Why to adopt formal governance mechanisms?

Why to adopt formal governance mechanisms?

There is an increasing global trend for family owned businesses to take on a more formal governance. This is a sign of the serious intent of family-owned concerns to develop a shared vision of their company. It is also an excellent way to side step major conflict.

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There is an increasing global trend for family owned businesses to take on a more formal governance. According to our latest survey (“Family Businesses: optimistic, entrepreneurial, open to disruptive technologies”):

  • 52% of companies have a formal board of directors (39% in 2011)
  • 51% of companies have a formal policy in place when it comes to the selection, remuneration and promotion of family employees (26% in 2013)
  • 43% of companies have a shareholder’s agreement in place (36% in 2013)
  • 31% of companies have a Family Constitution or code of conduct (20% on 2011)

The latter, in particular, is a sign of the serious intent of family-owned concerns to develop a shared vision of their company. It is also an excellent way to side step major conflict.

Better governance – better performance

Good governance and formal governance mechanisms have a positive effect on the performance of the company, as they enable the owner to keep his finger on the pulse of the business progress.

A deeper look in the governance structures of high-performing family businesses confirms this statement. Specifically, the analyzed high-performing family businesses:

  • had a formal board of directors, usually with a non-family non-executive director;
  • adopted already the governance mechanisms that lay out the expectations of the company and individuals and facilitate agreement and better communication between all parties involved (business / family / owners). These included adopting a Family Constitution, shareholder meetings, shareholder agreements, and policies for family and non-family employees, as well as a succession plan outlining strategically the future of the family in the business.
  • used business management practices that observe what goes on outside of the business. These involved benchmarking, competitor analysis, annually reviewed strategic plans, and progress reports.

Unique company – unique approach

There is no cookie-cutter, one-size-fits-all method to establish governance mechanisms.

One of the best ways is to let the governance evolve as your business progresses and goes through its necessary ownership and family lifecycles.

For example, while not all firms will benefit from implementing a formal board of directors, establishing one will become increasingly important and valuable as they grow. It helps lead to better management of risks, a more professional work culture, a higher calibre of management, and makes it easier to procure outside investments.

Another example is a Family Constitution or Code of conduct, which is usually established by companies when the business is transitioned from a founder-controlled institution to a sibling partnership

Outside VS inside non-executive director

Choosing a non-executive director from outside of your family offers the potential benefit of a more objective, fresh perspective on the business and can lead to a superior business performance. Despite this, more and more family-owned businesses are doing the opposite, putting a family member in the position of a non-executive director of the board. Some of the reasons for such decision are:

  • a family member wanting to continue to be involved in the business, transitioning from managing the family concern to sitting on the board;
  • a family member wanting to participate in family business governance;
  • family battling to find the right outside non-executive director to take on the role.

Trust is paramount in this decision, and lack of trust to someone outside of the family is often why businesses tend to appoint a family member as the executive director rather than an outsider.

Often business members are reluctant to employ non-family executive directors as they feel the outsider won’t understand how their business operates, they don’t want someone else meddling in how they work, and they are reticent to share confidential information with a non-family member.

However, with the increasing complexity of a growing business and broadening number of family stakeholders, formalising governance is invaluable. Particularly as a family-owned business transitions from a founder-controlled business to a sibling partnership. This is when it is especially advantageous to have a non-executive director who can better observe the development of the business, help develop leadership and management approaches, and also mentor the younger family directors.

Aligning family and business needs

Family governance is critical for aligning the needs of both family and the family business, and for developing a shared vision for the future of the business. Creating a family council or code of conduct is imperative as it significantly decreases the likelihood of conflict between family members. It is also the perfect forum for family members to discuss any issues of concern and to clarify their expectations of each other.

A formalized governance is definitely an increasing trend within the family business community. That said, as a family business owner/director, you still need to continually examine how you can make the various governance mechanisms more effective. Board roles should be abundantly clear. You may also need to formalise the way you and your family evaluate the board performance. Whatever the case, by instituting family governance mechanisms, you are definitely moving in the right direction.

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