Preserving Prosperity: Legal Strategies For Family-Owned Business

The key difference between the majority of family-owned businesses and publicly limited companies lies in the structure of ownership.

Where publicly listed companies are concerned, the ultimate owners are the investors, with the day to day running and management of the company placed in the hands of the management and the board. Shareholders have the chance to influence matters to a degree at annual shareholders meetings, but the ultimate form of control lies in the fact that shareholders are free to sell their shares if they are less than satisfied with the operation of the business.

The situation in a private family business is completely different, with ownership in the hands of what is usually a small number of family members. This ownership model is both a huge strength and a potential weakness. The strength of a family business lies in the commitment to long-term thinking and the creation of a lasting legacy that family members bring to running a business.

The ethos of many family businesses lies at the heart of the success they manage to achieve, with customers buying into a set of values as much as a particular product or service. They have a personal as well as financial stake in driving growth and creating something they can pass on to future generations.

The potential downside of this emotional investment, however, is that it can lead to decision making which isn’t wholly based on a rigorous analysis of the facts and which doesn’t draw on a sufficient number of external voices. The antidote to this risk lies in creating ownership and governance models which are robust and effective, and having a clearly defined expectation of what the family business will regard as success.

Ownership Model

The first choice the owners of a family business will need to make applies to the model of ownership, which essentially covers issues such as who is entitled to own the business and – if there are multiple owners – how the control over the business will be shared.

What needs to be remembered is that the ownership model of a family business is intended to create a structure which can successfully be passed on through the generations for many years. This means that it needs to be chosen very carefully, with reference to the strengths and weaknesses of each potential model, and, once chosen, legally enshrined within documents such as articles and agreements.

In some cases, the creation of a family constitution will enable the owners to clarify issues such as what is meant by ‘family member’, who actually owns the business, how decisions will be made within the business and how the question of succession will be handled.

Formulating a family constitution helps to crystallise the aims, practices and processes of the business at the same time as creating a reference point if disputes arise at some point in the future.

The various ownership options include the following:

Sole Ownership – one individual owns the business and has responsibility for all decisions, a model which works when firm and decisive leadership is required, and when the business as a whole creates sufficient income to satisfy those members of the family who don’t have a say in how things are run. The biggest risks of the sole ownership model arise when considering how succession will be dealt with. The question to be answered will be whether succession is based on merit or birth-right, with the risk in either case being that the expertise and talent responsible for the success of the business will depart with the sole owner.

Partnership – in this model the ownership of the family business is restricted to family members who actively work within the business. This model only works if clear rules are in place to deal with issues such as how individuals can leave or join the ownership group, and how those family members outside the group will be treated. The benefits of this model include the active engagement of the owners in day to day operations (and thus a clear understanding of how the business is functioning), with more resilience than the sole ownership model, as the load and responsibility are shared. The risks of a partnership model include the chance of conflict arising over which individuals are admitted to the ownership group.

Distributed Ownership – in this model any member of the family is entitled to be an owner and take part in decision making. For some families this is as much a cultural choice as a business issue, and is particularly effective when the bulk of a family’s wealth is contained within the business. The risks of this model are that some members of the family entitled to be part of the ownership group may be less engaged than others, with dividing lines opening up between those family members who operate and run the business, and those who are investors. It is also important for this ownership structure to have an exit route set out for those family members who wish to sell their shares in the business and exit the ownership group.

Concentrated Ownership – in this ownership model any member of the family is entitled to be an owner, but a specified smaller group are in control of making decisions and running the business. This deals with some of the issues often faced with the distributed ownership model, such as decision-making being slow when decisive action is needed. In many cases, the structure dictates that consensus may be sought on big decisions, but ultimately the CEO has a casting vote.

The majority of family businesses will make use of one of these ownership models, or a hybrid combining two or more. It should be noted, additionally, that an ownership structure isn’t set in stone, as it may need to adapt when the business grows or when a choice is made to bring in third-party decision makers.

Governance

The ownership of a family business is important, but the governance structure which is in place is equally important. In the case of sole ownership, for example, the ability to make quick decisions can be hugely advantageous, but if the leadership is ineffective, it can be difficult for the business to drive growth and to attract and retain the kind of talent needed to compete.

The ideal governance structure will be one which occupies a middle ground between the owners having total control and some responsibility being passed over to others, and hitting this sweet-spot becomes more difficult and complex as the business – and the family itself – grows.

One simple template for an effective governance structure is to divide decision making into four:

• Owners – sets the overarching goals of the family business and elects the board

• The Board – oversees the operation of the business and hires the CEO

• Management – handles business strategy and direct operations on a day to day basis

• Family – maintains clear and transparent communication with the owners

This model creates clear levels of decision making, and should be bolstered by a written constitution stating clearly which of the four branches of the business are entitled to make which types of decision, and who needs to be consulted before major changes are carried out.

Other issues which need to be decided and set out through the ownership and governance structures include a definition of what the business will regard as success, and the degree to which this will include matters above and beyond earning power, such as links with the wider community, a commitment to sustainability and the creation of a long-term legacy.

This definition of success needs to be communicated clearly across the business and the wider family, with concrete goals put in place alongside key metrics such as debt levels and return on investment.

Last but by no means least, a successful family business is one which has a clear succession plan to deal with the issue of handing over to the next generation. A continuity plan needs to be in prepared long before the issue of succession becomes urgent, with conversations taking place amongst all interested parties in the family to create a framework for succession which has buy-in from all levels of the business.

An approach which involves the current owners simply handing down their plans for succession is likely to cause conflict.

Should you require assistance or support in any aspect of structural, governance or succession planning for your family business, the team at Buckles can offer impartial, experienced guidance on all aspects of ownership transferal. Contact us now to discuss the options available.