Creating value through good governance

By its very definition, the controlling family in a family business is a driving force for deciding how the business chooses to operate and how it will define success. Often, these choices are based on the shared purpose of the family and the business: ‘Why are we here? What do we want to accomplish together? How do our choices reflect and support our family’s values?’

Several family business leaders shared that it was essential for them to have formal governance practices in place as their companies grew and matured. The time came when it was necessary to create appropriate frameworks and structures to make sure that checks and balances were in place for the business to scale up successfully. They told us that good family governance practices were a key factor in fulfilling their family’s purpose and creating value for customers, employees, shareholders and their communities.

What does the business and the family – as owners, executives and family members – need in order to be successful at any given point in time?

Due to changing demographics, we are beginning to see an emerging theme. There is a gradual shift away from being ‘family owned and run’, which is particularly common in first- and second-generation family firms, to being ‘family owned and non-family managed’, where family members are only involved at the ownership level (and occasionally on the board), but not in the day-to-day operations of the business. This makes it necessary for governance structures to adapt to a new scenario in which family members are primarily owners and are not involved in running the business.

The evolution of informal governance systems to those that are more formalized is inextricably linked to the increasing complexity of the business and the family. This makes it necessary for the governance systems to evolve in parallel with the progression of the family and the business in order to continue to be fit for purpose at that particular time and stage of the family’s evolution. With appropriate governance structures and systems in place, both business decisions and family relationships can be enhanced.

Therefore, family governance needs to be adaptable and reflect the generational composition, roles and responsibilities of family members as their ownership and management responsibilities evolve.

We have learned through research and direct experience with family businesses throughout the world that families who engage all generations of family members in planning and implementing their governance systems achieve two objectives. First, senior members of the family have the opportunity to reflect on what they have built and to pass on what they have learned through various changes in the family’s approach to governance. Second, next-generation members of the family bring fresh perspectives for addressing the challenges that the current generation is facing, both in the family and in the business. Perhaps most importantly, the next generation’s involvement gives them the opportunity to co-create the future systems that they will ultimately oversee.

Family business leaders we spoke with described how their family governance practices and tools are helping to shape and reinforce a shared future for their families. They are opening up opportunities to review and agree upon the fundamental purpose of the business, confirm the family’s core values and define the desired culture and vision of the business.

The goal of good family governance is to make sure that family members stay connected and have opportunities to voice their concerns and share their emotions in a professional setting.¹ However, family dynamics often make conversations challenging and discussions in family businesses are no exception.

It can be difficult to talk about how the business may need to change and to agree on how to support its evolution from one generation to the next. As the business matures and grows, therefore, the presence of family governance mechanisms becomes all the more essential.²

These mechanisms may include the management of assets and wealth through family councils, assemblies and constitutions and to create greater cohesiveness throughout the family, especially when it begins to move to the cousin consortium stage and beyond.

Families in business have the opportunity to build their own unique family governance systems to balance their economic and family-centric goals and translate them into a shared vision for the family. And, when family governance processes are added to customary corporate governance systems, together they help the family to maintain the necessary equilibrium between what the business is trying to achieve and what the family wants to achieve.

Effective family governance systems promote cohesion, flexibility and communication. Family cohesion is defined as the emotional bonding that family members have toward one another and the degree to which they are connected.³ In environments that are often dynamic and unpredictable, flexibility is the key to finding the right balance between stability and change to maintain the health of the organization.

The intent is to make sure that family members stay connected, have opportunities to voice their concerns and are able to share their emotions in a professional setting.⁴ An effective governance framework that includes communications protocol and conflict resolution processes is often used to provide a neutral mechanism for recognizing and resolving conflicts and promoting family harmony.

Forums such as family assemblies and family councils often provide a dedicated platform for family members to discuss specific issues. However, it is important to note that these structures may be ceremonially adopted⁵ and do not necessarily diminish the need for family members to acquire good and respectful communication skills for speaking, listening, self-disclosure, clarity and staying on topic with each other.

Despite the recognition of the importance of open and honest dialogue, family boundaries can undermine the goals that are necessary to drive meaningful discussions and resolve potential conflicts. Poor family relationships can add to the hazards because they typically represent a lengthy history of personal and familial development.

These situations are not unusual and conflict can be the norm for some families in business. In addition to being potentially detrimental to family harmony, such situations can also spill over and affect the long-term sustainability of the business itself. Avoidance isn’t usually considered to be an ideal conflict resolution strategy. Because conflicts can be detrimental to some families, however, it can lead them to practice partial avoidance by resorting to an ownership exit or the termination of a family relationship rather than reopening old family wounds.

In certain situations, there is value in being preemptive. In one case that we became aware of, a prenuptial agreement is included in the family protocol as a mandatory requirement prior to the marriage of any family member. These agreements are intended to ensure the continuation of family ownership in the event of a divorce and they define, in advance, that any division of property will be based exclusively on matrimonial assets that are not linked to the ownership of the family business.

Those families that have effective systems for managing potential conflicts such as this are more successful in focusing on the goals of the business and the family rather than on personal views or old grievances. Without question, “open communication” and transparency are cited as the most effective strategies for preventing and resolving conflicts.

The principal purpose of our research was to evaluate the impact of changing demographics on family business practices. We weren’t surprised to learn that the pace of change is increasing rapidly with the growing multi-generational outlook and approaches of family business leaders.

In this environment, we found several families who are seizing the opportunity to secure the futures of their businesses by investing in their most valuable asset: the next-generation family members who will lead the business and the family forward.

The development of this new breed of future leaders does not happen in a vacuum, but at the nexus of the family and the business. It also isn’t confined to formal education, but also includes the informal learning opportunities within the business that the family often provides from an early age. This implicit knowledge usually begins to develop in the early years through family experiences and working in the family business.⁶

By applying their family governance systems to create learning opportunities, families are also able to provide coaching and mentoring options to next-generation members through their participation in philanthropic projects, internships and apprenticeships. Future family leaders are often also engaged in junior boards or as observers of the family council, owners’ council or a business board.

Others have embraced the concept of the “learning family”, setting up education and career committees within the family governance system. In this way, they coordinate learning initiatives through a family-specific curriculum that educates the next generation about family values and traditions and provides an opportunity for their talent and creativity to be explored.

There is a strong association between family education and career planning. Successful families that have formal family governance systems typically establish a dedicated education and career committee to help identify the career aspirations of family members and bridge them to the development plans of the business and the family.

Even when next-generation family members do not see the family business as their preferred career choice, families tend to immerse them in the entrepreneurial environment of the family at a young age. The intention of next-generation family members to make the family business their career choice can be reinforced when they see a clear development path ahead of them.

The importance of developing human capital is reflected in both corporate and family governance systems due to the need to engage and develop family as well as non-family members.⁷ As we heard from family leaders, there are various factors that affect decisions about engaging non-family members as managers (or even leaders) of the family business. When the family perceives advantages in engaging professional management for the sustainability of their business, it is typically based on a fundamental decision to put ‘business first’.

Several factors can influence such a decision. Some families choose to engage family members almost exclusively in leadership and managerial roles. And while some family firms may be accused of nepotism in these types of succession and recruitment practices, this is not universally true. The choices they make have to be right for that specific family and at that specific time in their lifecycle. They also need to be the right choices based on the history of the family, their current dynamics, future aspirations and overall attitudes and values.

As highlighted in our first article in this series regarding the topic of succession, “The courage to choose wisely”, choosing the right leader at the right time is one of the most critical decisions that family business leaders need to make in order to secure the success of their business. And rarely has continuity and succession planning been more important given the increasingly multi-generational experiences, outlooks and aspirations within their families.