businesses to acquire the public sector companies offered for sale.
• As the country believes in the role played by the Family Businesses in the economic and social development and to find a balance between the foreign companies and the national companies,these countries give incentives to the private companies, including, but not limited to, financing small projects in many developing countries. This encouraged many individuals and families to establish projects.

Before going into the discussion, we would like to agree on the definition of Family Business. Family Business is a company
in which family members have effective control over its strategic direction. The Family Business significantly contributes to
the income, wealth, name and goodwill of the family. A company can be classified as a Family Business, if it meets all or part of
the following requirements:
• Family members effectively contribute to the company’s capital.
• Family members have the majority vote in the Board of Directors or the General Meeting.
• Family members have authority or influence on the strategic trend of the company.
• All or some of the family members actively participate in management.
• More than one generation involved in company management.
• Family members’ desire or intent to continue as a family business.
In this article, we will not only discuss the specific concept of the family represented in the father, mother and children, but also extends to its broad concept to the brother, sister, cousins, and their spouses … etc.

Characteristics of Family Businesses,many of which constitute challenges:
1) The strong overlap between the affairs of the family and the company and the absence of separation between ownership and management unlike other companies. This role in turn exposes the Family Businesses to circumstances that may affect them,
to the extent that the decisions of management, who are also owners, are not fully subject to the achievement of economic objectives, for example marriage, divorce, death, or graduation of a family member and his desire to work in the company.

2) Family Businesses focus more on long term sustainability than short-term profits. Most of Family Businesses are managed to maintain, develop and deliver same to their children and grandchildren in a better position than making big profits by selling them.
For instance, a German family from the Bavarian region has an impressive proportion in the German company (BMW), and such family refused several offers from international companies to acquire its share and preferred to retain its ownership of the shares.

3) Most of the time preference will be in the appointment of employees based on personal relationships more than the efficiency, i.e. (Trustworthy persons have priority over skillful and qualified ones). But preference may also extend to giving promotions and opportunities
that are available in the company to family members or close persons.

4) Family Businesses may have difficulties in attracting and retaining employees who have special experience or those who occupy leading managerial positions for the following reasons:

• Family members or their relatives usually hold leading positions.
• There is often no career path plan for those employees.
• Low salaries and job benefits if compared to non-family businesses.
• Family members interfere with the work of competent staff and solely make decisions.

5) Relative difficulty in obtaining finance, as the owners of family businesses are often unable to attract external investors in the company, and the banks don’t finance Family Businesses, especially medium or small-sized ones compared to other companies. This, in turn, disables Family Businesses to expand, replace and renew their assets.

6) The Family Businesses’ decisions are severally taken by the founder or owners thereof.

7) Poor Governance System; for example, there is often no clear formal regulatory structure, policies and procedures manual, risk management or internal audit management.

8) There is often no plan to find an alternative or successor to the president / founder upon his retirement or death.

This is one of the most important challenges and problems that are experienced by Family Businesses and may have a fundamental impact on their future course. This problem is not limited to Family Businesses, but it also extends to major global companies.
However, this problem is more acute in the Family Businesses for the following reasons:
1- The difference in the method of work and the strategic vision among the different generations in the family between those who lead or manage the company and its successor, while we believe that the difference in the strategic vision and the method of work may
have several advantages and may enrich the performance of the company if it is contained and managed in a proper manner.
2- Due to the family ties that exist between the members of the family that owns the company and some of whom are overlapping in the management, the family members do not express their expectations, feelings and need to the chairman of the company or founder
fearing conflicting with one of the other members of the family who is close to him and the impact on family relations.
This leads to adopt an indirect and informal style of communication among family members.
3- It is difficult to agree on the right person who will succeed the chairman or founder. Several discussions often occur on this subject and may sometimes reach to wrangles. Family members often accept decisions of the founder when he is at the head of the company even if it
is inconsistent with those decisions, but the person who heads the company and succeeds the founding president may not enjoy the same advantage, which may create more challenges for subsequent generations of family members who run the company. The problem of choosing the right person from the family, especially when the family is a big one and there are several sons of several wives, may increase, creating more sensitivity in choosing the right person that succeeds the retired president.
4- Inability and reluctance of the founding chairman of the company in the delivery of the leadership of the company to his successor. This is often the case for many reasons, the most important of which is his desire to not lose control over the financial and operating decisions of the company or due to the low income that he will obtain after retirement or he is not convinced of the existence of the right individual to
succeed him.

Challenges Experienced by Family Businesses’ Auditors:

1) The auditor’s role as the agent of the shareholders is considered one of the most important roles when the ownership is separated from the management. However, in the Family Businesses as mentioned earlier there is no clear separation between ownership and management, and therefore the project owners do not appreciate the role played by the auditor.
2) The auditor faces more difficulties upon conducting discussion with the management as to the settlement process resulting from his audit, and also if the report is conservative. Moreover, the matter may extend to non renewal of the auditor’s appointment, if the auditor insists on
the adjustments or his conservative report.
3) The poor internal control system exists in such Family Businesses which management deviates from the internal control systems, if any. This leads the auditor to not rely on internal control systems, which increases the period and cost of audit.

Some suggested recommendations for addressing the challenges:

The existence of the family council encourages and helps all members of the family to deal in a responsible manner with regard to their company without the introduction of non-economic factors in the decisions. The need for the family council increases when the size of the
family becomes large, to the extent that it is difficult to communicate and meet with each other and reach decisions.

The International Finance Corporation,a member of the World Bank Group, has defined the Family Council as the body to be elected by the Family Assembly for consultation and study of matters related to the Family Business and may also be called “Family Advisory Council” or the Family Executive Committee. The Family Council shall:

be the primary link between the family and the Board of Directors of the company and the senior management of the company;
• suggest and discuss names of candidates for membership of the Board of Directors;
• determine and review the strategic vision of the company and its mission; and
• determine and review family policy regarding the family members’ employment, and their contribution to the company.
When the Family Council is elected by the Family Assembly, criteria can be set for the elections. For example, there shall be a representative in the Council for each family branch represented by several generations of the family, i.e. the first generation, the second generation and the third generation, and there shall be criteria for electing/not electing those who have a close relationship with family
members, and the rules of women and men representation.

The topics that can be discussed and decided by the Family Council, include, but not limited to, the following matters:

  • The policy of distributing profits and making balance between the material needs of family members and the financing needs of the company.
    • The training needs of family members, especially when they have the ability to act as successor or substitute for the
    founder.
    • The policy related to the purchase and sale of family shares and the valuation method of shares that may be traded among members of the family.
    • Discussing and selecting a shortlist of those who have the qualification, experience and ability to lead the company in the future as a successor of the current chairman
  • Discussing and selecting the alternative to the current chairman when he retires.
  • Discussing the possibility of creating a fund to support and adopt any ideas or suggestions made by family members regarding their company or related to new investment opportunities for the family.
  • Discussing whether the company will continue, be sold or a special or public offering process will be made.

In this regard, it should be clarified that the Family Council is an illegal entity and therefore it is not a substitute for the company’s board of directors, but rather it is complementary to it. As mentioned above, it is the link between the company owners and the company’s board of
directors.
The Family Council shall have a President and a Secretary of the Council and shall include up to nine members.
Other proposals to regulate the role of family members and their involvement in management are the preparation of a charter or constitution for the family.
Ivan Lansberg defined the family constitution in Succeeding Generation as “an official charter or book prepared with the cooperation of all members of the family to include the values, beliefs and objectives of the family in relation to their relations with each other and how they deal with the company or companies that they own.”

There are several advantages benefiting the family members and the companies they own, when there is a family constitution, as:

  • During the period of preparation of the provisions of the Constitution, all members of the family even those who do not interfere in the management of the company shall be involved.
  • This increases communication among them and their sense of belonging to the family and to the company, which has a positive impact on the company.
  • The existence of a family constitution helps avoiding disputes among members of the family and preventing the misunderstanding, as it explains the roles of people who are interfering in the management and others who have no right to interfere in the management.
  •  The existence of a family constitution with the elected Family Council sets the expectations of the second generation and the third generation of family members in its proper framework and governs their intervention in the management as per standards specified in advance.
  • The contents of the family constitution are the strategic objectives of the family in relation to their companies, values, beliefs, family mission, family members employment policy, method and rules for nominating a member of the family for leadership positions.
  • Method and way of trading shares of the company among members of the family and the basis of evaluation.
  •  Method of resolving any disputes that may arise among family members.
  •  Time of accepting an external investor or making a private placement or public offering.

Finally, we discussed the characteristics of the Family Businesses and the challenges they face. Then we addressed the challenges

facing the auditors of these companies and then presented some suggestions to overcome the challenges experienced by the Family Businesses to ensure long term sustainability of these types of companies because they have a positive impact on the economic and social life of the country.