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TheFamily
Business
Constitution:A
Roadmapfor
Business
Continuity&
FamilyHarmony
TenKeyInsightsintotheprocessofmakingyour
ownFamilyConstitution
ChristianG.StewartManagingDirector
FamilyLegacyAsia(HK)Limited
www.familylegacyasia.com
1
Contents
1. IntroductiontotheFamilyConstitution.............................................................2
1.1 FamilyBusinesses:PredictableProblems........................................................2
1.2 WhatIsFamilyGovernance?...........................................................................4
1.3 FamilyGovernanceStructures........................................................................5
1.4 HowFamilyGovernanceStructuresHelp........................................................6
1.5 HowFamilyPoliciesCanHelpAvoidPredictableProblems............................7
1.6 ExamplesOfFamilyPolicies&Agreements....................................................7
1.7 WhatIsAFamilyConstitution?.......................................................................8
1.8 WhatAreTheBenefitsOfHavingAFamilyConstitution?..............................9
2. TheKeyInsightsintotheprocessofcreatingaFamilyConstitution....................11
2.1 ItstheProcessThatCounts..........................................................................11
2.2 NotaLegallyBindingDocument...................................................................11
2.3 TheFamilyMakeTheirOwnRules................................................................11
2.4 FamilyProjectLeader....................................................................................11
2.5 TheConceptOfFairProcess..........................................................................12
2.6 AChangeProcess..........................................................................................13
2.7 ASocialContract...........................................................................................13
2.8 WhatAreTheExistingArrangements?.........................................................14
2.9 HowLongDoesItTake?.................................................................................14
2.10 WhatIfTheyDontFollowTheRules?.......................................................15
1. IntroductiontotheFamilyConstitution
1.1 FamilyBusinesses:PredictableProblems
Whatisafamilybusiness?Onecommonaspectofthedefinitionoffamilybusiness
is an intention to continue the business under family control. Another way of
definingafamilybusiness is to refer toabusiness inwhich there isasignificant
overlapbetween(i)afamilyemotionalsystemand(ii)theownershipsystemand(iii)
thebusinesssystem.
Notwithstanding that a family business, by definition, is one where there is an
intentionofkeepingcontrolinthefamily,thechallengesofsuccessfullyperpetuating
afamilybusinessarewellknown,leadingtotheoftenquoteduniversalproverbthat
wealthonly lasts for threegenerations,or from shirt sleeves to shirt sleeves in
threegenerations.1
Research into Asian family businesses2 has concluded that the majority of family
businesses inAsia fail as a result of internal factors, rather than external factors.
Theseinternalfactorsincludefailuretoplanforsuccessionandfamilyconflicts.Yet
thesurprisingfact isthatmanyfamilybusinessconflictsarepredictableandcanbe
plannedfor.
1ThisisthestartingpointofthepopularbookFamilyWealth:KeepingitintheFamilybyJamesE.
HughesJr.,BloombergPress2TongCheeKiong,NationalUniversityofSingapore,FeudsandLegacies,ConflictandInheritancein
ChineseFamilyBusinesses,InternationalSociology,March2005,Vol2091);4570.
3
Onereasonforfamilybusinessfailurecanbetracedtoshareownership.Overtime,
the number of shareholders increases, share ownership becomes fragmented,
resulting in it becoming harder for the family to make decisions concerning the
business.Itissaidthat:Familiesgrowfasterthanbusinesses.
Over time,as the shareownershipbecomes fragmented, the shareholders start to
loseemotionalcommitmenttothefamilybusiness.3Emotionalcommitmenttothe
business4andhavingactiveowners5hasbeen identifiedasafeatureofsuccessful
multigenerationalfamilybusinesses.
It is alsopredictable thatover time, therewillbemore familymemberswho are
ownersratherthanmanagers,andthattheinterestsoftheseoutsideshareholders
willbe inconflictwiththe interestsoftheinsidemanagers. Againsuchconflicts
arepredictableproblems.
There are examples of successfulAsian family businesseswhere the business has
beencontinuedasaresultofaconsolidationofshareownership.Thispointstothe
importance of having a mechanism for allowing for share ownership to be
consolidated. The need for such a mechanism (often called an Exit Plan or a
familyshareholdersagreement) ishighlightedbycaseswhere (i)afamilyconflict
startsovertheissueofhowtovaluethesharesinthebusinessor(ii)theexitofone
familyshareholdercreatesaliquiditycrisisforthebusiness.6
Another challenge for the family business is the basic inconsistency between the
goalsandvaluesofthefamilysystemontheonehandandthegoalsandvaluesof
thebusiness system. Anexampleofa familypolicydesigned toaddress sucha
conflictbetweenfamilygoalsandbusinessgoalsisthefamilyEmploymentPolicy,
whichwillsetoutclearrulesforentryintothebusinessbyfamilymembers.
3WongSiuLun,FamilyBusinessReview,volVI,no.3,Fall19934Carlock&Ward:StrategicPlanningfortheFamilyBusiness,Palgrave5Responsibleownershipofthefamilyfirm,LorraineM.Uhlaner6TongCheeKiong.
4
1.2 WhatIsFamilyGovernance?
Ifthegoalislongtermbusinesscontinuity,thispointstotheneedtoinstitutionalize
therolesandrelationshipsthatarepresentinthefamilybusiness,ratherthansimply
to rely on current relationships. In short, long term business continuity requires
theretobeclarityastohowthefamilybusinesswillbegoverned.
Governance isconcernedwithallof theways that the interestsofowners
arereflectedand implemented intheorganizationalsystemIngeneralthe
purposeofgovernanceistoformalizetheinvolvementofkeystakeholdersin
thedecisionmakingprocessattheapexofafamilyenterpriseGovernance
isinherentlyaboutinstitutionalizingcontrol.7
Governanceinafamilybusinesscanbethoughtofintermsof:
(i) Structures for example, deciding to create a family learning and
developmentcommittee;
(ii) Processes forexample, creatingand runningongoingownershipeducation
programsandtheannualpreparationofapersonaldevelopmentplan;and
(iii) Policies for example, an aspectof the FamilyEmploymentPolicy couldbe
that family member employees are expected to participate in the family
learninganddevelopmentprograms.8
Foranotherdefinitionofgovernance,takenfromthecontextofafamilycontrolled
listedcompanyinHongKong:
Corporategovernance canbebroadlyunderstood as the interrelationship
among the companys stakeholders, including shareholders, the board of
directors, the management, and other relevant partiesGood corporate
governance depends largely on the separation of ownership and
7TraditionandAdaptationinChineseFamilyEnterprises:FacingtheChallengesofContinuity,Ivan
Lansberg&KelinGersick.8YoucanalsoaddAgreementstothislist,e.g.theshareholdersagreement.
5
management. Under a good corporate governance structure the
responsibilitiesofdifferentunitsinacompanyareclearlydelineated.9
Thispoints to the importanceofensuring that there isacleardistinctionmade
betweentheroleofownershipandtheroleofmanagement.
1.3 FamilyGovernanceStructures
Another form of predictable problem in a family business is where an issue or
concern from one dimension of the family business system (for example, an
ownershipissue)arisesinthewrongcircle.
Iftheneedsofonedomainhavenowaytoberepresentedtheydont just
evaporate, they find another outlet. This is like the displacement of an
emotion.Forexampleifthereisnowayforownershipissuestobeexpressed
expressed they may appear in the board and board meetings turn into
shareholdermeetings.10
Thispoints to the importanceofhavingappropriatestructuresand forums so that
the interests of the family circle and the interests of ownership can be properly
expressed. Anexampleofthiswouldbethecreationofafamilycouncilorofan
ownerscouncil.
One of the most pervasive lessons we have learned is that when the
legitimate interestsofownershipdonothaveaforumforexpression, issues
ofcontrolandreturnon investmentwillfindawaytoemerge ineitherthe
familyortheoperatingbusiness. Whenthose issuesdocometosurface in
the wrong circle, they are almost always disruptive and sometimes
destructive.11
Basicgovernancestructuresinafamilybusinesscaninclude(i)afamilyassembly(ii)
afamilycouncil;(iii)itmightincludeaseparateownershipcouncilorforum;(iv)the
boardofdirectors;and (v)perhapsalsoanadvisoryboard.Fromthereaparticular
9100YearsofLi&Fung,byFengBanYan.10GettingAlonginFamilyBusiness;theRelationshipIntelligenceHandbook,Hoover&Hoover.11GenerationtoGeneration,HBSPress.
6
family might decide that it also needs one or more committees (see the below
diagram)or,forexample,acareerplanningcommittee.
Asimplediagramreflectingabasicgovernancestructureforafamilybusinesscould
beasfollows12:
1.4 HowFamilyGovernanceStructuresHelp
Wellfunctioningfamilygovernancestructuresaimat:
(i) Communicatingthefamilyvalues,mission,andlongtermvisiontoallfamily
members.
(ii) Keeping familymembers (especiallynonexecutives) informedaboutmajor
businessaccomplishments,challenges,andstrategicdirections.
(iii) Communicating the rules anddecisions thatmight affect familymembers
employment, dividends, and other benefits they usually get from the
business.
(iv) Establishing formalcommunicationchannels thatallow familymembers to
sharetheirideas,aspirationsandissues.
(v) Allowingthefamilytocometogetherandmakeanynecessarydecisions.
12AdvisingtheFamilyBusiness:AGuideforProfessionalsDavidBork,DennisJaffe,SamLane,Leslie
Dashew,andQuentinHeisler,JosseyBass
7
1.5 HowFamilyPoliciesCanHelpAvoidPredictableProblems
Becausefamilybusinesshavepredictableproblems,theseproblemscanbeplanned
forandfamilypoliciesdevelopedtoaddressthe issuesbeforefamilyconflictarises.
Accordingly another aspect of family business governance is the creation of an
ongoing process for the creation of relevant family policies and for their periodic
review.
Familypolicieshavemanyadvantages.Makingfamilypoliciescan:13
(i) avoidproblemsorsolvethembeforetheyoccur;
(ii) reducefuturefamilytension;
(iii) strengthenthefamilywithexperienceincomingtoagreement;
(iv) clarifyyourfamilyspositionsandreducemisunderstandings;
(v) helpthefamilysortoutitsvaluesandwhatitstandsfor;
(vi) improvefuturedecisionsbyensuringthatpolicyformation is informedand
objectiveratherthanmadeintheheatofbattle;
(vii) createmoreenthusiasmforandknowledgeofthebusiness;
(viii) increasethelikelihoodoflongtermbusinessandfamilysuccess,survivaland
prosperity.
1.6 ExamplesOfFamilyPolicies&Agreements
Examplesoffamilypoliciesinclude:
anEmploymentPolicy aDividendPolicy aRemunerationPolicy ajobdescriptionfordirectors alearninganddevelopmentcurriculum aCodeofConduct apolicydealingwithConflictsofInterest aCharity/PhilanthropyPolicy aStatementofFamilyValues
13DevelopingFamilyBusinessPolicies:YourGuidetotheFuturebyCraigAronoff,JosephAstrachan
andJohnWard,FamilyEnterprisePublishers.
8
a family shareholders agreement (note, unlike the above policies, this isnormallyalegallybindingagreement)
anoperatingagreementforthebusiness(again,thismightbealegallybindingagreement)
1.7 WhatIsAFamilyConstitution?
Thefamilyconstitutiondefinestherulesoftheroadforthefamilywithrespectto
itsrelationshiptothebusiness.
Insimpletermsafamilyconstitutioncanbethoughtofasacollectionofkeyfamily
policies. It would also reflect the mission vision and values of the family and
importantprinciplesforworkingtogetherorforthebusiness.
Itcouldalsoincludeadescriptionofthecompositionandroleofthefamilycouncil,
andhowthefamilycouncilmakesdecisionsandresolvesconflicts.
Itcouldincludeadescriptionoftheothergovernancestructuresthatgotomakeup
the family business (or thewider family enterprise if youmake reference to the
family foundationand the familyoffice, forexample). There isno fixeddefinition
andthereisnoonewaytodoit.Herearesomemoredescriptionsofwhatafamily
constitutionis:
AFamilyConstitutionisaformaldocumentdevelopedcollaborativelyby
familymemberstoencapsulatethevalues,beliefsandobjectivesofthe
family,asafamily,withspecificreferencetothefamilysrelationshipand
dealingwithitsfamilybusiness.
IvanLansberg,SucceedingGenerations
AFamilyConstitutionis.alegal,orquasilegal,guideforfamilybehavior,
decisionmaking,andsettingupthesuccessionfromonegenerationto
another.Beginningwiththemissionstatement,theconstitutionthen
extendsthemissionintopracticalactions.Itsetsupaframeworkanda
forumforagroupofequalstodeliberateissues,createpoliciesand
procedures,clearlydefinefamilymembersrightsandobligations,andmake
decisionsabouttheimportantissuestheyshare.
DennisT.Jaffe,PhD,StewardshipinyourFamilyEnterprise
9
1.8 WhatAreTheBenefitsOfHavingAFamilyConstitution?14
Whatarethebenefitsofhavingafamilyconstitution?Asyoumightexpectthereare
actuallytwodimensionstothisquestion.First,youshouldask,whatarethebenefits
ofgoingthroughtheprocessofcreatingafamilyconstitution?Second,whatarethe
benefitsofhavingafamilyconstitution?
(i) What are the benefits of going through the process of creating a family
constitution?
The process can help to include or involve family members or family
branches thathavenothada role toplayor thathave started tobecome
distantfromthefamilybusiness.
Itcanbefun.Itcanstrengthenfamilybondsandfamilyunity.
It shouldhelp to improve family communication andproblem solving and
conflictresolutionskills.
Ideallyitshouldhelptoimprovethelevelofindividualselfawareness.
Itmakes the familymembers think about how they need to develop and
whatnewskillstheyneedtolearn.
Itprovides anopportunity to talk about and toplan for the future.Often
without a structured platform to have such discussions, families tend to
avoidsuchimportantbutdifficultconversations.
It helps to bring the family members /shareholders onto the same page
together.
(ii) Whatarethebenefitsofhavingafamilyconstitution?
FamilybusinessguruJohnWardsaysofthefamilyconstitution:
TheFamilyConstitution,acomprehensivearticulationofphilosophy,
14Source:CreditSuissePrivateBank
10
principlesandpoliciesforthefuturethatbalancesandsynthesizesthe
welfareoffamily,ownersandthebusiness,isamongthemost
importantstepsabusinessowningfamilycantaketosecureand
strengthenitsbusinessand,mostpreciously,itsfamily.
DanielaMontemerlo,PhDandJohnL.Ward,PhD
Afamilyconstitutionhelpstoavoidfamilyconflictsandpreventunnecessary
misunderstandings.Byclarifyingroles,thishelpstoavoidroleconflicts. By
providingforumsfordiscussionoffamilyandownershipissues,thisprevents
such issues from exploding in the wrong forum. By providing an exit
mechanismthisprovidesawaytoletoffsteam.Havingthings inwriting
helps ensure family members are all on the same page. The family
constitutionwillnormallyincludeaprocessfordealingwithfamilyconflicts.
Thefamilyconstitutionhelpstoshapetheexpectationsofthemembersof
thenextgenerationwithrespecttotheirrolesinthebusinessandasfuture
owners.15
Havinga familyconstitutionhelps togive thebusinessastrong foundation
andtobuildtheconfidentofnonfamilymanagersandbusinesspartners.16
Withrespecttofamilyownershipthefamilyconstitutionhelpstokeepthe
ownership united and to forge family commitment to the future of the
familybusiness.
Finally, the preservation of family wealth across generations ultimately
comes down to having the best possible process for joint family decision
making.17Theheartof the family constitution is a fairprocess formaking
jointdecisionstogetherasafamily.
15CreditSuissePrivateBankWhitePaper16CreditSuissePrivateBankWhitePaper17JamesE.HughesJr.FamilyWealth,KeepingitintheFamily.
11
2. TheKeyInsightsintotheprocessofcreatinga
FamilyConstitution
Thefollowingpointsareworthkeepinginmindwhenpreparingtoworktogetheras
afamilytocreateafamilyconstitution.Akeyconceptthroughoutisthatthefamily
gettomaketheirownrulestherulesthatmakesenseforthem.
2.1 ItstheProcessThatCounts
Itisoftensaidthatwhenmakingafamilyconstitutiontheprocessismoreimportant
than theoutput. Theprocessgives familymembers the chance towork together
andmakedecisionstogetherandtalkinastructuredlogicalwayaboutthefutureof
thefamilybusiness.
As such there is very limited value in modeldocumentsor templateswhichare
likelytobeput inthedraw. Thegoal istocreatesharedunderstandingamongthe
familymembersandcreateasetoffamilynormsofbehavior.
2.2 NotaLegallyBindingDocument
Familyconstitutionsarenotnormallylegallybindingdocumentsalthoughafamily
shareholdersagreement isusually legallybinding. Again it isaboutclarifyingroles
andexpectationsandcreatingfamilynorms.
2.3 TheFamilyMakeTheirOwnRules
Thefamilymembersshoulddecideonwhatgoesintothefamilyconstitutionaswell
astheapproachtobetaken,andtheonthetermsofpoliciesetc. Ithastobethe
familysproject.Thereisnodefinedlistforwhatmustbeinafamilyconstitutionso
itshouldbetailoredbytheindividualfamilyforthemselves.18
2.4 FamilyProjectLeader
Ideallytherewillbeoneormorefamilymemberswhodrivethefamilyconstitution
project(thefamilytaskforce).Themorethefamilymembersowntheprojectand
18Ontheotherhanditwillbehelpfultohaveachecklistofissuestobeconsideredforinclusion.
12
andputtheirownthinkingintoit;themoreeffectiveandrobustitwillbe.Itoften
makes a lotof sense tohaveone familymember at leastwho is chargedwith (i)
actingasthecoordinatorandliaisonbetweentheoutsideconsultantand(ii)whois
responsibleforcoordinatingtheworkthatneedstobedonebythefamilymembers.
2.5 TheConceptOfFairProcess
(i) In working on a family constitution the concept of fair process is very
important.19 Ifapersonfeelsthattheyparticipated inmakingadecision, if
theyhaveavoice, iftheybelievetheprocessformakingadecision isfair
andtransparent,theywillaccepttheoutcomeofthatprocessevenifitmay
notreflecttheirownpersonalview.
(ii) Fair process is about participation and having a voice in the process.
Howeveryoumaybeable toget the inputandparticipationofagroupof
personswithouthavingtocededecisionmakingauthoritytothem.Decision
Decisionmakingauthorityandparticipationcanbedifferentthings.20
(iii) Theprinciplesof fairprocessmightdictate thatnormaldecisionmaking
processesofa family shouldbe suspendedwhileworking togetheron the
familyconstitution.21
(iv) Inthecontextofafamilybusiness, itwillalsobe importanttoconsiderthe
nonfamilymemberswhoshouldbeaskedtogivefeedbackontheproposals
and policies the family members develop, e.g. non family directors and
seniormanagers; and to consider how&when their feedback should be
obtained.
19SeeBlueOceanStrategy,byHarvardBusinessSchoolPress.20ProfessorRandelCarlock.21FamilyGovernance,BeyondtheBasicsBarbaraHauser,STEPJournal
13
2.6 AChangeProcess
(i) Workingonafamilyconstitutionmight involvemakingachange intheway
the familydo things. For example if anownership council is formed and
startstomeetandstartstogetreportsthatwerenotgiveninthepast,this
wouldbeachange.Itisimportanttounderstandthatchangetakestimeand
isusuallymetwithresistance.
(ii) Ifnewconceptsareinvolved,ifachangeiscontemplated,inpracticeitmight
benecessary fornew informationor feedback tobepresentedmore than
oncetothefamily..
2.7 ASocialContract
(i) If, for example, you are asking a familymemberwho is a shareholder to
participate in the family council and to abide by its decisions, to put the
interestofthefamilygroupinfrontoftheirownpersonalselfinterest,then
you are talking about forming a "social contract".22 A "social contract"
means that people are willing to give up some of their own personal
freedoms"for thegreatergood".23The theory is thatyouaregoing tobe
"safer" and better protected as a member of the group, even though it
involvesgivingupsomeofyourpersonalfreedom.24
Everyattempttocreategovernancebyandforafamilygroupwill
of necessity involve an accommodation or curtailment of the
individualsfreedomforthegreatergoodofthewhole.Accordingly,
each individual must be convinced that this accommodation will
result in an overall benefit to the individual by being part of the
largergroup.25
(ii) Inpracticaltermsitfollowsthatitisveryimportanttogeteveryonetothink
carefullyaboutthebenefitsofhavingafamilyconstitutionandwhatarethe
22GenerallyseeFamily:TheCompactAmongGenerationsbyJamesE.HughesJr.23SeeJohnLockeandhisSecondTreatiseonCivilGovernment1689.24Thisissubjecttotheprovisothattheleadershipofthegrouphastobeseenasgoodleadership.25FamilyGovernance,BeyondtheBasicsBarbaraHauser,STEPJournal
14
benefitsofworking togetherasaunited familygroup.26Working together
mightholdup thevalueof the familyvotingbloc.Working togethermight
providetheopportunitytoensurethatthefamilycompanycontinuestobe
runinlinewiththefamilyvalues.
(iii) Socialcontracttheorypositsthatthereisgovernmentbyconsent;byfreely
given consent. Membership of the family group therefore has to be
voluntary.27
(iv) Inorderforittobevoluntary,therehastobeawaytoexitthegroup.This
points to the importance of (a) a voluntary commitment to the family
constitution, (a) having a way to amend and modify the family
and(c)havinganExitPlan(forexampleafamilyshareholdersagreement).
2.8 WhatAreTheExistingArrangements?
Workonafamilyconstitutionwillnotoccur inavacuum. Thefamilybusinesswill
alreadyhave itsexistinggovernancearrangements inplace,even if theymightbe
relativelyinformaloreveniftheyarenotdocumented.
2.9 HowLongDoesItTake?
How longdoes it take? Just like there isno set formula forwhat shouldgo intoa
family constitution, there is no one right answer for the question of how long it
wouldtake.
(i) Some families hold a series of family meetings over a period of several
monthsandcreateafamilyconstitutionwhichreflectstheirsharedviewon
a listof importantquestions thatcan impacton familybusinesscontinuity
(for example, Can in lawswork in thebusiness?or Whatwillwedo if
there is a dispute?. Theywould then plan on reviewing it at an annual
familymeetingandifnecessaryupdatingit.
(ii) Somefamiliesfocusonformingafamilycouncilandarticulatingtherulesfor
26ArelatedconceptisthatofexaminingEmotionalCommitmenttothefamilycompany.27Family,TheCompactAmongGenerations,JamesE.HughesJr.BloombergPress.28Thoughamendmentsshouldnotbetakenlightly.
15
participation inthefamilycounciland itsroleandpurposeandtheprocess
bywhichthatfamilycouncilwillmakedecisionsandresolveconflicts.Thisis
isdocumented in the familyconstitution. They thenholdquarterly family
council meetings which debate important family agreements, policies &
issues.Thisthenbecomesanongoingprocess.
(c) At theotherendof the spectrum, there isawelldocumentedexampleof
one Indian family, theGMRGroup, thatspentconsiderableeffortovera3
year period developing a comprehensive family governance structure and
familyconstitution.29
2.10 WhatIfTheyDontFollowTheRules?
Thisisacommonquestion.Therearetwoaspectstothis.Thefirstisthatthefamily
shouldconsiderthealternativesandmaketheirowndecisionasto(i)whetherthere
will be any express consequences for a breach of the family constitution and (ii)
whatthoseconsequenceswillbe.Thefamilyshouldmaketheirownrules.
Forexample,thereisafamilyconstitutionpreparedbyawealthyJapanesefamilyin
1722,calledtheMitsuiConstitution,whichcontainsthefollowingclause15:
Inprinciple,theeldestsonistosucceedhisfatherasheadofthefamily;but
ifhisconductshouldcauseharmtothefamily,heshallbeexpelled,even if
heistheonlyson,andsentintothepriesthood.Insuchacase,asuccessor
will be adopted from among the other members of the House. Those
memberswhoproveincapableofmaintainingtheirfamiliesorwhoconduct
themselvesimmorallyshallalsobesentintothepriesthood.
The second aspect to this question though is the question ofwhether complying
with the family constitution and being a member of the family group is an
attractivepropositionornot. Thisalso includes theconceptof fairprocessagain;
i.e. has there been an adequate opportunity provided to participate in the rule
makingprocess?
29ThiscaseisreferredtoinFamilyBusinessTheEssentialsbyPeterLeach.