Families who own businesses often overlook the challenge that is “governing” all that they do together inside, and outside, of the business.
To some, governance itself is a necessary evil; to others, it’s a dirty word best left unsaid and undone. The reality, however, is that all business-owning families already have governance in place on multiple levels, but it’s often overlooked. Here are some steps to take so that business-owning families can get a better handle on governing and governance.
Crossing the Line Into Governance
Imagine that George and Martha, an entrepreneurial couple, come up with an idea for a new product that has potential commercial appeal. Perhaps it’s a new machine that dramatically increases the efficiency of their farming operations. It works so well on their own farm that they decide to go into business to sell it to others. So, they go to their corporate lawyer, Ben, and he recommends that they set up a limited liability company (LLC), “Farming LLC,” so they can minimize their personal liability just in case the machine malfunctions. The LLC has the added benefit of being a pass-through entity for income tax purposes. They like the idea, and Ben drafts some documents for them. In Farming LLC, they’re both named as “members,” sharing their ownership in percentages that they agree on between themselves. Martha agrees to be “manager” so she can sign documents. George has no formal title, but they agree that he’ll be in charge of day-to-day business operations. Like most entrepreneurs, they don’t think much about the legal documents and are happy to quickly return to getting the business off the ground.
Even if they might not realize it, George and Martha already have crossed the line into formal governance with a whole new set of rights, responsibilities and opportunities. The LLC agreement redefines their relationships with each other and under the law.
More Governance Requirements
Things go well for Martha and George, and not only is their business extraordinarily successful, but also, their two children, Betsy and Abe, are chips off the old block. They share their parents’ entrepreneurial spirit and actively join the business just as soon as they’re able. Martha and George are thrilled to work alongside their capable children, and they decide to set up some trusts and a family limited partnership (FLP). At the recommendation of their lawyer, they begin to make gifts of membership interests in the LLC to or for the benefit of their children. They understand that this gifting is good for tax purposes and sign the paperwork that’s handed to them. All this is done without giving a thought to the fact they’ve now dramatically expanded the governance requirements in their lives. This pattern proceeds for a long time. As more documents get signed, and more entities created, this business-owning family unwittingly creates its own little government—or at least its own governance system.
Just as every ship must be headed in some direction, every business needs to know where it’s going and how it will get there. And someone—or more likely, several people—must guide it that way. This is the work of governance. It’s not just about managing the business for profits, or merely making sure that owners get their fair share. Further, in the family business context, governance isn't simply helping everyone get along. It’s about overseeing the business, making sure that it’s headed in the right direction, doesn’t get off course, and yes, is accountable to its owners.
Instill Better Governance Practices
Here are some ways that an advisor could help a family business instill better governance practices:
- Provide guidance. Each new corporation or LLC document should be accompanied by guidance on governance activities that are required and recommended. In the family business context, this may be as simple as outlining whether a board of directors must be appointed, and how. Or, even if a board of directors isn’t legally required, outline some of the benefits of having one. For example, studies have shown that a family business with independent board members may have a better chance of succeeding across generations.
- Outline required and recommended procedures. How often should meetings be held? How are directors and officers to be elected and removed? By making clients aware of the default provisions, it becomes possible to spark conversations about how they actually would want things to run so they can tailor it to their own style.
- Recommend additional resources. There are more than enough books and related resources about corporate boards, shareholder relations and corporate best practices. Rarely are these shared with family businesses until a conflict arises. And, that’s when the underlying governance—whatever it is—will become apparent as one source of the problem. General resources would be helpful.
- Conduct check-ins. Make it a regular practice to have “check-ins” with clients, on at least an annual basis, to review ongoing issues including governance.
- Develop interdisciplinary teams that are appropriate for each stage of a family business. For some, an outside facilitator might be needed to get meetings off the ground. For others, sharing educational resources on an ongoing basis might help clients carry through with best practices.
- Compare with other family businesses. Identify practices that have helped or hindered other families in similar situations.
This is an adapted and abbreviated version of the author’s original article in the March issue of Trusts & Estates