Family Enterprises: choosing the right Governance Model
GETTING ACQUAINTED WITH THE GOVERNANCE MODEL SYSTEM IN THE CONTEXT OF A FAMILY BUSINESS
At the end of this module you will be able to:
01 identify different Governance Model for Family Business
02 recognize the main issues related to Governance
03 see the connection between the Governance model and the relationship between FB and the stakeholders
04 identify the right Governance model for your FB
Governance Model for the Family Business: what is it?
A Governance Model is the organizational and strategic system that favors the dynamic achievement of two objectives: the ability of the owner family to express a clear vision of the future of the controlled business; the possibility of management (whether composed of family members or not) to realize this vision using the best resources available on the market.
A good Governance Model is also a system that allows the family business to prevent and address any causes of conflict, such as: low communication among family members, communication between managers and family members, succession, remuneration, sibling rivalry, intergenerational rivalry, dividend policy, valuation of the company, legal issues.
The Governance Model depends very much on the stage of growth of the Family Business and it is strictly connected to the peculiar issues linked to each stage.
It is possible to say that the family governance is a combination of structures, processes and family agreement.
Structures: set of executive, decision-making, management and advisory bodies
Processes: set of activities and initiatives which, despite having different characteristics, are united by the pursuit of the common growth objectives of the company
Family agreement: Set of principles and/or rules that establish how to configure and manage relations between the owner family (or families) and the controlled company. It is a tool for directing, orienting and guiding the behavior of families to preserve family and ownership unity and cohesion; it contributes to the success and development of the company.
Different kinds of Governance Issues for different kinds of Family Businesses
In order to understand the governance systems, it is important to have clear in mind that these vary based on the stage of growth of the family business and the characteristic issues each stage face the most.
The evolution of ownership and management within most family businesses goes through the following stages:
The Founder(s) (Controlling owner(s)): the initial step of the family business’ existence. The business is entirely owned and managed by the founder(s). Most founders might seek advice from a small number of outside advisors and/or business associates but they will make the majority of the key decisions themselves. This stage is usually characterized by a strong commitment of the founder(s) to the success of their company and a relatively simple governance structure. This stage contains limited governance issues compared to the next two stages since both the control and ownership of the company are still in the hands of the same person(s): the founder(s). The most important issue that will need to be addressed during the life of the founder(s) is succession planning.
Sibling Partnership: This is the stage where management and ownership have been transferred to the children of the founder(s). As more family members are now involved in the company, governance issues tend to become relatively more complex than those observed during the initial stage of the business’ existence. Some of the common challenges of the sibling partnership stage are: maintaining siblings’ harmony, formalizing business processes and procedures, establishing efficient communication channels between family members, and ensuring succession planning for key management positions.
Cousin Confederation: At this 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. Since many of these members belong to different generations and different branches of the family, they might have diverse ideas on how the company should be run and how the overall strategy should be set. In addition, any conflicts that existed among the siblings in the previous stage would most likely be carried to the cousin generation as well. As a consequence, this stage involves most family governance issues. Some of the most common issues that family businesses face at this stage are: family member employment; family shareholding rights; shareholding liquidity; dividend policy; family member role in the business; family conflict resolution; and family vision and mission.
From first to second and third stage: Most family-owned companies are successful during their infancy stage thanks to the tremendous efforts made by the founder(s) as they are implicated in all aspects of the business. In the longer term though, it becomes necessary to set up the right governance structures and mechanisms that will allow for efficient communication channels and a clear definition of the roles and expectations of every person involved in the family business.
The adoption and development of a governance model must be a thoughtful process, which requires time in order to be shaped to its optimal system. There are many risks a family business can encounter, originating also from the family business’ own history, and they may include: closure of the company to external expertise, leading to limited attractiveness and poor valorisation of external managers; totalitarian control, resulting on a sub-optimal size of the firm; risk aversion, which slows down the family business on the path to innovation; merging of company and family assets, resulting in an improper use of company resources.
When dealing with a family business, there is the actual risk of appointing the wrong figure (maybe just because belonging to the family) to the wrong role. It is necessary to acquire a detached attitude, in order to evaluate in an impartial way the characteristics, knowledge and abilities necessary to carry out a certain role within the family business, and sometimes the best strategy is to hire an external and independent person.
Complexity. Family businesses are usually more complex in terms of governance than their counterparts due to the addition of a new variable: the family. Adding the family emotions and issues to the business increases the complexity of issues that these businesses have to deal with. Unlike in other types of businesses, family members play different roles within their business, which can sometimes lead to a non-alignment of incentives among all family members;
Informality. Because most families run their businesses themselves (at least during the first and second generations), there is usually very little interest in setting clearly articulated business practices and procedures. As the family and its business grow larger, this situation can lead to many inefficiencies and internal conflicts that could threaten the continuity of the business;
Lack of Discipline. Many family businesses do not pay sufficient attention to key strategic areas such as: CEO and other key management positions’ succession planning, family member employment in the company, and attracting and retaining skilled outside managers. Delaying or ignoring such important strategic decisions could lead to business failure in any family business.
UNDERSTANDING THE NEED TO APPLY A GOVERNANCE MODEL TO THE FAMILY BUSINESS
Governance model: why is it important to develop it? A strategic choice
The governance model must favor the consolidation of the values of the family business decreasing conflict and facilitating the generational shift.
The implementation of an effective governance system allows significant benefits such as: helping entrepreneurial families to grow their business while reducing the level of risks; help families entrepreneurs to define a clearer distinction between personal property of the family and assets of the business; allow the family business to be more trustworthy in the eyes of banks, customers, suppliers and more generally international markets; attract and define a solid collaboration with managers independent from the family environment, also in order to increase the international competitiveness of family businesses; act as a useful compass in the management of generational handover processes; for businesses potentially interested in opening up to the stock or bond markets, acclimatize to the processes of governance envisaged in these contexts.
The adoption of an advanced governance model, inspired by the principles of balancing of powers and representation of the interests of the company in compliance with all the other stakeholders’ interests, owners and not, and aimed at ensuring continuity and growth, should characterize the concept of a healthy and responsible entrepreneurship.
Together with the organization of an effective succession plan, the set up and consolidation of a good governance model is a factor which may determine the longevity of the family business: it is a fact that most family business have a short life span beyond their founders’ stage and that some 95% of family business do not survive the third generation of ownership. In most cases, their failure can be attributed to the total lacking or a severe malfunction of the governance model.
An effective governance plan can support and highlight the innate strengths of a Family Enterprise:
- Commitment. The family, as the business owner, shows the highest dedication in seeing its business grow, prosper, and get passed on to the next generations
- Knowledge Continuity. Families in business make it a priority to pass their accumulated knowledge, experience, and skills to the next generations
- Reliability and Pride. Because family businesses have their name and reputation associated with their products and/or services, they strive to increase the quality of their output and to maintain a good relationship with their partners
Stakeholders: who are they and how do they benefit from a good Governance Model?
Employees. The adoption of an advanced governance model, which represents a correct balance of powers and requests (considering also the top management figures), represents a guarantee for all employees, especially in family-controlled realities with less advanced management systems. This is especially important for those family businesses where the implementation of human resource management policies that protect career expectations are lacking, and an adequate space for merit must be developed. A good governance model can encourage the attraction of managerial talents external from the family. At the same time, a more balanced system of governance is capable of ensuring a better and more fruitful dialogue with employee’s representatives.
Banks and lenders. The adoption of more structured and advanced governance mechanisms facilitates the achievement of the following two basic objectives that responsible ownership should pursue: clearly distinguish the company's resources from the entrepreneur's personal resources, even if the company is small size; ensure transparent, rapid, timely and complete disclosure with credit institutions, as the creditworthiness is positively influenced by accurate and exhaustive data.
Suppliers and Customers. It is essential that relationships of trust, clear contractual relationships and correct payment arrangements are established with both suppliers of products and services, and with customers. A correct and balanced governance system can guarantee numerous advantages in essential business relationships for every family business, in terms of: greater trust on the part of suppliers about the solidity and the solvency of the company over time, and of customers side about the correctness, ethics, legality of the company's operations; a better agreement of the contractual conditions towards both suppliers and customers, by reason of a more balanced internal decision-making process.
GETTING PRACTICAL – DESIGNING THE PATH TO DEFINE THE GOVERNANCE MODEL
Evaluate the stage of the Family Business
Governance does not happen overnight. It is an evolutionary process that needs a very careful and patience analysis. We have learnt that the selection and development of the right governance model depend very much on the life stage of our own Family Business, on the willingness to expand the business, maybe at international level, and on the capacity to be innovative in the market.
What kind of Family Business are you?
Are you a “Simple Family Business” (first and second generation) or are you an “Advanced Family Business” (from the second/third generation onwards)???
Simple Family Business → the Governance model is based on good, strong relationship within the family and on regular family meetings. The involvement of externals might be sufficient at counselling level.
Advanced Family Business → family meetings are not sufficient, the business needs more complex structures (boards, committees, agreements) and the involvement of independent/external professional, who can determine the decisive development of the company with their expertise.
Defining our governance model
Once we have clear in mind the stage of growth of our Family Business and therefore we know which level of complexity we should reach with our governance model, we cannot forget that the Governance structure needs to be:
Governance systems are a dynamic set of tools and it’s important to review them regularly to ensure that they continue to be appropriate and relevant at given points in time and, most particularly, during times of significant change.
Keep in mind that a Family business is an ecosystem involving three main systems: Family, Business, Ownership. One of these three components can be predominant and, if it is strongly unbalanced, it can jeopardize the development and survival of the Family Business itself.
While overlapping in some spheres, each component has its own goals, priorities and dynamics and the long-term success of family business systems depends on how well each group functions and supports the others.
Remember, you can always benefit from the consultation with experts in the field.
Family Constitution & Family Institution
The family constitution is a statement of the principles that outline the family commitment to core values, vision, and mission of the business.
The constitution also defines the roles, compositions, and powers of key governance bodies of the business: family members/shareholders, management, and board of directors.
In addition, the family constitution defines the relationships among the governance bodies and how family members can meaningfully participate in the governance of their business.
The family constitution is a living document that evolves as the family and its business continue to evolve. As a consequence, it is necessary to regularly update the constitution in order to reflect any changes in the family and/or the business.
Family governance institutions help strengthen the family harmony and relationship with its business. By allowing family members to get together under one or more organized structures, family institutions increase the communication links between the family and its business as well as provide opportunities for family members to network and discuss aspects that can be related to the business or the family.
These organized activities help increase understanding and build consensus among family members. Family members should be well informed about the purpose and activities of any established family governance institutions.
It is also very important to make sure that family members distinguish between the role of these institutions and the governing bodies of the business such as the board of directors and senior management. This can be achieved by developing written procedures for these institutions and sharing them with all family members.
Below is a list of just some of family governance institutions that a family business might have. Of course, not all family businesses need or must establish all of these institutions. 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
- Family Council
- Family Office
Now think: do you have or need a Family Constitution? What kind of Family governance Institutions support your Family Business?
Remember (now you know):
01 how to identify different Governance Model for Family Business
02 how to recognize the main issues related to Governance
03 you can see the connection between the Governance model and the relationship between FB and the stakeholders
04 how to identify the right Governance model for your FB