Why is Family Governance so Important & How to Create it in Your Family?”

Family Governance is how families make decisions together. If they create a good system, i.e. one that includes transparency, accountability and participation—they should be able to avoid the family fights that often occur in inheritance-related disputes. The process the family follows in creating a good governance system is easy to understand but requires the commitment of all family members. By simply going through a good process to create documents like a Family Constitution or a Family Mission, the family is at the same time practicing good governance in a “hands-on” practical manner. This article includes “how to” create a good family governance system.

Why do wealthy families have such public fights about inheritance issues? How can they avoid them? How can creating a good family governance system help?

Part III

Should we have a Family Constitution and what should it cover?

A Family Constitution is like a constitution for a country (or the By-laws for a listed company). The benefits of having a Family Constitution are:

  • Decision-making is clear. In a Family Constitution the rules are set out for exactly how decisions will be made.
  • Which kinds of decisions are made? The Family Constitution will explain which kinds of decisions will made by the Family Council; which are areas of personal decisions, for the family member to decide (such as the Bill of Rights in the United States), and which are the major decisions that need to be referred back to the larger family group for approval. (For a listed company this is like the business areas that can be addressed, and which decisions can be made by the Board itself and which are the larger decisions that need to be referred back to the shareholders/owners for approval (such as a sale or major acquisition)).

What is usually included in a Family Constitution? Each Family Constitution is very much tailored to the particular family. Some families like to begin with a simple, short Family Constitution and add to it in future Family Council meetings. Other families like to address and include every issue they have in their minds.

  • Preamble is very important. The best Family Constitutions begin with a Preamble of why the family is making the Family Constitution. This allows a family to tell its story about why it cares, what the history is, and what the long-term goals are.
  • Flexibility is very important. The Family Constitution is intended to apply to future family members and in future circumstances. It is very important to include a provision on how the Family Constitution can be amended. It must be a flexible document or it will not survive.
  • Creation and Operation of a Family Council. The Family Constitution will include the basic structure of the family decision-making process. This includes the formation and operation of the Family Council.
  • Rules for Shared Assets. If the family has shared assets, these often cause friction within the family because of the lack of clear rules about how and when they are to be shared (and who is responsible for what). These include vacation homes, family compounds, private aircraft, yachts, etc. This is a common area that comes out of the initial individual interviews. The Family Council can propose rules for use, for approval by the larger family, and these rules can be included in the Family Constitution.
  • Conditions for Employment in the Family Business. If there is a family business, another area that often causes family conflict is whether or not there are any agreed-upon rules for entering the family business. Families who decide to have clear rules often want to include them in the Family Constitution. The exact rules will depend on the particular family. Sample rules include:
    • Educational Requirements. Are there any agreed upon educational requirements? These might include having a particular type of degree, in a particular field of study, from a particular type of institution, with a particular set of successful grades, etc.
    • Outside work experience. Another common type of requirement is to be employed outside the family business prior to entering the family business. These requirements often include the number of years to be employed outside, the type of outside business, and the success/promotions displayed during that time.
    • Defined Progress System. After joining a family business, it may be helpful to spell out how important it will be for the family member to report to someone outside the family, who can monitor the progress by evaluations and also to provide mentoring.
    • Provision of Executive Coach. Another provision that can be helpful to a family member who joins the business is to provide support in the form of offering an executive coach.
    • Termination of a Family Member. This is not usually addressed, but is a very sensitive subject that could be addressed ahead of time, instead of at a time of crisis. Most families agree that it is important to the business, to the other employees, and to the family members, that the family member who works in the business be accountable for his or her performance in the same way that non-family employees are accountable. In the Family Constitution it may be sufficient to simply state that principle.
  • Family Members Serving on the Board of Directors. If there is an operating business, one area of great value for the future is to provide that one or more family members will be expected to serve on the Board of Directors. This area could include provisions for:
    • The number of family members expected to serve on the Board.
    • Their required experience (if any)
    • Their term of office (best practices would treat them the same as all other board members)
    • The possibility of creating a “Junior Board” for members of the next generation to gain experience of a Board.
    • Encouragement of at least one family member to serve on the investment committee of the Board.
    • If there are multiple businesses, to adopt a procedure of family rotation among the various Boards.
  • Dividend (and distribution) Policies. If there is a family business one issue that is always of great interest is the amount of a dividend distribution. This is an especially sensitive issue if one or more family members work in the business (and receive a salary income) and one or more family members do not work in the business (and would receive only dividend income). It is critically important that the employed family members are paid salaries that are considered fair by all family members. (The communication about the salaries is part of the “transparency” value.) It is also important that the whole family agrees that the dividend policy is a fair one.
  • Salaries for Family Members. Usually family members agree that a family member who is employed should be paid the same amount that a non-family member would be paid for the same position. That can vary by family, however. Some families agree that the employed family member, especially at the Chairman level, is expected to spend more as part of the related social obligations in that culture, and so should be paid more to cover those expenses.
  • Exit Provisions. If there is a family business, and especially if some family members are not satisfied with the amount of the dividend distributions, it may be wise to include in the Family Constitution a method for the dissatisfied family member to “exit” from his or her ownership position. In other words, the family member could sell his or her stock and receive the cash instead. In fact, some multi-generational family businesses claim that this “escape valve” has been the key to the lasting success of the business.