The issue of "who is in charge" affects families and businesses alike, but it is within the unique operating environment of a family business that potentially destructive tensions are most likely to emerge, if ground rules are not established that effectively separate family from business.
In the family, there is a natural hierarchy whereby the parent has authority over the child and an older sibling has hierarchy over a younger sibling. In the world of business, it is more complex. The CEO or MD presides over the board of directors, and the board of directors in turn preside over the senior management who preside over the staff.
In a family business these roles can become more complex as younger generations come into the business and, for example, demonstrate technical expertise and management capability that may be superior to that of their older, more senior family. Consequently it is very easy for the family hierarchy and the business hierarchy to come in to conflict.
Trust and corporate structures can however provide a perfect starting point for introducing a system of structured governance to families, whilst allowing the family to develop their business. Such structures would typically include Private Trust Companies, Foundations and Special Purpose Trusts, with offshore jurisdictions competing on the range and sophistication of structures available.
- The Private Trust Company (PTC). Many consider the PTC as the most appropriate and flexible structure for family businesses. The board of the trust company can comprise family members, advisors, and fiduciaries, so a blend of family and external, specialist expertise can be assembled at Board level.
- Special Purpose Trusts. The British Virgin Islands have developed VISTA trusts which can be created for the sole purpose of holding shares in a BVI company, which is then run by its directors. The settlor's family can comprise the directors of the board, so allowing ownership and control over the company. By way of comparison, Cayman's STAR trust regime allows trusts to be created for a pure purpose or beneficiaries or both. The STAR trust can be used for holding operating companies which are principally comprised of the director's family as the board.
- Foundations. Families may find foundations an effective way of exercising influence over a structure. Although Jersey foundations must have at least one Jersey regulated person on the council, the other council members can include the founder or family members.
One of the key features of a Jersey foundation is that the council is answerable to a guardian (who can be the founder or his representative) rather than the beneficiaries. The council does not have a fiduciary duty to the beneficiaries and accordingly, a foundation may be able to undertake entrepreneurial activity.
On a day to day basis, conflicts may arise between family members, so there needs to be an effective and formalised channel for resolving such disputes, if these are to be prevented from impacting upon the business. One way forward is to lay down a clear code of practice for the family to abide by which would clearly identify a dispute resolution process in a given set of situations. Those scenarios include:
Business goals and family goal conflicts
It is really very easy for the goals of a family business to become incompatible with those of a family. In business, the core goal is usually to make a profit and provide a return on capital to the owners and investors.
In a family, goals are infinitely more complex. Emotional ties can come into play and there is often a need for support, both for the old and the young. The governing principles of a family are usually founded upon love respect and kindness, not making profit.
Often, parents who have founded a business may often want to see that all of the children are supported by the business, even though only one or two siblings may be working in the business. This can create intense friction, if the business and family goals are not clarified and reconciled.
Compensation disagreements may arise in family businesses when there is a lack of clarity around business and family goals. In a family feud over money, the members working in the business may believe they are entitled to market rate compensation. Other members may not agree and may insist that everyone receive equal distributions from the business, irrespective of whether they are directly involved in wealth generation or not.
The essential problem is one of justice based on equity, equality, and need. These three interests must be in balance for there to be a sense of fairness in compensation.
Ownership issues can often be generational. A key question that needs to be resolved is 'how long should parents hold onto the business before turning it over the children?' For parents, the business may represent their life's work, and the majority of their wealth. For the offspring, the business may mean their future and the future of their own families. The tension in ownership and succession can result in emotional disputes.
Sometimes the family is more important than the business. When members simply cannot get along in the business, one side may have to buy out the other. This is an emotional situation because the selling side will always see more immediate value from the business than those who remain. The problem is complicated by mistrust and a sense of betrayal which almost always underlies these types of conflicts.
Managing owners sometimes fall into the trap of believing the business is solely theirs. Consequently, outside family members can easily believe that, rightly or wrongly, the managing owners are cheating and defrauding them.
For the family business therefore, a clear set of operating rules and a disputes resolution process are vital. In defining such rules, a good starting point is the rules that commercial companies must adhere to.
Rules for family governance – establishing a benchmark
The Financial Reporting Council (FRC) outlines a series of codes by which corporate entities should be governed, which it recently published in 'The UK Corporate Governance Code, June 2010'.
In the report, the FRC stipulates that 'The purpose of corporate governance is to facilitate effective, entrepreneurial and prudent management that can deliver long-term success of the company'. The main principals of the code encompass:
- That every company be headed by an effective board which is responsible for running the company. No one person should have unfettered powers of decision making.
- The role of chairman is separate from that of the board and the chairman's role is to ensure the leadership and effectiveness of the board is maintained.
- Non-executive directors should constructively challenge and help develop proposals on strategy.
- The board should have a balance of skills, experience and independence to allow them to discharge their responsibilities effectively.
- There should be a transparent process for appointing new directors.
- All directors should have enough time to effectively discharge their duties.
- All directors should receive an induction to the board and regularly refresh their skills and knowledge.
- The board should be supplied in a timely manner with information in a form that allows it to discharge its duties.
- The board should undertake a formal and rigorous annual evaluation of its own performance and that of the directors.
- All directors should be submitted for re-election at regular intervals.
- The board should present a balanced and understandable assessment of the company's position.
- The board should maintain sound risk management and control, and apply formal reporting methods for risk.
- Levels of remuneration should attract the directors but a significant proportion of their rewards should be linked to the company's success.
- There should be a formal policy for deciding remuneration. No director should decide their own remuneration. Relations with shareholders
- There should be a dialogue with shareholders on a mutual understanding of objectives.
- The board should use the AGM to communicate with investors and to encourage participation.
Whilst the above codes are expansive, they do also have the benefit of being very clear and outlining a methodology by which good corporate governance can be employed. As a starting point, is it possible for the codes that have been developed for corporate governance to be used as a basis for family governance? The requirements that family governance present are not really that dissimilar from those needed to achieve good corporate governance.
Family decision making
At the heart of family governance is the way that families make decisions. If a 'normal' family is anything to go by, this can be a complex process, with many dynamics coming into play which are simply not there in a corporate environment.
A protocol and methodology for making decisions needs to be put into place, and appointing a board (which can be comprised of both family members and expert advisors) can often be a good starting point.
In the context of family decision making this would outline the process for bringing new opportunities to the table, the process for agreeing the decisions and in the event of a split decision it would resolve how a casting vote might be made.
Having a good decision making process allows families to move forward with their business. This means that wealth is not dissipated through inertia or an inability to reach a consensus.
Where trust structure are used to hold family businesses and these do not include clear governance rules, this lack of governance can cause issues for trustees where a fiduciary obligation needs to be considered. Central to this would be how a trustee is able to represent all the beneficiaries and their best interests. If a trustee is unable to make an effective decision, the trustee runs the possibility that the trust is ultra vires.
Implementing formal planning and procedures
Whilst the codes suggested by the Financial Reporting Council might not exactly be to every family's taste, they do provide a principal upon which a dynastic concept can be built. This allows a family structure to be created, the purpose of the family to be agreed, and procedures to be created that make the governance implementable.
The family purpose can be documented and could be an equivalent of a company's Memorandum of Association. Issues that might be covered within it include:
- How the family wishes to address wealth preservation
- The business focus of the family
- Family values, reputation and ethics
- The family's approach to philanthropy
- The family's distribution and investment policy
- Procedure and succession planning.
If the family purpose is viewed as an equivalent of a company's Memorandum of Association, the family procedure can be viewed as an equivalent to a company's Articles of Association. Accordingly, the family purpose must include detailed operational provisions. These will be typically contained in:
- Articles of association for the family's private trust company
- Articles of the enforcer entity
- Family constitution
This will allow for a range of areas to be covered, including communications procedures, meetings and decision protocols, minority protection, dispute resolution, an agreement as to how professional advice is co-ordinated and a central strategy and administration.
Using trusts to aid family governance
Trustees can play an essential role in the running of family structures. Trustees can ensure that the governance principals are applied as adopted and agreed by the family. Trustees have the necessary independence and fiduciary obligation to ensure that all beneficiaries are looked after and as a result will naturally apply checks and balances and ensure that the power base within the family is spread.
The primary advantage of a trust is its ability to keep the family on track. For a trustee, the trust deed is binding and the trustee must enforce the trust deed, as to not adhere to the trust deed is to be in breach of trust. Adherence to family governance codes can be written into the trust deed and therefore act as a strategic tool for resolving family disputes.
Ruling the family roost
Long term planning is essential for any family, and keeping all elements of a structure well maintained is critical. Proactive and regular input is needed which in turn will help prevent disputes arising in the first place. Above all, seeking continued professional advice is advisable for any family.
Trusts and Foundations can provide an ideal framework for both ensuring the future health of the family business and the family itself. Running a family is a complex matter and all families have their specific requirements, so one size certainly does not fit all. Whilst the Financial Reporting Council guidelines are clear and useful, it should be realised that they just provide a starting point, as they will need to be adapted to suit each family.
The modern high net worth family may have multi-jurisdictional requirements and multigenerational needs, which result in complex tax treatments and business needs. At Vistra (Jersey) Limited we work with families and their advisors on a day to day basis developing appropriate family and business structures to protect and enhance the long term prosperity of both.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.