A classic family business progresses through various phases from its start-up to maturity. It is quite common for the family business to metamorphose from a certain form of business to another across these phases. In most scenarios, the Founder typically starts the family business as a small enterprise or a sole proprietorship, which then continues to evolve through several business forms as it grows and expands into a conglomerate with a robust governance system and a well-defined multi-generational wealth transfer structure.
Most of the successful family businesses all over the world started as small enterprises with the Founder's goals and vision as a major driving force in the conduct of the business. The early stages of the business see the Founder taking up most of the major operational roles in the business. This leads to accountability, tax and other operational issues which small enterprises usually encounter in the course of running the business. As the family and the business grows, a small enterprise may no longer be an ideal business form to accommodate the vision of the Founder in terms of wealth succession, capital sourcing, liability exposures etc.
This article addresses the various phases of family business transitions, the features of each phase and the role of family business governance across these phases.
Governance structures for phases of Family Business
Decisions on transition or conversion of Family businesses from a particular form of business into another are made based on the development stage of the business, the financial needs of the business and several other factors. Family businesses have been known to transit through business forms such as sole proprietorship/small enterprise, private limited company, public limited company (with the family owning the majority shares) and conglomerate. The structures to adopt for family business governance differs for each form of business. Hence where structures have been put in place at the initial stages, modifications would have to be made at each level of change to enable a fit of the governance practice with the form of family business.
The Founder of a family business may operate the business as a small enterprise in its early stages. This basically means the operations and transactions are conducted in his name as legally, there is no separation between the business and himself. One of the major business governance issues that arise at this stage is lack of accountability, i.e. the inability of the Founder to separate the family business expenses from his personal expenses due to improper record-keeping. This further creates inefficiencies in the business as the business performance cannot be adequately measured. With appropriate family business governance structure, the Founder is able to transcend this stage of the family business.
Over time, the small enterprise would be an inadequate form of business to accommodate the purpose of a family business. One of the key basis of starting a family business is to ensure that other generations of the family succeed the Founder in the running of the business. This aim is not achievable with a small enterprise as the business may rarely survive the death or incapacity of the Founder. This is quite expected as the entire business revolves around the Founder alone. Another factor to consider is the need for funds. Funds could be sourced for the business mainly via loan or equity. Although equity is a cheaper source of capital for the business, it is usually uneasy for small enterprises to access loan facility from financial institutions due to their business form. These issues could be addressed by the transition of the small enterprise into a private company.
A private limited company enables the other members of the family to have an interest in the family business via share ownership. The number of shares allocated to each member is usually as decided by the Founder based on certain criteria such as age, relationship etc. At this stage of the family business, governance measures such as the avoidance of nepotism would become necessary. This is to ensure that the business is run by capable employees rather than family members without the adequate technical capacity to run the business.
Some family businesses decide to go public as the business keep expanding. These decisions arise based on various reasons such as a need to access more funds or where increased public awareness becomes beneficial for the business. The Founder is able to maintain the ownership of the business where a majority interest in the shareholding of the business is maintained within the family as it goes public.
A public company has increased regulatory obligations and disclosures due to public investments in the business. Hence, the family business governance measures for this business form would ordinarily be in sync with the regulatory and statutory requirements of the business.
A good governance system should be put in place to ensure the success of any business. For family businesses, a family governance structure should also be developed along with the business governance structure to ensure that family goals are aligned with the business goals. As earlier mentioned, for family businesses, the business governance measures are determined on the basis of the form or phase of the family business. This is mostly because the threats to the success of the family business are quite different for the various forms of the business. Nonetheless, there are certain factors that should be considered whilst developing a governance structure which cuts across the various phases of the family business. Some of these factors are the Founder's goal and vision, the family constitution, nature & size of the family business, stage of development of the business, regulatory & statutory requirements, availability of resources etc. The family council is expected to work with the top management of the family business in developing a robust business governance structure which would guide the affairs of the business to ensure that the business is run profitably, efficiently whilst considering the posterity and wealth succession goals of the Founder.
Family businesses should engage the services of professionals in implementing global best practices for their businesses. Andersen Tax is a global firm with wealth of knowledge in various areas cutting across Family Wealth Practice, Private Client Services, Restructuring, Tax Advisory, and Regulatory Service amidst others. We will be happy to work with you in setting up a framework for family and family business governance to meet your family and business goals.
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.