Introduction
At the heart of multi-generational businesses and wealth, lies the crucial balance between achieving commercial objectives and preserving family values. This begs the questions: “How do you keep a family business/organization or foundation going?” “How do you sustain these family businesses over many generations?” The scope of this article seeks to highlight the management factors and structural needs that preserve relationships across generations while meeting business demands.
A family business is characterized by the nature of its ownership. In this case, control is held by family members rather than retail investors. As a result, governance structures must balance established family dynamics and rules, alongside daily operations and long-term planning.
The rigidity of conventional company forms such as articles of association falls short in a family based dynamic. Company forms serve a purely commercial entity that do not share familial bonds, values and identity. Whereas articles of association set standard, clear controls and definitive rules, family businesses contain underlying emotional complexities and an overlap of relationships. These complexities bring to the fore the ‘Family Constitution’, a unique constitutive document tailored for family businesses and foundations that guides the intricate interplay of family relationships in a business operation.
Protecting Ownership and Control
In the early stages of a family business, governance roles and internal controls are not well defined. The founder is the owner, director and chief executive (CEO). As the business grows and second and third generations actively participate, these governance roles fragment informally. This affects decision making power and power sharing. Commercial survival is greatly dependent on strengthening governance foundations, however, without clear rules governing these intersecting roles, conflict becomes almost inevitable.
What is a family constitution?
A family constitution is a document that helps manage the relationship between a family and its business. It is a guiding foundational document whose design accommodates the family’s traditions, culture and vision into strategic business objectives.
Management and Corporate governance
The family constitution serves as the anchor that bridges commercial output and the family environment. In its absence, gaps are revealed and the business may not have a long life.
The ethical dimension in governance is seldom clearly defined in family organizations. This includes policies and enforcement of accountability and transparency measures to ensure integrity and internal effectiveness. Audit committees, financial officers and internal and external auditors to review business operations are imperative for the long-term success of the business.
Another real problem faced is the absence of a clear division of responsibilities, where a few individuals dominate decision making. The best interest of the business as a going concern may be compromised by breaches occasioned by those intended to steward the family business.
Additionally, the family constitution provides guidelines for equity holding by setting rules on restrictions on the transfer of shares to non-family members, and by establishing rights of first refusal for those within the owning family. The constitution creates dividend policies such as reinvestment and profit distribution ratios, income expectations and business capital needs. The constitution may even provide for prenuptial arrangements to shield company shares from matrimonial disputes and third-party claims.
Critically, providing for dispute resolution mechanisms and clear pathways are essential for preservation of the family business. Regrettably, conflict poses the greatest risk to family run businesses, with resulting consequences that tear a family apart. Hence a constitution outlines the procedures for conveying grievances and an approach for resolving disputes as they arise. The advantage of a family constitution is that the approaches for grievance management are broad, including democratic approaches, consensus approach or even diplomatic approach. ‘Being tailored to’ the family processes, is the defining feature of a family constitution. Disputes in turn remain private, protecting the business’ reputational value.
Preserving Business Value Across Generations
Succession planning falls at the forefront of transferring business value to succeeding generations. The success of a generational transition not only rests on ownership transfer but more essentially, the succession of values, wealth and leadership. Predecessors must plan ahead before ceding their roles to make provision for alignment of capabilities, personal values of succeeding generations.
It is within this framework that a family constitution becomes indispensable to protecting the family enterprise’s commercial strength and market value across generations.
Conclusion
The enduring advantage of a family business is pegged on its dual approach: value creation objectives and family orientation. The Family Constitution serves this very purpose, by codifying the vision of a family legacy into anchored structures and frameworks. The Family Constitution ensures that the very model upon which a family enterprise thrives, does not become its source of its instability and eventual dissolution.
Contact Us
At CM Advocates LLP, our Family Business Unit advises family-owned enterprises on the development and implementation of robust governance and succession frameworks designed to preserve continuity, manage risk and facilitate smooth generational transition.
If you would like to consult on this article or any other related matter, you may contact the Family Business Unit via email at familybusinessservices@cmadvocates.com
Do also visit our website cmadvocates.com for more information about us and our services.
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