Family businesses can be difficult to manage due to the effects of expansion and generational change. It is said that the typical family business goes from rags to riches and back to rags again over the course of 3 generations. As evidence of this claim, a 2010 article stated that fewer than half of all family businesses manage to survive a generational change, and in a family business survey conducted in 2014, it was found that only 12% of family businesses go beyond the third generation.Respondents to a 2013 survey indicated the balancing of family and business issues was their biggest challenge, yet 84% of those respondents did not have a family constitution.
Those who manage family businesses should consider the advantages of having a family constitution to help plan for and manage the operation of their business and deal with complex or unexpected situations.
WHAT IS A FAMILY CONSTITUTION
A family constitution is a formal document which sets out the rights, values, responsibilities and rules applying to stakeholders in the family business and provides plans and structures to deal with situations which arise in the course of the family business’s operation.
WHEN TO CREATE A FAMILY CONSTITUTION
A family constitution may be entered into any time throughout the life of the family business. However, it is advisable to enter into a constitution as early as possible before the creation of the business or any important transitions.
It is important that when the time comes to draft the constitution the family has a clear idea of the goals of the business, the roles of the family members and the internal structures of the family business.
WHEN A FAMILY CONSTITUTION IS USEFUL
A business must be able to withstand the effect of sudden events which can paralyse the operation of the business, unravel the management or legal structures in place, and cause uncertainty amongst family members and other persons who have a stake in the business. Such difficulties may arise where:
- a family member dies or suffers a severe illness or injury;
- there is a divorce or serious dispute between family members; and
- a creditor enforces a substantial claim against the family or the business.
While not every conceivable situation can be thoroughly planned for, it is very useful to have processes and protocols in place, such as the formation of a committee to meet periodically, restrictions on incurring any large liabilities until the issue has been resolved, and consulting a specialist lawyer or accountant. This can all be outlined in the family constitution.
A family constitution can serve as a valuable motivational tool to help family members stay on the same page, be informed of the goals of the business and be encouraged to actively consider plans for the future.
Although family constitutions are generally not legal binding, they are said to be ‘emotionally-binding’. Given the family relationship, a family constitution acts on the conscience of those involved. Although non-compliance with its provisions may not result in legal sanctions, there is a pressure on a family member or other employee to comply with the constitution, as if they don’t they will appear to be departing from the family’s vision and values.
The success or failure of generational change of a family business depends significantly not only on business issues, but on family issues as well. When a new generation of a family enters into the business, this may cause:
- changes in the number of shareholders in the business;
- new sources of input into the management of the business; and
- expansion of the business and greater demands on management
Given the variability associated with generational change, and the views and values of the new family members who may be involved, a family constitution cannot set out comprehensive rules which can be strictly adhered to. Instead, a family constitution directs the family’s attention to the key issues which will need to be resolved, provides a vision to govern the change, and outlines internal structures which can be referred to when dealing with specific scenarios (e.g. disputes, apportioning ownership interests).
A family constitution can provide for informal and internal dispute resolution processes to help minimise costs and avoid publicity. While the constitution will not prevent conflict entirely, it provides guidance and mechanisms as to how conflict can be most efficiently resolved. This could involve a compulsory mediation procedure and the appointment of an impartial mediator to refer disputes to. In addition, the mere existence of the constitution may reduce disputes as there is less likely to be confusion and ambiguity in how the business should be run.
COMPONENTS OF A FAMILY CONSTITUTION
This serves as a brief aspirational outline of the long-term goals of the business, its core principles and its vision and strategies for the future. The mission statement should reflect any family values which management wishes to impose on the business’s dealings.
Some of the common provisions of a family constitution include:
- The procedure for the recruitment and remuneration of the family members employed in the business.
- The process for resolving disputes between the family members which concern the business.
- Succession plans and policies and processes for the retirement of family members.
- Rules for the disclosure and exchange of information between family members (both employed and not employed by the family business) and the confidentiality of that information.
- Providing for periodic reviews of the business.
- An outline of the division of assets between the family members and how those assets will be shared.
ENFORCEABILITY OF FAMILY CONSTITUTIONS
Unlike company constitutions, a family constitution tends not to be legally binding on the family members. This has the advantage that it can apply to members of the extended family network who may be affected by the performance of the family business, yet it would not be fair or practical for them to be bound by the constitution as they have little input in any of the business’s affairs.
This is why it is best to complement the family constitution with separate documents which are legally binding, but which no external family members are parties to. Common examples of such documents are shareholders agreements, confidentiality agreements, and documents concerning conflict resolution. Enforceable documents should be kept separate from unenforceable documents to prevent confusion.
HOW FAMILY BUSINESS MANAGERS CAN USE FAMILY CONSTITUTIONS TO PLAN FOR THEIR BUSINESS
- Consult the family members to determine the goals of the business and plans for its operation
- Obtain professional advice concerning how to draft the provisions of the constitution
- Have a family constitution prepared before the commencement of business or before undergoing any significant changes
- Continually monitor the level of compliance with the constitution and determine if any amendments to the constitution are needed.