The power of governance in family business | KPMG | CY

The power of governance in family business

The power of governance in family business

Trust, traditions and expectations can only get a family business so far. Each generation wants different things, so establishing the rules of engagement for everyone is essential for success.

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Like any enterprise, a family business needs to have governance in place to ensure that its family and business strategies are achieved. This governance must protect the business from the normal and predictable challenges that family involvement brings. However, formalising ownership structures, power and processes can sometimes stir up resistance, particularly from the founding generation as it transitions from a ‘dictatorship’ to ‘democracy’.

Dominic Pelligana, Partner, KPMG Enterprise, says the benefits of governance far outweigh the challenges of developing it. He says as more generations become involved, and the demands of people in the business increase, the need for governance structures is vital.

“When we talk about governance, we’re talking about education and pre-arranged rules about how things are managed and how we will implement strategies,” he says. “These rules must apply to everyone involved in the enterprise, from directors to shareholders, managers and staff.”

There typically needs to be two separate but related sets of rules (governance). One regarding how the family will behave and relate to the business – a Family Constitution – and the other regarding how the family will behave and relate in the business – a Shareholders’ Agreement and sometimes a Board Charter.

Discussions must start now

Unlike a regular enterprise which has governance at the core and does not need to consider the family dynamic, a family business is usually built on a level of trust and informality by the Founder. However, Pelligana says that if a business is to grow, and employ more people, including family, it will need a level of structure to help the business ‘scale up’.

“Founders shouldn’t expect that following generations can or will run the business the way they have. Governance structures can help ensure there are clear rules around the different ways family can participate and be recognised as members of the family and business.”

Pelligana says conversations around governance can be challenging, and it can be hard to transfer from a tradition of ‘trust, informality and implicit rules’ to a new tradition of ‘structure and explicit rules’.

“But it’s important to have these discussions. For example, if someone wants to join or leave the business, how do they do so?” he says.

He adds there is no point waiting until a critical juncture to try and solve succession, ownership, management structures, roles and responsibility issues.

“It should be part of the normal business operation to have this conversation, now,” he says.

To minimise distraction to the business and tension within the family when formalising governance structures, it is important to recognise that these issues are completely normal and predictable. It can be helpful to work with an independent party, who can lead conversations, share proven frameworks and use their experience to navigate the process.

“Invariably that will lead to a better outcome,” Pelligana says.

 

Four pillars of governance

Governance should be broken into four categories – management, income, control and equity – with each family arriving at a unique position on each area, Pelligana explains.

Management

A common trigger of problems is when the founder brings ill-prepared children into management roles. This not only creates tension, but it can stunt the business’ performance, Pelligana says. Pre-agreed rules must be implemented regarding how family members can join the business, and the required experience, involvement, development and output – just like any other employee.

“You could say it is encouraged that they work on school holidays when they’re younger, and you could make it a requirement that to go on to management roles, they need a minimum level of experience. This ensures that they bring capability and experienced points of view,” he says.

The pre-agreed rules must consider reporting lines, and establish performance expectations and review processes, as well as how issues are communicated and resolved.

“Ideally, family members should report to someone outside the family, but if it is a family member, their performance review should happen with an independent adviser as well. These rules help prevent disagreements later on.”

Income

There must be clarity around how family members, in and out of the business, will be recognised and rewarded, and how they can develop and progress. These rules need to reflect the different roles family members can play in relation to the business as employees, directors and/or owners.

Pelligana says employees need to be remunerated at market value, non-executive directors will require directors’ fees, and owners should receive dividends in accordance with a pre-agreed dividend policy. Often, family businesses not only blur these roles, but they also blur the remuneration for each.

Control

Pelligana adds that there also must be pre-agreed rules in relation to the decisions that managers, directors and owners make. These need to be clearly defined, communicated and respected.

“Family members are ‘equals as members of a family’ but not ‘equals as managers, directors or owners of a business,’ setting structures, processes and strategy,” Pelligana says.

Some of these rules will reside in the Family Constitution, Business Policy and Shareholders’ Agreements.

Equity

Like any business relationship where there is more than one owner, there needs to be agreement and communication of how people will behave as owners, Pelligana says.

“This includes defining who can appoint directors, the payment of dividends, how decisions will be made, how and when ownership interests can be sold or transferred, and how the business will be funded.”

These rules need to be documented in the Shareholders’ Agreement or a Deed of Family Arrangement.

Respect the separation of powers

The creation of a governance structure is all about “clearly defining and respecting the separation of powers”, says Pelligana. Focusing on the above four pillars ensures that each area has clear governance, helping family business members to avoid arguments and ensure the success of their strategy.

“A lot of this comes down to ‘best fit’ rather than ‘best practice’. Family businesses need to do what’s right for them in their own context. Making sure a governance structure is in place will mean they avoid arguments and problems down the road,” he says.

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