Policies help family businesses meet challenges

Policies help family businesses meet challenges

In addition to general business challenges—like the economy, competition and the need for product innovation—family-owned companies must contend with issues unique to family businesses, such as the need to preserve harmony. But potential family disagreements need not threaten the survival of the business. Early and proactive planning before the issues arise enables family businesses to successfully navigate internal and external pressures.

Shareholder policies are one element of planning that can prove instrumental in maintaining family harmony. They can help manage the sometimes overlapping and frequently competing interests of three key constituents of a family business: 

* Family members.

* Owners or stockholders.

* Business management.

Emotional ties within a family and family members’ differing levels of engagement with the business can put a strain on its operation if policies aren’t clear, vetted and determined before emotions intensify. Families can prepare for potential knotty issues by developing and implementing shareholder policies before they’re needed. 

Developing shareholder policies

What’s the best approach to creating policies and practices to sustain and support the business? First, it’s important to understand and document the overall objectives, values and goals of the family business. This is a crucial conversation to have because a shared understanding of business and personal priorities establishes a framework for shareholder policies. This conversation is not always easy. When it comes time to formalize and capture the objectives, disagreements about values and goals among the three constituent groups are often brought to the forefront.

Once the business objectives are determined, shareholder agreements are perhaps the most important policies to delineate and formalize. These policies establish the rights and responsibilities of shareholders, as well as the relationship of the shareholder to the company. They govern issues that encompass dividends, the transfer and valuation of shares, and ownership representation on the company’s board. 

Shareholder policies can also help family businesses navigate issues such as compensation, communication of the business results to shareholders, family employment and actions that require a shareholder vote. Sometimes these policies are “understood” but not documented. As with the business’s objectives, values and goals, shareholder policies must be formally captured.

Dividend distribution and share sale or transfer 

Family business owners can derive value from their shares through dividend income if the company is profitable or through the sale or transfer of shares. It’s important to establish policies that govern dividend distribution and share sales or transfers before conflicting financial interests spark business disruption and family discord.

Dividend income is often an important source of liquidity for the shareholders—and can be a major source of disagreement. As the family business generates profits, a natural tension may arise between shareholders who are at some distance from the business’s day-to-day operations and favor larger dividends, and shareholders who are closer to the business, such as members of senior management that might prefer reinvesting more profits into the business. 

Policies should define criteria for dividend distributions, such as linking them to profitability levels, to keep potential competition among family factions from harming the business. Rather than being a source of conflict, thoughtful dividend policies can reinforce a family’s values and goals for the business. These policies might take into account the growth plans for the company, the need for stable income for all family members or the potential to maximize the value of the business.

Situations likely will arise when a family member desires or needs to sell shares. In such a case, it’s prudent to have policies in place that identify the process and authorization necessary before a sale can take place, as well as the valuation method to be used. Valuations can be determined in many different ways. Unless this is documented in a pre-existing policy, it is likely to be a source of disagreement. Effective policies establish parameters for:

* Share purchase eligibility.

* Valuation method.

* The company’s obligation to buy shares.

These policies help formalize the business relationship among family members on potentially sensitive financial issues.

Many family businesses are S corporations, a designation that comes with its own regulations about share ownership. To protect the tax status of the business, most family operations will further restrict the transfer of shares. They may also disallow the sale of shares outside the family or require shareholders to transfer shares back to the company itself.

Governance should keep pace with growth

With each successive generation, shareholder policies and governance should be re-examined to ensure business continuity, growth and unity. As the family multiplies, only some of the family members might be involved actively in the business, though others might be shareholders. This situation increases the risk of fragmentation. Significant issues can arise if family members aren’t engaged in the business or don’t feel connected with it. Processes and procedures should be established to protect the business from potential family feuds.

As family businesses seek to reconcile potentially competing interests within the three constituent groups, policies governing nomination of directors should be developed. A board of directors serves to protect shareholders’ long-term interests. Board composition must be considered carefully. Key considerations include:

* Number of owners represented on the board.

* Total number of board members and number of independent members.

* Criteria for selecting family board representatives (e.g., experience in the company, outside experience, seniority in the family).

* Term length.

* Compensation of board members.

* Rules about proxy selection should board members be unable to attend meetings.

Beyond the board, families should outline and communicate requirements for the next generation of leaders. Family employment policies ensure that a family member’s qualifications will be evaluated according to specific criteria before he or she can work in the business. Specific policies that family businesses implement may include:

* Requirements for work experience outside the business for a certain number of years. Outside experience enhances a family member’s credibility and enables them to bring a new perspective to the family company.

* Requirements for children’s college majors to relate to their current or anticipated role in the business.

* Leadership rotation that requires a family member to switch roles to gain experience in several key areas of the business.

As pressures intensify for family businesses to innovate to stay competitive, these companies are placing a greater emphasis on entrepreneurship and leadership skills. More and more family businesses are looking outside for non-family members to fill CEO and other senior leadership posts. This indicates that the already challenging dynamics of a family business will become even more complex. Shareholder policies can be a stabilizing force, one that helps family business owners navigate the intersection of family membership, business management and ownership.

In virtually all cases, shareholder policies are best developed before a disagreement arises. Policy decisions should be made in an environment that is non-confrontational and unemotional, since intentions and decision making can become skewed when emotions are high. Outside advisers with an objective perspective—lawyers, consultants or other trusted professionals—should be involved early to help develop and vet policies that align with the goals of the business and family. Well-designed shareholder policies can keep the business on the right path. 

 

Jay Mattie is a partner and U.S. Clients Leader in PwC’s Private Company Services practice.