Governance in the Family Business

Many family businesses are guided by the founders or family shareholders who provide a combination of strategic, operation and governance roles with little advice from external advisors. 

This thin structure, where family members fulfil a number of roles, allows for quick decision making and the business to be more nimble and quick than others who have a more complex operational and governance structure.

The success of many family businesses can be attributed to the knowledge, passion and capability of the founders and family members employed in the business. 

As founders grow older, their businesses face challenges from technology and other disruptors while at the same time, the owners are forced to address the looming issue of succession.

An increasing number of businesses are appointing independent directors or external advisors to navigate through these challenging times.  While the appointment of independent directors and external advisors can add value, their appointment will also in many cases require a change in mindset for the owner.

Owners, who in many cases have made decisions with little consultation, developing and modifying their business  as they go along, will now need to include their independent directors and advisors in their decision making process.  

“Independent directors on family companies need to understand how to manage the unique dynamics of a family business”

Listen and respect advice, not just hear and carry on

Independent directors or advisors to family businesses will normally be appointed based upon their experience and the perceived value that they can add when addressing strategic issues facing the business.  An independent director can be particularly valuable if they are prepared to ask the difficult questions that business owners may not ask themselves. 

For many family business owners, their historical success may have been due to their acting on ‘gut instinct’ and making decisions in real time with little analysis or review.

Despite championing the appointment of external directors and seeking their opinion, many business owners can struggle when the concept of being questioned by parties external to the business becomes a reality.  There will be an expectation from independent directors that their questioning and advice will be listened to, and while not always followed, will at the least be considered when strategy is being developed.  Independent directors or board advisors will rapidly become disenfranchised if their advice is not given due consideration or business owners simply hear the advice, and then proceed with their original plans. 

Requirement to Act in Good Faith and Best Interest

The duty of an independent director, like all directors, is based on good faith and best interests of the company. 

Where a family business has a shareholder base which is wider than the founder or immediate family members who manage the business on a day to day basis, there can be conflict between the shareholder managers who may have differing objectives and the independent directors who are looking after the interests of all shareholders but who were also likely appointed by the more influential shareholders who work in the business.

Governance as part of a contingency plan

New Zealand as one of the highest incidences of business ownership, per head of population, in the OECD.  Many New Zealand families also have much of their personal wealth tied up in their businesses.

Earthquakes and other various tragedies that have affected individual businesses over the years, have made business owners more aware of the need for contingency plans.  If for example, the owners of a business were unable to continue their management roles due to death or disability, it may be necessary to sell the business at short notice to provide necessary capital release to the family.  While many family business owners are not actively considering a sale of their business, it is prudent that a business always has the necessary governance and operational systems which would support the sale of a business, if this was necessary due to unforeseen circumstances.

Visibility over all Company Affairs

Company directors can have extensive legal duties and liabilities outside the Companies Act 1993, including:

-         Health and Safety at Work Act 2015;

-         Fair Trading Act 1986;

-         Commerce Act 1986; and

-         Income Tax Act 2007.

Other legislation may be business or industry specific and may include such Acts as:

-         Food Act 2014; and

-         Financial Markets Conduct Act 2013.

In many cases, family business owners, who have had limited historical need to disclose information on their businesses, are very private and hold much of this information from management and staff.  Advisors are often kept on a ‘need to know’ basis.

Directors need full visibility over company affairs to discharge their legal obligations.  Family business owners often need to change the amount of information they share and how this information is distributed.

The People or the Process?

Family business owners must determine whether they want the expertise of the independent director, or the enhanced processes that appointing an external director will bring.

Many family owned businesses operate with limited reporting systems that are often inadequate for the scale of the business.  In many cases, as the business has grown, reporting has not evolved at the same rate as the business. 

A family business may opt to retain a governance advisor to assist with the design and implementation of appropriate reporting processes, allowing the family to establish a board which would operate as if it had external representation, while avoiding the potential dynamics that external directors may bring to a family controlled company. 

Appointed Directors vs Advisory Board

An alternative to appointing an independent director is to assemble an advisory board of external advisors who are selected to provide advice but do not make decisions and have no authority to govern.

This team will support the business to develop strategy and a culture of accountability and governance without the restrictions that business owners may perceive will be associated with appointing independent directors. 

An advisory board can be a useful first step in creating a formal board structure.

Summary

There is strong anecdotal evidence that family businesses will benefit through the strengthening of a reporting and governance structure as they experience growth and prepare for future succession.

It is however up to individual business owners to determine where they are at on the continuum and to what extent they wish to introduce independent directors or external advisors to assist the company.

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