François de Visscher is founder and president of the family business consultancy de Visscher & Co. www.devisscher.com
As the family business expands it is not enough to rely on informal governance procedures. An official family governance structure will ensure business' continuity – and could prevent another corporate scandal, says François de Visscher
In the post-corporate scandal wake, the US government and media have codified rules of corporate governance to ensure that executives and directors can no longer claim ignorance when off-book transactions or inflated earnings come to light. The resulting Sarbanes-Oxley Act of 2002 (SOX) forces CEOs and CFOs of most public companies to sign off on financial reports personally, requires strict independence of the external auditors and strengthens the audit committee's oversight of financial record-keeping. These measures should go a long way to preventing future Enron- and Worldcom-type debacles.
Four years later, many privately held companies have voluntarily, or as a result of pressure from financiers, vendors and even customers, adopted many of the SOX measures.
Corporate governance rules, however much compliance may cost in time and money, may not go far enough to prevent another Adelphia or even another Parmalat scandal. In those cases, family shareholder/executives employed various self-dealings and other non-transparent practices that are not uncommon (and not necessarily illegal or inappropriate) in the early years of a first-generation startup, when the founder may have few if any financial controls and rely on informal record-keeping. And so what, if no-one gets hurt? As the company grows and ownership expands to include a wider array of stakeholders, such financial practices can harm family shareholders, vendors, customers and employees and investors.
The emergence of family governance
Family-run and other privately held companies need more than corporate governance policies and structures. They need family governance policies and structures to establish clear and formal boundaries between family and business.
Corporate governance organises how management and the board interact and provides checks and balances on each other's functions. Family governance organises how the family interacts and works with the business and defines the family's multiple roles as employees, owners, managers and family members. In progressive family businesses, family shareholders realise that ownership in the family company comes with a whole set of responsibilities, not just to family shareholders, but to all the stakeholders in the family company. Responsible family shareholdership is an effective recipe for long-term ownership of family wealth and values.
Additionally, banks, investors, vendors and customers, who bear some risk in their dealings with private companies, are equally taking a closer look not only at how the board – especially the audit committee – is organised, but also how shareholders are organised, and how they make decisions. Could an irresponsible son or cousin suddenly become chairman? Might family squabbles interfere with company operations? Are there formal liquidity programs to ensure that the business is not exposed to unreasonable or sudden liquidity demands of shareholders? Family governance is quickly becoming a critical part of due diligence that banks, private equity investors and other stakeholders study carefully. Customers want to make sure the business of the family is taken care of so the business can be run without interference. Suppliers, banks and investors want assurances that the company's credit-worthiness will not be jeopardised by financial fantasies of the family.
Recipe for effective family governance
Families themselves need to protect the assets of the company from themselves, to perpetuate their patient capital and enhance the family effect.
Family governance structures and policies, as outlined in the table (right), can help develop the entrepreneurship of the family, its ability to assume and assess risk and even develop future leaders in the family and business.
In Belgium, the Lippens Code was introduced in December 2004 to dictate corporate governance practices of listed companies, much like the US SOX law regulates US public companies. Recently, the Buysse Code evolved to suggest a parallel set of policies for privately held companies. This code, created by Baron Paul Buysse, chairman of the board of Belgium-based NV Bekaert, includes five recommendations for family governance: a family forum, family charter, consultation with shareholders, succession and resolving conflicts.
Before even developing a family governance framework, families would be wise to create a vision and mission statement. This may be different than the business vision and mission. The family statement would focus on family values and wealth objectives (protecting and perpetuating the family's tangible and intangible assets). At some point, these values may guide the business strategy. For instance, to develop family wealth, it may eventually be wise to sell the family company and reinvest the assets. As the family develops, the need increases to define a credo of what they believe in and what they want to achieve together.
The next stage is for the family to build a governance structure. For instance, Code Buysse recommends creation of a family forum for family businesses in which shares are owned by several members or several branches of the family, or if several generations of one or more branches are involved in various roles in the company (whether or not they are active in the company or own shares in the family company). The family forum will manage the family's interests and implement the family vision and mission.
The type of family governance structure may be as simple as a family assembly or a gathering of all shareholders to talk. A slightly more official structure, for larger families with multi-generation companies, could be in the form of a family council that would select some members to represent their interests and concerns to the corporate governance structure (such as the board of directors). Yet more complex companies might benefit from a family office that operates like a mini family corporation that actively invests family assets, manages philanthropic activities and provides professional services and products.
The family structure should create rules and policies for the family, which Code Buysse calls the family charter. The charter should decide who can own shares, and under what circumstances those shares can be bought and sold, and to whom, and how and when family information will be communicated among relatives, and between the family and the business.
The family structure can also outline expectations for how family members conduct themselves within the family and in public. The family should define its current and anticipated liquidity needs and, through its family liaison to the board, help create liquidity programs to meet those needs. Other policies could cover how family members nominate company board directors and rules of entry into the company.
One of the objectives of family governance should be full disclosure of any business relationship family members have with the business, including salaries of family employees, hiring of family members as professional service providers or vendors, and loans from the company to relatives.
The family governance structure should also list any potential future conflicts and outline mechanisms for resolving them. In the event that disagreements or conflicts cannot be resolved, the governance structure should outline ownership and liquidity options to buy out disgruntled shareholders.
Family governance rules are not only an integral part of responsible family share ownership, but a major contributor to the value creation opportunities in a family company. Vendors and customers will look at family governance to gage the values, reputation and ethical character of their potential family business partners. Banks and lenders will rely on family governance for the protection of the assets they are lending against. Investors will examine family governance rules to monitor their return and how this return will be allocated among all the shareholders, family and non-family.
Families and businesses continually confront unpredictable challenges. Corporate and family governance goes a long way to help companies operate with greater transparency and responsibility and will assure greater continuity of the enterprise for future generations of the family.