Governance & Succession for Family-Owned Businesses

Family-owned businesses (FOBs) are a cornerstone of the global economy. It is estimated that FOBs represent approximately 70-90% of global businesses. Despite their prevalence and economic importance, FOBs face unique challenges that require careful planning and governance to ensure their continued success and longevity.

The purpose of this article is to discuss the following key aspects:

• Establishment of robust governance structures; 
• Implementation of key governance documentation;
• Succession planning; and
• Conflict resolution. 

This article is primarily written within the context of an FOB incorporated in England and references throughout this article to “Articles of Association” or “Shareholders’ Agreement” are to an English FOB’s constitution/bylaws.  

Establishing Robust Governance Structures for FOBs 

A key foundational aspect of a successful FOB is the establishment of a robust governance structure. FOBs often blend the personal and professional spheres, which can lead to complex dynamics in decision making. A clear and well-defined ownership structure and governance framework can help navigate these complexities, protect the interests of all family members and assist with the stability of the FOB over time.

Instrumental to the establishment of a governance structure is a clear understanding of: (1) the ownership of the company (who holds shares? Family members or employees too? In what proportion will they hold shares, and what rights will their shares have?); and (2) the management of the company (should the directors have general control over the FOB day-to-day? Should those directors be family members, external professionals or a blend of the two?). Once questions relating to these aspects have been answered and tested, a well-advised FOB would enshrine those answers within the constitutional documents of the FOB, namely, the Articles of Association and a Shareholders’ Agreement.

Implementation of Key Governance Documentation for FOBs

Articles of Association

The Articles of Association (Articles) are the primary governing, and binding, document for any company and its shareholders. They set out the rules for the company’s internal operations, including the rights and duties of shareholders and directors. In the case of FOBs, we would ordinarily expect the following to be considered and provided in the Articles: 

Shareholder Rights and Share Transfers: The Articles should establish clear rules regarding share transfers (should the shareholders be permitted to transfer their shares to whomever they like, or should this be restricted, eg to spouses?); dividend distributions (who should declare a dividend – the board, or shareholders?); voting rights (should all shares carry equal voting rights?); and decision-making processes (should certain decisions be reserved for the shareholders (i.e. family members) of the FOB?). This ensures that all shareholders and directors understand their rights and obligations, reducing potential conflict.

Board Composition: The Articles should specify how family members and non-family members will be involved in the governance of the company, by way of their appointment on the board of directors. A balance between family representation and external expertise on the board is generally recommended to ensure both continuity in the interests of the family and professional governance. An additional key aspect to consider is whether shareholders should have the right to be a director of the company.

Decision-Making Processes: Clear decision-making processes for business decisions (whether material or immaterial to the FOB) should be outlined. For example, decisions relating to investments, acquisitions, or business strategy may require shareholder (and therefore family) approval, in addition to board approval. Often the articles of FOBs will include weighted votes in favour of family members on key decisions, to ensure that the family retain overall control when it comes to decisions which are material to the FOB.  

It is, however, important to note that in certain jurisdictions such as England, Articles are publicly available and may therefore be studied by anyone. To the extent a family wishes for their affairs and internal dynamics to remain confidential, it is instead advisable for certain key provisions regarding the ownership and management of the FOB to be contained within a shareholders’ agreement.

Shareholders Agreement

In addition to the Articles, a Shareholders Agreement (SHA) is an essential tool for binding the shareholders of a company, and the company itself, whilst maintaining confidentiality over the decided regime. While the Articles provide the framework for corporate governance, an SHA can address more specific family-related issues that might not be suitable for inclusion in the publicly available Articles.

Key considerations for an SHA include:

Transfer of Shares: The SHA should set out rules for the transfer of shares within the family and to external parties. This is particularly important to ensure that shares remain within the family or that the business can remain under family control if desired. A right of first refusal is often included, allowing family members to purchase shares before they are sold to a third party.

Reserved Matters: An SHA will often set out a suite of decisions which must not be made by the FOB without the consent of the shareholders / certain family members (such as a decision to issue more shares, or change the business of the FOB, etc). One benefit of including reserved matters is that they can be crafted to allow for the protection of minority shareholders: requiring their consent to decisions fundamental to their shareholding, such as the sale of the FOB.  

Dividend Policies: An SHA would often set out the dividend entitlement of the shareholders – how much each shareholder should receive, and whether this should be commensurate to each shareholders’ involvement in the FOB. Of course, the company’s ability to pay dividends at any point is subject to its financial performance and health, but such policies make it clear what the parties have agreed at the outset.

Exit Strategy: An SHA would also often address exit strategies for the shareholders, should a compelling sale offer or listing opportunity become available in the future. It would not be uncommon to see a ‘drag’ or ‘tag’ right in an SHA, permitting either the majority shareholders to ‘drag’ the minority shareholders with them in the event of a sale, or the minority shareholders to ‘tag along’ with the majority in the event the majority propose to sell their shares.  

Other family matters: As a private document between the company and the family members/shareholders, one can also recite certain intentions of the family as regards the company which are more as a guide to avoid disputes between family members rather than the more official legal obligations.

Succession Planning for FOBs

One of the most critical aspects of family business planning is ensuring a smooth transition of leadership and ownership over time. Succession planning can be a sensitive issue in FOBs, where emotions often run high, and the future of the business may be intertwined with family relationships. It is therefore of the upmost importance for the owners of the FOB to consider this and take advice as to how to best ensure the succession of the FOB.

Effective succession planning therefore extends beyond corporate governance documents and must consider personal estate planning. Owners of FOBs must consider how their testamentary documents - such as wills, letters of wishes and trust documents - interact with the governance structure of the business.

Wills and/or letters of wishes can specify how a shareholder’s interest in the business will be distributed upon their death, but it is also important to coordinate these provisions with the family’s broader succession plan. Family members should seek legal advice to ensure that their personal estate plans are aligned with the FOB’s corporate governance structure, helping to avoid future complications and conflicts.

Trusts can be used to manage family wealth and provide for the smooth transfer of shares to successive beneficiaries. A well-structured trust can ensure that the family’s business interests are mediated by a respected family advisor, and allow the FOB to continue to provide a benefit to a family on notwithstanding the passing of a previous generation.

In practice, we often see founders of FOBs contain a provision in their letter of wishes requesting that their successors enter into a pre-drafted set of Articles and a SHA if they are to receive shares in the FOB. Whilst this is not a panacea to the risks involved in running such businesses after a founder’s death, such documents can help provide a stable framework within which to continue the business in those circumstances.

Conflict Resolution for FOBs

Disputes are inevitable in any business, but they can be particularly damaging in FOBs where personal relationships are at stake. Having effective conflict resolution mechanisms in place is vital for maintaining family harmony and ensuring the ongoing success of the FOB.

A common source of conflict in FOBs are deadlock situations, where family members cannot agree on critical decisions. To avoid paralysis, FOBs should include deadlock resolution mechanisms in their governing documents. These might include:

Buy or Sell Provisions: A buy or sell provision allows a shareholder to purchase the shares of the other shareholders in the event of a deadlock. This can provide a clear, practical solution to resolving disputes.

Mediation or Arbitration: Including a clause that mandates mediation or arbitration in the event of a dispute can help resolve conflicts without resorting to litigation. Mediation or arbitration can provide a more collaborative and cost-effective means of resolving disagreements.

Independent Decision-Maker: Some families appoint an independent third-party mediator or advisor to make decisions when family members are at an impasse. This helps avoid personal bias and ensures that decisions are made in the best interests of the FOB.

FOBs face unique challenges that require careful planning and thoughtful governance. By establishing robust governance structures, properly documenting these, addressing succession planning and instilling conflict resolution mechanisms, FOBs can begin to safeguard their long-term success and ensure a smooth transition of leadership and ownership.