United States: Family Held Entity Governance Challenges

One of the challenges for a family held enterprise is how to manage control of its resources, both financial assets and human capital.  Business families face continual external pressure as their business develops and internal pressures as the family develops.  In order to address these pressures, the family must develop an infrastructure, a bureaucracy if you will.  Successful families often create a complex web of structures, agreements, councils and forms of accountability to manage their wealth.  This becomes an even more compelling need as the family held enterprise enters the second, third and subsequent generations.

The simpler the family is (first generation usually as opposed to second and third generation businesses where cousins are involved), the fewer legally binding policies are required to ensure a good functioning system.  However, with time, as the family becomes more complex and family members start growing apart, implicit social relationships are not enough to maintain the minimum level of trust and shared expectations required to ensure stability in the family business.

Ownership succession plans are the first thing that comes to the mind of most family business advisors.  While some family members may desire to create and participate in a multi-generational family legacy, others may not want to be part of the business.  The basic governance documents such as articles of incorporation, bylaws and buy-sell agreements can be used to address these issues.  In creating these agreements, the advisors must look carefully at unintended consequences.  For example, what if the articles require a supermajority of the shares for a quorum, but Dad only owns 62% (after some gifting to other family members to bring him below supermajority), so he can't hold a shareholder meeting to replace directors even though he owns a majority of the shares. 

In order to create the infrastructure to ensure the ongoing stability of the family business, the family needs to create guidelines that outline how the family will address various challenges in addition to ownership succession.  A number of policy statements might be created such as:

• An employment policy:  This policy outlines the necessary requirements necessary to obtain a position within the family business.  For instance, is there a certain minimum education requirement?  Oftentimes, in addition to education, family members are required to have a certain number of years of experience in a non-family owned business before coming to work for the family business.  Once a family member enters the business as an employee, what type of first job will they have as compared to other non-family members who enter employment will similar skill sets?
• A compensation policy:  An offshoot of the employment policy, the compensation policy is used to determine reasonable pay for family member employees.  How will family members be reviewed?  What types of perks will family member employees receive?
• A leadership development policy:  This policy outlines the way that the current leaders and stakeholders will select and develop the future generation of leaders, through education, mentoring and experience.

These guidelines and policies can be developed in several ways, including the use of family councils and outside advisory groups.  Successfully family enterprises use family retreats as a way to bring family members together to do business but also to maintain the connection between the generations and the sense of purpose in the enterprise as an important and enjoyable element of family life. 

As family business advisors, our role is to help our clients understand what they need now and in the future to collaborate effectively. The interpersonal family relationships must be understood and preservation of these relationships must be valued to create the collaborative relationship necessary for the family business to thrive.

Farella Braun + Martel's Family Wealth Group assists individuals, families and fiduciaries with sophisticated business and personal succession planning and post-death administration of estates and trusts. 

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.