Family Business Governance & Alignment

For family businesses in America, the chance of successfully transitioning the business to the next generation is approximately 30%.¹ While there are multiple factors outside the family’s control on which business success is predicated, there are several internal factors that are within the control of the family. If addressed, these controllable factors may increase the likelihood of a successful business transition to the next generation.

Family business governance is a system of human capital, correlated tools, and philosophies to support the next generation with the ownership, control, and operation of the business. It can assist your family in their interactions regarding business decision making, family and business vision, and asset oversight. Additionally, it sets expectations of family members on employment, control, and distributions and assists in capturing the human capital of the family.

In creating a family business governance structure, you as the current owner will likely need to think about the business and your family in a manner that you have not previously considered. From a business perspective, ownership, control, and operations should be separately reviewed, and decisions can and likely will be made separately for each of these areas of the family business. For most owners, ownership, control, and operations are thought of as one and no distinction is made between them.

Furthermore, the human capital of the family should be analyzed, and an inventory should be made as the business transition is being considered. Not only will this likely benefit the business, but the family as a whole will likely benefit long term as well. In his book “Family Wealth” by James E. Hughes, Jr., James lists four types of human capital:

• Human (what makes us unique as an individual)
• Intellectual (experiences or stories that express the family’s heritage, traditions, or faith)
• Social (what is it that the family stands for in terms of responsibility, values, and purpose)
• Financial (the capital assets of the family)

Human capital should be evaluated to understand how it can best be used in the family business. Are there certain roles in the business that lend themselves to the capital in the family from a human or intellectual perspective? Will family members attain positions in the company based on a birthright, or on the capital they contribute?

There are several tools that can be employed as part of the family business governance system. These may include (but are not limited to): a buy-sell agreement, family employment policy, distribution / dividend policy, professional board, family business board, family mission statement, estate planning documents including irrevocable trust structures, and business documents (operating agreement, by-laws, etc.). Each family and its circumstances are unique. The tools that are right for your family and business situation will vary. How you elect to use any of these tools begins with education to understand each of these tools and how they can benefit your family and business. Start the conversation with your financial advisor and they can bring in the appropriate resources to provide you with the education you need and want. You need to understand how these tools work collectively and determine which combination, if any, would work to the benefit of the next generation. Additionally, the system should be aligned to help ensure all documents work together for the benefit of the family business.

In contemplating what to put in place for the next generation, soliciting thoughts on what should be created becomes an important part of creating a well-thought-out plan. An important group to consider eliciting input from in this process is the next generation. Ultimately, their buy-in and support of the system and tools is important for the success of the business in their generation. The next generation may have different thoughts for the future, and they could have additional insights you may not have considered. Additionally, giving the next generation a voice in the process of creating this system will allow you to confirm or alter your understanding of their desires and goals.

One important question that needs to be asked of the family and especially the next generation is, “Is this an optimal asset of the next generation?” While it has been a great asset of the current generation and likely created substantial wealth for the family, it does not mean that it is an optimal asset of the next generation. Care should be taken in determining if the family business is a fit for the next generation. It may be that there is not the appropriate amount of human capital in the next generation to continue the family business. It may be the next generation does not want the family business or have different ideas to grow the family wealth that do not include the business. This is where communication and allowing the next generation to have a voice matters. The goal in critically addressing this question is to find the best outcome for the family, all things considered.

A key part of the success of this system and the business as a whole is the open communication you provide to your heirs regarding the business governance system and the tools you have put in place. The system and tools should be openly and regularly discussed during family meetings. Depending on the system you establish, it may take multiple meetings to share the entirety of what you put in place.

Transitioning the family business down to the next generation is much more than transitioning shares. A well-thought-out and documented plan in which you address ownership, control, and operations builds a strong governance system for your business. We believe that this system, combined with communication with the next generation, is key to a higher likelihood of success.

¹ Family Business Succession Planning White Paper, Family Business Institute, 2019

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