Family Business Governance
Maximizing Family and Business Potential
By Craig E. Aronoff, John L. Ward
Palgrave Macmillan Copyright © 2011 Family Business Consulting Group
All rights reserved.
govern: the aim of keeping in a straight course or smooth operation for the good of the individual and the whole.
Family business leaders seldom think of themselves as "governing" the business or the family.
Yet thoughtful business owners almost universally value the goals of good governance, both in the business and the family—peace, cohesiveness, effective conflict resolution, and freedom from internecine political warfare to pursue shared objectives and values.
A business that is well governed is free to work toward the highest and best objectives of business—maximizing profit, improving strategy, creating jobs, fostering employee development, and serving all stakeholders, including shareholders, employees, customers, suppliers, and the community.
And while most people do not think of "governance" in a family context, a family that runs smoothly is free to nurture and expand upon the most positive elements of its heritage, such as family values, pride, unity, history, tradition, mutual support, and legacies of service.
Families in business together have an especially powerful motivation to govern themselves well. They hold shared interests that are vast and profound, often including a large capital investment, prospects for future employment of themselves and their offspring, and the larger-than-life image of a family business in its community.
Yet many business-owning families drift unconsciously into haphazard or destructive patterns of decision making and communicating that can threaten and even destroy those shared interests.
Binding Together for the General Good. After its stormy Atlantic crossing in the year 1620, the day the Mayflower anchored off Cape Cod, Massachusetts, 41 adults aboard came together and signed the Mayflower Compact. Drawing upon what historians Samuel Morison and Henry Steele Commager have called "a remarkable instinct for self-government," they agreed to a code that would bind them together for the general good of their proposed colony. Though their agreement lacked legal status, it had the strength of common consent and became a benchmark for governing institutions worldwide.
Similarly, a desire to work together for the general good of the family and the business is the common glue a growing number of family business owners are using to establish a framework for governance—the principles and processes that enable maximization of the potential of both the family and the business. In this way, families can draw upon the same strength of common consent recognized by the Pilgrims to fuel productive growth in their businesses and forge a unified and committed family—goals few business owners would disagree with.
The Purpose of this Book. Our purpose here is to describe principles and processes of effective family business governance. This book explains the importance of maintaining two distinct points of focus—the family and the business. It lays out governance processes for organizing each of these two equally important domains: family meetings or a family council for family concerns; and an active board of directors, preferably including a majority of independent board members, for the business.
The book also lays out the distinct functions of family and business and areas in which they overlap. It offers specific techniques for smoothing communication between the family and the board. And, to aid future planning, the book shows how business and family governance processes typically change as the business evolves from its entrepreneurial stage to later generations of family ownership.
In the process, the book will show how effective governance can empower leaders of the business and the family to make the most of the unique strength of family business: the synergy between a strong, unified owning family and a well-run family enterprise.
The Importance of Thoughtful and Effective Governance
The history of family business is full of examples of what can happen in the absence of effective governance.
Emotions among even a handful of shareholders can erupt into clashes that disrupt strategic planning, tie up management in court for years, and drain corporate assets. The Posner family, the Schoens of U-Haul, the Robbies of the Miami Dolphins, and the Haft family, owners of the Dart retailing empire, are well-known examples.
In another extreme example, a second-generation minority shareholder in a family business was denied any information about the performance of her investment. She was refused the opportunity to work in the business. Her attempts to redeem her shares were summarily rebuffed, and her requests for higher dividends were refused. Her petition for a board seat was denied.
The result: her relationship with the other two shareholders, her brothers, had crumbled into enduring bitterness. In frustration, the sister decided to use either litigation or a damaging media campaign against her brothers to escape from what had become a costly burden—family business ownership.
How could effective governance processes have averted this problem? First, effective governance requires accountability between shareholders and the business. If the founder of this business had begun family meetings to teach these principles in the first generation of family ownership, his three children might have learned accountability—a value that would have prevented his sons as adults from behaving in a way that rendered their sister's shares worthless to her.
Second, effective governance requires setting family policies that would have prevented the seemingly arbitrary decisions that the sister found so damaging. Such policies govern family members' participation in the business, liquidity for shareholders, information and education for shareholders, responsible stewardship of shareholders' assets, family succession on the board, and other potentially contentious matters. Policies and procedures, once accepted and understood, provide for shared expectations and a sense of consistency and fairness.
Just as successful societies embrace a rule of law, smooth-running family businesses embrace policies that provide for orderly decision making on difficult issues. Through the governance process, family members define fairness relative to necessary sacrifices as well as distribution of benefits. In a way, effective governance can be defined as creating processes that make revolution unnecessary. In the absence of these processes, as the example of the alienated sister shows, shareholders' needs denied do not go away; they fester and turn malignant.
The Importance of Accountability. It is easy to resist account ability in the family firm. A business may survive and thrive temporarily on the energy, vision, and knowledge of a fiercely independent, high-achieving founder. He or she may hold employees and family members accountable but may see no particular need for developing an organized approach to accountability.
But because no one lives forever, the lifeline provided by the single strong leader inevitably snaps. Then, the business and the family both can fall victim to a profound and urgent need for governance processes that protect the interests of both family and business.
Three dimensions of governance are intrinsic to any family business, and each must be accountable to the other two. (Please see Exhibit 1.) Most obvious is day-to-day management of business concerns—running operations, finance, employees, supplier and customer relationships, and so on. These are the responsibilities of management. They are the domain of the chief executive or executive committee and are not a focus of this book.
The remaining two domains of governance are our focus here. Ownership or shareholder concerns include:
* Liquidity issues
* Allocation of corporate capital
* The survival of the business through ownership and management succession
* The performance of shareholders' investment
* Strategic direction
Family concerns are an equally important but more often neglected dimension of family business governance. These include:
* Family members' shared interests in the health, prosperity, and continuity of the family
* Family participation in the business
* The role and image of the business in the community
* Information and education of family members
* Family communication
* Manifesting family values and goals in the business
Each of these governance dimensions warrants special attention. Each has tremendous potential as a positive force in the family business.
And if neglected, each has vast destructive power. Consider these fictitious examples:
—For estate-planning purposes, four siblings who are third-generation owners of ABC Co., a family business, are given ownership of a newly acquired subsidiary of the family business. When one brother develops serious personal financial problems, the siblings agree, without talking to other family members, to take a large amount of cash out of the business—enough for the troubled brother to stave off bankruptcy and for each of the remaining siblings to feel they have been "fairly treated." But the distribution seriously weakens the subsidiary, forces the parent company to rush to the rescue with an unplanned cash infusion (depleting its R&D funds), and angers senior family members.
—A second-generation family business CEO, son of the founder, pursues an aggressive growth strategy for the family business, XYZ Co., pumping cash into acquisitions. The value of the business is increasing rapidly on paper, but shareholder dividends remain low. Family members, kept in the dark about the business's financial performance, are increasingly vocal and pointed in their criticism of the CEO. He, meanwhile, grows angry when a trusted professional advisor to the company urges him to delay plans to increase his bonus. "I'm making my relatives rich. What's their problem?" the CEO complains.
—The third-generation CEO of Thunderhead Corp., a family business, is clearly grooming as a successor his protege, a non-family Ivy League M.B.A. who has successfully overhauled the business's financial-reporting systems. But several other family members among the business's 14 shareholders discover while chatting at a family gathering that they share strong feelings in favor of continuing leadership of the business by a family member. When they approach the CEO, he brushes them off, reasoning that "they don't understand the business issues" behind his choice. Angry, the dissatisfied shareholders, several of whom hold seats on the board, start planning to organize a board majority in opposition to the CEO's choice.
While these three dilemmas could be dismissed as the result of such "human failings" as poor communication or bad judgment, the root cause is actually a failure of family business governance. In each case, decision makers failed to hold themselves accountable. Regardless of the merits of their decisions, the consequences of that failure became a stumbling block.
In the case of ABC Co., the three siblings attended to family concerns without holding themselves accountable to the business.
In the case of XYZ Co., the CEO is pursuing his strategy for the business without holding himself accountable to shareholders.
At Thunderhead Corp., the CEO is attending to business interests without holding himself accountable to family goals relating to family business leadership.
Accountability in family business governance doesn't mean turning the business into a democracy or "giving away the store." It merely means setting up processes that ensure respect for the interests of both the business and the family.
Business First? Or Family First? Another stumbling block for family business leaders is the assumption that they must choose one set of interests over another—embracing a "family first" or "business first" philosophy of governance.
Some business leaders put "family first" and operate on the premise that family members have a right to be heard under any circumstances—no matter how disruptive to the business their self-expression may be. They proceed on the assumption that family members' ideas always should be taken seriously and that business leaders should report back to the family. In this line of thinking, the business should compromise to avoid potential family conflict and ensure family harmony.
Other family business leaders put "business first." They discriminate against family members who lack skill, knowledge, and proven experience. They assume some family members' comments on the business are always inappropriate and disrupt management. In this line of thinking, shareholders should be passive. Over time, either a "business first" or "family first" mode of operation can cause serious problems. A "business first" perspective allows family concerns to fester and erupt into clashes that can threaten the future of the business. A "family first" view can distract and drain management and undermine the competitiveness of the business. Either sharply increases the likelihood of conflict between managers and shareholders.
In fact, both family and business domains are crucial to long-term family business prosperity. Both require equal care. Neither needs to assume a dominant role. Instead, respect for the needs of the business must be balanced with legitimate family concerns if the family business—and the family—are to endure. Appropriate governance can provide balance responsive to all.
The Special Role of the Family. The importance of good governance of the business is often evident to the experienced business owner, who understands the need for perspective, accountability, and breadth of resources in making business decisions.
The importance of family governance is not always as obvious. But in fact, one of the greatest values of owning a family business is the opportunity it provides the family to experience the rewards of coming together and working together on common interests and goals.
The dynamic quality of a cohesive, conscientious family bears powerful reciprocal benefits to the business, conveying a positive message to all stakeholders. Consensus-building efforts by the family show that the family feels a sense of responsibility to all those connected with the business. That message to employees, customers, suppliers, and the community at large builds confidence in the business and its future.
The Risks of Neglecting the Family. Without governance processes that systematically encourage families to attend to shared concerns, most families find the business becomes too central a focus in everyone's thinking.
Too often the business takes priority in family members' actions, while the family side of the governance equation is underrecognized, underappreciated, and underdeveloped. Family concerns then go unfulfilled—and grow potentially malignant—or surface in places where they don't belong, such as management or board meetings. Instead of a positive, the potentially powerful asset of family ownership can be converted to a negative, a drag on management and on business governance.
If the family is to survive, and its role as the capital base of the business with it, family members must develop a collective agenda, purpose, and method for resolving differences.
The Differing Roles of the Family and the Board
The principle of parallel focus on the interests of family and business, in our experience, has proven the best and most enduring strategy for successful family businesses.
Every family business, no matter how large or small, has "the business of the family" and "the business of the business," which require a dual spotlight and a degree of separation. While the twain meet on many issues and must be coordinated in a planned and thoughtful way, independence and focus are also crucial in maximizing the potential contribution and richness of each. Like yin and yang, family and business are equally important and require mutual respect and equal care.
Some essential disciplines of focus and separation are critical. Family members must earn a voice in business governance by showing or developing qualifications that convey the right to be heard. These qualifications are the province of the family to decide, but they might include such traits as excellence at one's vocation, flexibility in viewing issues, and literacy in the language of the business. (Please see Table 1.)
While the opportunity to be heard in the family is often more readily available than in the business, many families have implicit or explicit standards for voice in the family council. (Please see Table 2.)
The Second Discipline: Accountability to the Family. The business in turn needs to be accountable to the family. Business leaders must respect the right of the family to be informed about the business and to guide certain overarching dimensions of its functioning. It also means major business decisions are guided by the family's goals for the business on such issues as family employment or shareholder liquidity.
The Importance of Independent Governance Processes. Setting up separate governance processes for the business and the family is the best way to develop these disciplines.
The distinct governance needs of the family are best served by family meetings or a family council (or similar family organization). Business governance needs are best served by an active board, preferably one with a majority of qualified independent directors. These two measures often represent a family business's most valuable efforts to sustain a healthy family and a healthy business.
Family meetings can range from occasional informal talks over dinner to regular sessions of a family council. (For suggestions on organizing family meetings, please see Family Meetings: How to Build a Stronger Family and a Stronger Business.)
Whatever form they take, family meetings allow airing of family concerns, the development of shared expectations, and smooth decision making around a variety of major family issues. These issues can include money matters, jobs or careers in the family business, education and training, succession questions, and much more. Family meetings also provide an opportunity for family members to learn to respect the complexity of the business and the roles of managers and directors in running it. (Please see Table 3.) (Continues...)
Excerpted from Family Business Governance by Craig E. Aronoff, John L. Ward. Copyright © 2011 Family Business Consulting Group. Excerpted by permission of Palgrave Macmillan.
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