• Service: Enterprise, Family business
  • Type: Business and industry issue
  • Date: 11/27/2013

Sustaining family businesses beyond generations with good governance 

Good governance
Family businesses are a source of wealth for the economy. They generally have a long-term focus and demonstrate excellent resiliency in the face of economic crises, compared with traditional companies. In addition, they are often integrated into the local economic fabric and contribute to economic growth.

At the same time, their familial nature can be a weakness in that it requires two fundamentally different spheres to coexist: business and family. Business is guided by performance and rational decision-making, while family is more strongly impacted by affection.

This can be a virtue for a company when all family members are in agreement, but also a disadvantage when their values and goals differ. The risk is even greater when several generations hold a stake in the company. Transition phases, in particular, are sensitive times.

Good governance and sustainability

Therefore, it is in the interest of the company to organize the family unit by setting forth rules that are accepted by all. Two major tools can be used for this purpose: the Shareholder Agreement and the Family Constitution. The Shareholder Agreement is a binding legal contract.

Its scope is easy to identify: by definition, it concerns the family members who are shareholders in the company. As a legal document its form is clearly delineated, even if its specific content may vary according to the family and the company. The Shareholder Agreement typically comprises four main sections…

The Shareholder Agreement: a legal framework

  1. Management of the company:
  • clauses concerning voting rights (quorum, enhanced majority, veto rights, etc.);
  • clauses concerning administration of the company (choice of governance bodies, their composition, appointment of independent directors, creation of committees, relationship between family and company governance, etc.);
  • information clauses (appointment of statutory auditors, control rights, communication about the company, etc.)
  1. Shareholders:
  • financial clauses and, in particular, those concerning distribution of the company’s profits;
  • clauses on control of ownership changes (preemption, stock market introduction, liquidity of shares, etc.);
  • termination clauses (exclusion, right to withdrawal, share appraisal, etc.)
  1. Management of the agreement:
  • its lifespan;
  • sanctions in case of breach of the agreement;
  • confidentiality;
  • non-competition clauses.
  1. Specific elements:
  • this section may include information relating to the Family Constitution or to the involvement of family members in company governance.

The Family Constitution: a moral commitment

Unlike the Shareholder Agreement, the Family Constitution does not have legal standing, but rather is a set of rules freely accepted by the family members on principle, that represents a kind of moral commitment.

While it is a more flexible document, laying out the principles and values that guide the family’s action, this does not prevent it from also precisely defining the objectives assigned to the company. First of all, the Family Constitution has a wider audience than the Shareholder Agreement.

It concerns all members of the family, whether or not they are shareholders. In fact, defining the family perimeter is one of the issues to be resolved prior to drafting the constitution. Who is acknowledged as being part of the family? Who wants to commit to the rules the family is defining?

Drafting a Family Constitution

At the same time, the Family Constitution addresses broader topics than the Shareholder Agreement. It is up to the family to decide what subjects will be covered by its constitution. There are many potential topics:

  • What are the family’s values?
  • What are the strategic objectives for the company?
  • How are relations between the family and the board of directors managed?
  • How are conflicts within the family managed?
  • How is created wealth distributed?
  • How are the family members integrated into the company? And how are they trained?
  • How is transmission of ownership of the company managed?
  • Etc.

Drafting a Family Constitution will not necessarily prevent conflicts, but it does provide a framework for better managing and resolving them. Often, the mere act of thinking together about these key questions helps a family anticipate future problems.

A framework for the governance process

By clarifying how the family operates and how its relation to the family business is expressed, the constitution helps defuse frustrations that could otherwise arise in the absence of rules. The Family Constitution is a complex document. Often an outside adviser can be useful in helping the family arrive at consensus on difficult issues.

An adviser with good knowledge of corporate and tax law will also be able to ensure that the Family Constitution and Shareholder Agreement form a coherent package. Finally, an outside adviser provides a framework for the process.

Drafting a constitution involves certain necessary steps, such as understanding the family and business environment and a phase for everyone to give their input. Only after these discussions can the adviser propose a document that corresponds to the family’s wishes, keeping in mind also that these rules will need to evolve over time.

For medium-sized companies and large family companies

KPMG has designed a dedicated approach to help families designing their own governance framework:

Shareholder Agreements and Family Constitutions are primarily advisable for family groups with two hundred or more employees. The Shareholder Agreement is useful wherever there are multiple family shareholders, while the Family Constitution becomes most advantageous once several generations are involved in the life of the company.

Alain Berthoud

Alain Berthoud
Alain Berthoud, certified Public Accountant since 1992, has been working for many years with Family Businesses before joining KPMG as a Partner.

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