(Article by JAMES WADDELL AND CLAIRE MILLER for BQLive)
Creating any successful business is a very personal achievement. The closeness of the relationship, and shared vision and values, can often be a family business’ core strength. However, that intensity can also make clear-eyed strategic decision-making particularly difficult. Emotionally, the participants in a family business often really do have ‘all their eggs in one basket’, with no separation between business and family life. What issues can family business scale-ups face and what can be done to prepare for them?
Family businesses usually begin with a clear sense of purpose and an inherent trust in the alignment of everyone’s goals. Limited financial resources are focussed on getting the business off the ground and initial profits are reinvested. Decisions have to be made quickly and there is no time to think about management structures. Ownership and management of the business often falls to the same small number of people and the line between the roles of shareholders (ownership) and directors (management) are often blurred. Once the business is established and generating consistent profits, that distinction can become relevant.
A company’s shareholders have an economic interest in the business represented by the increasing capital value of their shares and any dividends that the company can afford to pay to shareholders. They don’t owe duties to the company (in a legal sense) and are free to exercise their voting powers as shareholders in line with their own personal interests. On the other hand, directors owe legal duties to the company and must ensure that their decisions are in the best interests of the company as a whole. Shareholders delegate the management of the business to the board of directors and it is the board that takes operational decisions (usually by majority vote on a one-vote-per-director basis). The law doesn’t give many rights to shareholders (for example access to financial information) and most business decisions do not, by default, need shareholder approval. It is important therefore not to lose sight of the distinction, especially when there is more money at stake.
As the business expands and becomes more complex (and profitable!), consider:
- Reviewing the founders’ roles and job descriptions
- Reflecting on board composition – who should be on it (and who shouldn’t) if it is to function properly?
- Should directors start getting paid a salary?
- Is it time to put in place employment contracts and a shareholders agreement and new articles of association to formalize management structures (and to try to head-off future disputes)?
Who does what best?
Not everyone can be a Richard Branson or a Mark Zuckerberg. The entrepreneurial skills required to launch a successful business do not necessarily translate across to the management skills required to expand and run an established one. Businesses can sometimes outgrow (and outlive…) their founders. Subsequent generations of a family are sometimes not as business-minded as their parents and grandparents. It is important that the business has the right management expertise for the next stage of its growth and there may come a point when the founding family can’t provide it.
Inviting non-family members into the fold can be emotionally difficult, and recognizing the right time to call in that help is hard. Making sure there are appropriate checks and balances in place and that the right people are in the right roles (appropriately incentivized and with autonomy and accountability) will help to maintain cultural integrity and business success. It is here that the distinction between shareholding and directorship (and the importance of clear management structures reflected in appropriate legal documentation) comes sharply into play.
It is really important for family businesses to include change management processes and protections in their shareholders agreement and articles of association which reflect their succession objectives – and to be clear what those objectives are. Should the business pass down the generations? When is the right time to sell and who decides? These decisions can be particularly fraught, so it is vital that shareholders keep them under regular review and make sure their legal agreements are kept up to do date.
Particular areas to focus on are:
- Procedures around issuing new shares
- Transfer rights in respect of existing shares (including for tax planning purpose or on the death of a shareholder)
- Drag along and tag along rights in connection with a sale of the company
- What happens in the event of a matrimonial dispute (the emotional and financial fall-out from which can significantly disrupt the status quo in a family business)?Careful drafting is required in all these areas to ensure that the collective intentions of the founding family survive the inevitable impact of ‘life events’!
As a family business matures, and ownership potentially spreads amongst the second and third generations, shareholder motivations can become more defensive. The motivation of shareholders may be more about preserving hard-earned value rather than driving for further growth, embracing change and taking risk!
Recognise this tendency and seek to challenge it. Try to build a culture of innovation from the outset, and maintain it. Make sure that management is empowered to make decisions – no back-seat driving! As communication between shareholders and management becomes more complicated, it also becomes even more important to ensure continuing alignment of goals and ambitions. Do that, and a well-run family business is often well-placed to act decisively and to exercise agility in order to succeed. Keep in mind the founding principles which launched the business in the first place and stay true to them.