close
Share with your friends

In the second of a series of articles on the secret to sustaining a family business, Liam Lynch, KPMG partner and Head of Private Clients considers how governance can enable you to achieve a balance between family and business that supports sustainability.

Rules of engagement

In his first article of this series, Liam noted that the family connection with and passion for the business can provide an important foundation to sustain the business through changes in generations. But trust, traditions and expectations only get a family business so far. Each generation wants different things, so establishing the rules of engagement for everyone is essential for longer term success.

Like any enterprise, a family business needs to have governance in place to ensure that its family and business strategies are aligned and achieved. This governance must protect the business from the normal and predictable challenges that family involvement brings. However, formalising ownership structures, power and processes can create resistance and (often healthy) conflict as the management of a family business transitions from a ‘autocracy’ to ‘democracy’.

The benefits of family business governance far outweigh the challenges of developing it, Liam says. “As more generations become involved, and the demands of people in the business increase, the need for more formalised governance structures is vital”.

“When we talk about governance, we’re talking about education and pre-agreed rules about how things are managed and how strategies will be implemented,” he says. “These rules must apply to everyone involved in the enterprise, from directors to shareholders, managers and staff.”

i

There typically needs to be two separate but related sets of rules (governance).

One regarding how the family will behave and relate to the business – a family constitution if you like, even if not formalised as such – and the other regarding how the family will behave and relate in the business – a Shareholders’ Agreement and sometimes a Board Charter.

Discussions must start now

To echo his earlier advice, Liam has found that building a sustainable family business means starting early to communicate about plans for growth and future succession. 

Unlike a regular enterprise which does not need to consider the family dynamic, a family business is usually built on a level of trust and informality by the founder family members. However, Liam says that if a business is to grow, and employ more people, including family, it needs a level of structure to help the business ‘scale up’.

“Founders shouldn’t expect that following generations can or will run the business the way they have. Governance structures can help ensure there are clear rules around the different ways family can participate and be recognised as members of the family and business.”

Liam acknowledges that conversations around family business governance can be challenging, and it can be hard to transfer from a tradition of ‘trust, informality and implicit rules’ to a new tradition of ‘structure and explicit rules’.

“But it’s important to have these discussions. For example, if someone wants to join or leave the business, how do they do so?” he says.

He adds there is no point waiting until a critical juncture to try and solve succession, ownership, management structures, roles and responsibility issues.

“It should be part of the normal business operation to have this conversation, now,” he says.

To minimise distraction to the business and tension within the family when formalising governance structures, it is important to recognise that these issues are completely normal and predictable. It can be helpful to work with an independent party, who can facilitate conversations, share proven frameworks and use their experience to navigate the process.

“Invariably that will lead to a better outcome,” Liam says.

i

Governance should be broken into four categories – management, income, control and equity – with each family arriving at a unique position on each area, Liam explains.

Management

A common trigger of problems is when the founder brings children into management roles who have not gained the experience to perform the roles. This not only creates tension, but it can stunt the business’ performance. This can be alleviated by having pre-agreed rules regarding how family members can join the business, and the required experience, involvement, development and output – just like any other employee.

“You could say it is encouraged that they work in the business (e.g. during holiday periods) when they’re younger, and you could make it a requirement that to go on to management roles, they need a minimum level of experience. This ensures that they bring capability and experienced points of view,” he says.

The pre-agreed rules will consider reporting lines, and establish performance expectations and review processes, as well as how issues are communicated and resolved.

“Ideally, family members should report to someone outside the family, but if it is a family member, their performance review should happen with an independent adviser as well. These rules help prevent disagreements later on and spill-over between business and family relationships.”

Income

There must be clarity around how family members, in and out of the business, will be recognised and rewarded, and how they can develop and progress. Part of achieving the balance of a sustainable business will mean adopting rules that reflect the different roles family members can play in relation to the business as employees, directors and/or owners.

Liam says you can think about it as “employees earning a market-based salary, family members who contribute as non-executive directors earning directors’ fees, and owners receiving dividends or repayments of capital in accordance with a pre-agreed plans.” All too often, family businesses not only blur these roles, but they also blur the remuneration for each.

Control

Liam adds that there also must be clear rules in relation to the decisions that managers, directors and owners make in each of these roles. These need to be clearly defined, communicated and respected.

An important distinction to remember, advises Liam, is that “Family members are ‘equals as members of a family’ but not ‘equals as managers, directors or owners of a business,’ setting structures, processes and strategy,” 

Some of these rules may reside in a family constitution, business policy or shareholders’ agreements.  The important thing is that they are clear and agreed.

Equity

Like any business relationship where there is more than one owner, there needs to be agreement and communication on how people will behave as owners. 

Liam advises that “This includes defining who can appoint directors, the payment of dividends, how decisions will be made, how and when ownership interests can be sold or transferred, and how the business will be funded.”

Again, the important thing is that these rules need to be clearly documented.

Respect the separation of powers

Finally, the creation of a governance structure is all about “clearly defining and respecting the separation of powers”, says Liam. 

Focusing on the above four pillars ensures that each area has clear governance, helping family business members to avoid arguments and ensure the success of their strategy.

At the end of the day “A lot of this comes down to ‘best fit’ rather than ‘best practice’” explains Liam. 

Families and the businesses they own need to do what’s right for them in their own context. Making sure a governance structure is in place that is tailored to the specific history and needs of the family will mean they manage and avoid arguments and problems down the road to a sustainable future. 

Up next

In the next of this series of articles, Liam takes a closer look at sustaining a balance between family needs and the economic needs of the business. 

Have you signed up to TaxWatch, KPMG’s client-only portal on tax insights? Login/Register now for the latest topical tax insights and analysis relevant to you and your business.

i

Governance should be broken into four categories – management, income, control and equity – with each family arriving at a unique position on each area, Liam explains.

Get in touch

Family business strategy requires informed decision making. For experienced guidance for your company, please contact Liam Lynch, Head of Private Clients, or any member of our Private Client team. We'd be delighted to hear from you.

In this series

Read more