Anthea Stephens, Senior Associate in Cape Town, discusses the role of the family constitution in future-proofing a family business and preserving family values.
What is a family business? The answer is that a family business exists when family members are the dominant owners of a business and family issues have the ability to influence the outcome of the decision making process. Family businesses start out like any other businesses, as simple organisations. But as they develop and grow, the challenges they face bring greater complexity, often leading to tensions among the owning family over how they run the firm together. The consequences of such dissension can be far-reaching, potentially leading both to a breakdown of family bonds and a breakup of the business.
Fifty to eighty percent of jobs worldwide are created by family businesses and family businesses account for fifty percent of our economic growth in South Africa. History shows that the vast majority of family businesses will fail by the third generation, with the overarching cause being internal conflict as opposed to external events. With family businesses accounting for such a large portion of global wealth, their success and longevity are integral to economic well-being.
Challenges that face the family business
Challenges arise in many guises in the family business arena and potential conflicts and disagreements are manifold, with many family businesses not making it beyond the second generation. The amalgamation of professional and family ties in a family business is not a smooth road. Power struggles between successors and dispersion of wealth and control are but two of the ways in which a budding dynasty can fail. Some of the challenges that await might include:
- Resistance to change and a lack of willingness to let go of control;
- The position of the widow(er)s in the case of death;
- The position of spouses in the case of divorce;
- Disagreements that become protracted due to emotional dynamics;
- “Affluenza” – the rising culture of entitlement;
- Dilution of wealth through the unnecessary breaking up of the primary pool of wealth;
- Ownership versus employment; and
- How to treat a liquidity event.
The family constitution
Enter the family constitution, or family charter. The family constitution is a written statement that serves as a record of the family’s heritage, culture, hopes and ambitions for future success, as well as a plan for how to achieve this. At its core will be the mission statement for the family, and its clearly stated hopes and aspirations for the current and future generations. In larger businesses, a detailed family constitution lays down ground rules to ensure and delineate long-term ownership. It keeps the family together, but also provides a mechanism for separation, explaining how the business will be valued and shared with the family member seeking to exit.
Where the goal of the family is to continue to manage the family business or the family wealth collectively across the generations, a constitution is not only helpful, but imperative. Unfortunately the importance of having in place a comprehensive continuity plan is often not recognised while things are running smoothly and it may take chaos to inspire order although, by then, it may be too late. However, family enterprises are increasingly recognising the importance of documenting the values, principles and procedures that the family agrees to follow in order to help the businesses prosper and endure.
While the constitution itself may not be legally binding, it goes a long way towards informing and guiding decisions that may well have legally binding results and is used to inform legally enforceable agreements. The family constitution will typically set out broad principles which might include:
- The family’s values and vision;
- Investment philosophy, wealth strategy and distribution policy;
- Selection criteria for business leaders;
- Procedures for employment and performance management of family members (e.g. entry requirements, and remuneration and termination policies);
- Clearly defined roles and responsibilities for family members involved in the business and those who are not – the relationship between family and business;
- Rules of conduct for one or more governance bodies (e.g. a family council), including clear decision-making processes;
- Share ownership and share transfer issues, such as price, transfer restrictions and terms for transfer to other family members or third parties (this should be set out in a legally enforceable shareholders’ agreement);
- Differentiation between ownership and employment and separate reward structures;
- Procedures for distribution of income and wealth among family members;
- Exit strategy;
- A conflict resolution procedure (which should be set out in a legally enforceable document);
- Arrangements for communication among the broader family (e.g. a “family assembly” or social gathering);
- The scope and use of the family office;
- Involvement of external advisors;
- A formal mentoring programme for the next generation; and
- A succession plan and a process for choosing individuals for appointment to management, the board, or the family council.
While this list is not exhaustive, it highlights some of the important principles that should be taken into account. The constitution should serve as a reference point for relationships between family members and the business over a certain period so as to ensure a smooth transition to the next generation. The purpose of the document is to put in place a governance process to regulate matters of succession as well as the maintenance, creation and distribution of family wealth across generations.
Smooth governance processes can serve to strengthen the prospects of the family and avoid the kind of devastating damage that disputes or unforeseen catastrophic events can create for family wealth. Every family will have its own vision and its own special dynamics. There can therefore be no “boilerplate” template for a family constitution, but by creating bespoke methods of addressing some or all of the matters listed above, conflicts can more readily be addressed and disruptions kept to a minimum.
While the legal structures (such as trusts and companies) of the business separate the control elements between the interested parties (i.e. the family and non-family shareholders, the family trustees and the different generations of the family), the family constitution binds all these elements together in a cohesive way and with an overlying set of family principles and governance protocols that protect the different interests and assist the various parts of the family wealth structures in working together efficiently and successfully. The legal rights and responsibilities that arise from the structures do not generally cater for the individual characteristics of each unique family dynamic, nor the family members’ relationships with the business and other parts of the family wealth structure.
The most important feature of the constitution is that it should embody the personal ethos and closely held principles that the family have agreed to abide by in protecting and enhancing the operation of the family wealth. While a family constitution does not guarantee the prevention of disputes, long-term disruption can most certainly be alleviated by having in place a record of the long-term vision and family values that the founder sought to uphold.
As the business and the family both continue to expand, so does the role of the constitution, as it serves to maintain the focus on the core values underpinning the wealth strategy.
We at Maitland have assisted a number of multinational families prepare family constitutions and, having done so, are convinced of their value.
Give each child enough money so that they can do anything, but not so much that they can afford to do nothing.