Why Consider Formal Governance as a First-Generation or Small Family Business?

Formal family governance structures are often present in multigenerational, mid- to large-cap family businesses, with dozens, if not hundreds, of family members. As companies grow larger, the need for formal governance typically becomes more palpable; however, the benefits of a formal governance structure are not solely reserved for large family businesses. Formal councils and policies typically associated with larger family businesses can be translated to those with fewer shareholders – specifically, first- or second-generation businesses whose family members may not number more than a dozen. Not only can effective and efficient governance structures be implemented at smaller family-run companies, but they are oftentimes critical to the ongoing success of a young, thriving family business.

What Is Governance and What Are the Benefits?

Definitions of governance vary widely depending on the goals of the family or business. Generally, governance is a set of policies, structures and values that inform or govern decision making. These policies, structures and values are intended to maximize the value of the business through an orderly facilitation of ownership and business operation.

Similar to the definition of governance, the benefits of governance are also varied. Early in the life of a family business, the benefits of discussing and considering governance are largely cultural and foundational, meaning that what is really being created is an acceptance of an overarching governance framework and the discipline that accompanies it. Specifically, discussing governance early can yield the following benefits:

  • Formalizing not only the decisions that need to be made, but also which stakeholders will be included. This process guides how decisions are going to be made and streamlines the decision-making process, which is especially important in times of stress or sudden change for the business or family
  • Engaging the family to develop the policies, structures and most importantly, the values, that form the foundation for the governance can both increase buy-in to the eventual governance structure and build enthusiasm for the business and the family
  • Instituting governance can help avoid potential issues through guidelines and controls, while also reducing ambiguity and potential tension
  • Communicating the governance process and the process through which it was built can inform the next generation of owners and operators and give them a firm foundation off which to build a better enterprise

Developing buy-in for a governance structure can take a generation or more to build. Younger family businesses have the ability to be patient, thoughtful and deliberate in crafting governance structures. Despite the opportunity to delay, starting earlier than “necessary” often means that complexity and conflict levels are lower, and greater space may exist to be more forward-thinking with governance design.

Enhancing Communication through Governance

Governance also enhances and thrives on effective communication. Without highly functional communication, the success of governance bodies – and quite possibly the business overall – becomes increasingly improbable as the years go on. Beginning the dialogue on governance early allows leadership and ownership to prioritize communication. It is imperative that governance, formally or otherwise, be in place during growth or transition periods – specifically, generational, leadership or ownership transition.

Family Governance for the First- or Second-Generation Family Business

Whether they know it or not, every family business – large or small – operates under a governance structure, because every business has a decision-making framework. The following graphic outlines how to begin to formalize that framework and set the groundwork for a more sophisticated governance structure that will be necessary as the business and family ownership group expands. In a sophisticated family business structure, four major governing bodies typically exist (family assembly, family council, board of directors and family business advisory board), which provide formal points of engagement for the entire family and ownership group. Understanding what a typical governance framework looks like in a sophisticated family establishment allows the ownership team to “work backward” and create the precursors and conditions for success to build each. Most importantly, in contemplating the construction of any formal decision-making process, it is critical to consider what the family and business hope to achieve. Starting with the opportunity at hand will guide how the governance model is formed.

Creating Governance Structures for the First- or Second-Generation Family Businesses Chart

We the Family: The Benefits of Creating a Family Constitution

Setting the Foundation for Governance Bodies, Beginning with Family Meetings

For a smaller enterprise, a family assembly and family council can be subsumed in informal (or formal) family meetings. To begin planning these meetings, first identify the major topics of intersection between the family and the business – including employment, distributions, debt levels, conflict resolution, succession and communications. Having a list of items to address will help surface all relevant topics for the family members and determine the most pressing issues that need to be discussed. The first meeting agenda should not only list out these issues, but also provide context and background for why contemplating new governance structures are important for the family and the business. The family business could choose to address all the issues at once with all shareholders or instead decide to handle topics sequentially with different family members – the best course is highly contingent on the unique circumstances of the family and business. Critical to the latter option (covering topics sequentially) is ensuring input from all family members is accounted for and that all conversations are open and transparent. The meetings can be informal – for example, in a family member’s home or neutral destination – or formal, such as in the corporate headquarters or an intermediary office. Having well-run meetings, with coordination among all relevant members and a vision among the members, for what the value that this group may provide now and in future generations, allows the family and owners to set appropriate agendas and include the right individuals to participate over time.

Needs of the Ownership Group

A smaller enterprise oftentimes does not require a board of directors – or at least not one as sophisticated as one might find in a larger company. However, the current owners need a well-functioning decision-making framework for the ownership team, including many of the policies that are critical to running a private enterprise with family ownership. In place should be ownership policies, including a buy-sell agreement along with a valuation policy, both typically part of a shareholder agreement, an employment policy that addresses the role of family-member employees, a compensation policy and a succession plan. The ownership team can and should look to the family for guidance on employment policies, conflict resolution policies and liquidity preferences.

The Value of an Advisory Panel

Advisory boards are integral to the success of many large family businesses, providing knowledge and expertise, strategic idea generation and a strong network. At an early stage, first- and second-generation businesses often need this same objective, external input to guide the development of the business. While an advisory board might comprise between 10 and 20 members and be appropriate for a business that is relatively large, an advisory panel consisting of between two and 10 members may be a more appropriate precursor. This smaller subset of advisors, who are available to confer and, where necessary, meet with the management team and the ownership group, can help form a powerful partnership that adds value to the long-term success of the business. Often, family businesses utilize an advisory board without recognizing it as such. Formalizing these roles will lay the foundation for effective governance for future generations. The family ownership group should play a lead role in determining the composition of the panel.
We the Family: The Benefits of Creating a Family Constitution

Where to Begin

  • Collect your thoughts: Conduct research on similar family businesses that have undergone the process of developing working family boards; discuss with peers or with a group of advisors.
  • Put together your “case:” Formalize your thoughts on why you think embarking on a journey to set up a formal process is worth the effort; draft a vision for what the future would look like and the benefits that would accrue.
  • Build a team: Identify “champions” in your family, the business and externally who can help usher forward this process.

Conclusion

Committing to a discrete set of family meetings, a well-structured ownership group and a regular standing advisory panel – with solid coordination and communication among all of them – will put the first or second generation in a strong position to foster business growth for future generations. An important byproduct of setting up these processes early on is the cultural acceptance of objective, formalized decision-making that suits the family’s philosophy and needs. If you would like to discuss any elements of family business governance with a member of BBH’s Center for Family Business, we would welcome a conversation.

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