5 minute read 9 May 2018
How governance prepares family businesses

How governance prepares family businesses

By

Robert (Bobby) Stover, Jr.

EY Americas Family Office Leader

Leader and advisor in helping family businesses navigate the challenges they face. Instructor and speaker about business succession and wealth transfer.

5 minute read 9 May 2018
Related topics Tax Family business

As family businesses evolve and grow over time, strong governance is needed to build a positive legacy for generations to come.

When a family business first opens its doors, the future can seem a long way away. The founder was likely chasing a dream, wanting to control his or her destiny or perhaps just wanting to pay the mortgage.  

But times change. Businesses — and families — evolve and grow. Members of the next generation join the company, and the founder may wonder about the future of the family business. Questions arise about succession planning, corporate strategy and family dynamics, with each topic having the potential to introduce conflict within the family and business.

In an effort to answer these questions, many family businesses begin to wonder how and when to create more formal governance structures, such as boards of directors and family councils.

In our report, Demystifying family boards: strong governance builds a legacy for generations to come, we discuss how families need to decide on the right governing body for the size and stage of their business, as well as help their members understand their role within the business. We also explore:

  • How should business and family governance change over time?
  • When is it time to separate business governance from family governance?
  • What is the purpose of a board of directors?
  • What are the responsibilities of a board member?
  • Who should be on the board?

As a family business considers these questions, its members should remember that the needs of the family may not align perfectly with those of the business. Quite often, the initial board of directors is composed of family members, and family and business topics intermingle.

Over time, they may seek outside advisors for an alternative perspective. Eventually, they may separate the business board of directors from a family council to better handle issues unique to each realm.

Families need to decide on the right governing body for the size and stage of their business, as well as help the board members understand their role to best help the business.

Generally, a board of directors handles the strategic concerns of the business, from identifying and managing risk to planning for succession. It’s designed to serve the interests of owners, customers and management.

In turn, a family council oversees the family vision and charter, defines family compensation and employment policies and prepares the next generations for leadership. Its driving purpose is to build and maintain family cohesion and unity, while moving toward the family’s desired long-term legacy.

This complementary division of labor can prepare both the family and business for long-term success. Strong governance of the family and the business helps give a family the best opportunity to build a positive legacy for generations to come.

Evolution of governance in a family business

Not every business follows the same process, but there is a common pattern. Governance evolves from less formal to more formal, and from a blend of business and family decisions to clearly separating such decisions.

If your business is a corporation (C- or S-), you are required to have a board of directors. Sarbanes-Oxley and other laws specify board requirements (e.g., majority of independent directors) for companies listed on US stock exchanges, but there are few requirements for non-listed companies.

If your business is an LLC or partnership, using a board is not legally required but can be critical for maintaining and growing the business.

By the time it is obvious to a family that they need to move to the next stage of governance, they probably waited too long. Generally, the reasons for forming a board of directors are the following:

  • The founding generation wants to prepare the next generation to be owners
  • There is conflict or disagreements among family owners, and they want outsiders to facilitate agreement
  • Leadership wants strategic thoughts and ideas from other experts
  • The business wants to borrow money, and bankers are more agreeable if there is a formal board of directors
  • Because the board of directors has a formal decision-making process, the risk of family members (owners) bringing litigation is reduced

When to transition between governance structures

While the aforementioned points are the most common reasons for forming a board, there often are more specific causes for moving between each of the governance structures.

Founder

Some founders recognize the value of a board immediately, while others take some prodding. Frequently, this happens as the second generation (G2) becomes adults.

They have become owners in the business (through estate planning techniques), and the founder wants to prepare them for leading the business. All too often, this transition doesn’t happen until the founder passes away and the next generation shares ownership.

Advisory board of directors

Disagreements are frequent among family board members or family executives, and they want an outsider to mediate decisions or help change unhealthy behaviors. In other cases, business growth or industry changes are leading them into new territories, or perhaps growth has stagnated and they want experienced advisors who can help them through the transition.

Business board of directors

The number of family members has grown, particularly those not involved in the business, and family discussions in board meetings become a distraction from business demands. Also, it becomes difficult to attract high-quality outside board candidates when the board also provides family governance.

Family council

With the transition to a business board of directors, the family wants to establish a separate group to govern the family. Many families often initially ask a family member from the business to lead the council, but that person quite often doesn’t have the time or interest to lead it. Generally, the point of the family council is to encourage more family members to participate in family governance, providing different perspectives and representing more interests, while allowing the business board to focus on the business, potentially leading to greater growth.

Purpose of a board of directors

As you consider where your family and business reside in the evolution of governance, it is important to consider the purpose of having a board of directors. A board of directors is a strategic body, created to serve the interests of owners, customers and management.

Some key purposes include:

  • Assist with strategy and business development
  • Serve as the voice of shareholders
  • Advise management (or act as a sounding board)
  • Suggest ideas for improving the business
  • Identify and manage risk
  • Review and understand financials
  • Plan for succession
  • Balance the needs of shareholders, customers, management and employees

Summary

For success in family businesses, owners need to decide on the right governing body for the size and stage of their business, as well as help the members understand their role within the business.

About this article

By

Robert (Bobby) Stover, Jr.

EY Americas Family Office Leader

Leader and advisor in helping family businesses navigate the challenges they face. Instructor and speaker about business succession and wealth transfer.

Related topics Tax Family business