Family charters – a guide to governance structures for small businesses

Many family businesses struggle with governance structures and an estimated 100,000 businesses pass out of family control each year because of the failure to draft succession plans or business pressures.

Here, Ian Hodgkinson corporate partner at Liverpool and Manchester-based law firm Mace & Jones examines how to run a family business successfully.

According to the BDO Guide to Family Business, only 24% of UK family businesses survive through to the second generation and only 14% make it beyond the third. However, the Institute of Directors (IoD) reckons that family businesses can improve their odds of survival by putting the right governance structures in place and by starting as soon as possible an educational process for subsequent generations.

Spotlight on governance unlisted companies

Until recently, the concept of “corporate governance” was largely the preserve of listed companies. However, on 8 April 2010, the IoD published their Corporate Governance Guidance and Principles for Unlisted Companies in Europe. It is intended to provide guidance for unlisted companies (including family owners and founder-entrepreneurs) on corporate governance issues for unlisted companies and in particular some of the challenges involved in the implementation of good corporate governance for them. The document sets out fourteen principles of good governance, nine of which are intended for all unlisted companies.

Many family companies allow family matters (continuity, valuation, liquidity, transmission, dividends, etc) to become confused with and get in the way of corporate matters (operation-related decisions). Over time, down several generations, the family is likely to increase in size and typically by the third generation could involve over 25 people.

As family members may develop different preferences for the business (for example, re-investing profits in the company instead of distributing them as dividends) this can create tensions, especially between those who work for the company day to day and those who do not. A further problem for larger families is that members who work in the business have greater access to information than those who don’t.

Accordingly, we agree with the IoD that family businesses should consider establishing family governance structures that establish a level playing field for company information, promote discipline among family members, prevent potential conflicts and ensure the continuity of the business.

Family charters (sometimes called family constitutions or protocols) are a possible solution that are growing in popularity. They are statements of intent or agreements entered into by the family members in relation to a family business. Normally they are either not legally binding at all or only partly legally binding.

A family charter typically sets out how the family wishes the business to be run, the family’s goals and the long-term strategy for the business, as well as the family’s relationship with the business and an agreement as to how the family members should behave towards each other in the context of the business.

Family charters – typical questions

Essentially, a family charter represents a family consensus on the family’s relationship with the business and is a route map for the family and the business. It can be a method of reaching consensus on how a number of issues should be addressed, including the following:

• How will the next managing director of the business be chosen? Will he or she come from within or without the family?
• Who should be employed in the business?
• Who should be entitled to sit on the board?
• What happens if someone wants to sell their shares?
• Should all family members be entitled to own shares?
• Should in-laws be entitled to own shares?
• How does the family communicate its views to the board?
• What exactly should the relationship be between the family and any non-family executives?
• What happens if there is a dispute between family members in relation to the business?
• How does the family avoid a feeling of exclusion amongst family members who are not employed in the business and/or are not shareholders?
• How does the family tackle a divergence of views as to why the family are in business together or which direction the business should take?

A shareholders’ agreement, as the name suggests, is an agreement between the shareholders of a company as to how the company should be run. It is normally legally binding.

A family charter differs in that it is more likely not to be legally binding at all or only legally binding in part and in some senses is more akin to a mission statement. It also differs in that there may be some shareholders who are not parties to the charter because they are not family members.

For example, these could be current or retired non-family executives or external investors. Also, some parties to the charter may not necessarily be shareholders but only beneficiaries of a family trust which owns shares in the business.

A family charter typically deals with a number of issues which are not capable of constituting or which are difficult to construe as legally binding obligations. For example, stating family values to which the family members will adhere or ethical guidelines to be followed by the business.

In some cases, family charters may set out broad, non-binding principles relating to the family’s policy on certain matters, with those principles being enshrined in a binding form in the company’s articles of association or a shareholders’ agreement. A good example of this is the family’s policy on ownership of shares. There are, however, some aspects of a family charter which could be found in both a shareholders’ agreement and a family charter, for example an agreed dividend policy.

Family charters vary enormously in length. Some can be less than six pages long. Others can be well over fifty pages long. This is partly because family businesses range greatly in size and complexity. However, it does not follow that a large business should automatically have a long charter.

Charters can also vary in length because families have differing views as to how much detail should be included in relation to certain family policies. Also, where more than one family is involved in a business, this in itself may result in a longer charter.

Family charters – issues to consider

Issues which might be covered in a family charter include the following:

• The family’s long-term goals or long-term business strategy.
• Ethical guidelines to be followed by the business.
• The company’s policy relating to corporate social responsibility.
• Corporate and family governance issues, including rules and procedures relating to the membership and proceedings of any family council or other family meetings.
• Key business decisions in respect of which the family should be entitled to direct or influence the board.
• The company’s dividend policy.
• The family’s policy on share ownership and sales of shares by family members.
• Educating, involving and providing careers for the next generation.
• Employment in the family business.
• Communicating with and providing information to family members.
• A dispute resolution procedure to deal with conflicts between family members.
• The establishment and operation of any charitable foundation.
• Support for family members who wish to start up their own businesses.
• Reviewing and amending the charter.
• The extent, if any, to which the charter is legally binding.

Family councils and family assemblies for larger businesses

With larger family businesses, it may be appropriate to establish a family council and a family assembly. A family assembly may meet once or twice per year, and brings together all members of the family. It allows family members to stay informed about the business and furnishes them with the opportunity to voice their opinions. It helps avoid potential conflicts that might arise due to an unequal access to information.

It also has a social and bonding role and seeks to preserve the “glue” in terms of family relationships that holds the family together that can otherwise easily dissolve as the family grows larger with different generations and branches of the family.

A family council is a small group of family members or family representatives that acts as the primary decision-making body of the family vis-à-vis the company. It is also the main communication link between the family and the company and has a crucial role in conveying the expectations of the family owners to the board. It is normally elected by the family assembly. The view of the IoD (that we share) is that family institutions of this kind can play a useful role in coordinating and unifying the interests of extended families.

Having said that, the IoD still see the most important step for ensuring the long-term survival of a family company as the establishment of a strong board with independent non-executive board members. The appointment of appropriate non-executives is doubtless a crucial step in the evolution of a company. The right appointment can bring a different perspective and dimension to a company and in the right circumstances represent exceptional value for money.

There are companies, though, who do not get the right person and are heard to repeat the old joke about the difference between a supermarket trolley and a non-executive director (the punch-line being that you fill them both up with food and drink but at least the trolley has a mind of its own!).

The case for paying proper attention to corporate governance issues is compelling, however. It is estimated that only five in 100 family businesses survive beyond the third generation and even fewer the fourth generation – and in many cases, it is not only the business that disappears, but the personal wealth of the family too.

An astonishing proportion of family business owners are victims of the so-called “clogs to clogs” syndrome which sees the family wealth built up and then lost in only three generations. Proper professional advice can be crucial in avoiding this outcome. In the words of Nathaniel Rothschild in 1834 (and there’s a family that knows something about this) “It takes a great deal of boldness and a great deal of caution to make a fortune; and when you have got it, it takes ten times more wit to keep it”.