The family constitution solution

The family constitution solution

Constitutions are not enforceable by law, but they create a moral obligation among family members as it relates to the business, helping to plan ahead.

Associate Professor of Entrepreneurship, Insead

KPMG contributor

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The family constitution

In a recent article in Business Spectator, The constitution solution to governance clutter, Leon Gettler makes the case that every family business needs a constitution, especially when we consider the number of family-run organisations that don’t last beyond the third generation. According to Gettler:

As a family business grows, there will be tensions as more stakeholders and more family members with an interest in the enterprise move into the picture. The business, as it grows, will be demanding more financial and management commitments from its owners. Family issues rather than business issues determine generational change in every family business.

Preserving the family legacy

A family constitution is a roadmap setting out the family’s vision and values. Constitutions are not enforceable by law, but they create a moral obligation among family members as it relates to the business, helping to plan ahead and ensure divisive matters or issues are discussed before they happen.

Binding family members together morally ensures a greater commitment to preserving the family legacy. In addition, family constitutions create a mechanism to resolve and manage conflicts and focus everyone on the key issues that are being ignored.

Gettler argues that family constitutions can circumvent some of the most common mistakes of family businesses:

  • lack of succession planning
  • unclear family hiring practices
  • poor lines of communication that see stakeholders kept out of the loop
  • unfair compensation where family members are compensated differently from non-family members
  • out of date ownership structures.

Common mistakes family businesses make

According to KPMG Australia’s Family Business survey, four out of five family firms don’t have a constitution. And as Gettler points out:

“If family constitutions are ever put in place, it usually happens when there is a changing of the guard, when the founder passes it on to their children, comprising other branches of the family.As this can be unplanned if, for example, the founder dies or becomes ill, it is better to have the document in place earlier on.”

Unlike a shareholders agreement, a family constitution covers more than just the people who have shares in the business – all family members, or their representatives, should participate in the process.

What a family constitution should include

In the article, Gettler discusses what a family constitution should include. At the very least, the family constitution needs to document the mission, values, and principles of the business, and outline the key strategic objectives including the long and short term goals.

A family constitution also needs to set out the process for resolving conflicts about the business between family members and spell out their rights:

  • Should family members be renumerated above, at, or below market rates? Should all family members be compensated at the same rate, regardless of their contribution to the business? What education and previous work experience do they need?
  • How should communication be organised? A family council? Regular meetings?
  • If there is a family council, how is that nominated? What are the rules of conduct?
  • Who chairs the family meetings? How does the decision making process work?
  • What matters are decided by a majority vote? Where does it require a unanimous decision?
  • What are the rights and obligations of shareholders? What about non-family ownership?
Family constitutions can take as long as 18 months to develop because there are some hard decisions involved. Rolling it out might not be easy, as people will have to get used to referring to the document. And ideally, it would need to be reviewed and updated every three to five years. But like Gettler says, it’s important to give the process time.
To read more about family constitutions, some of the rules in creating them, and what they should contain, read  The constitution solution to governance clutter.

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