Must-knows for governance and family business

Governance is not just a concern for large corporate or listed entities, but should be addressed in all businesses, particularly in family businesses.

by | 31 Mar, 2017

Must-knows for governance and family business

Robert Tricker, the Oxford scholar who is regarded by many as the father of corporate governance, once said “management is about running the business, governance is about seeing that it is running properly”.

Governance can generally be defined as the rules and processes by which a business is operated and controlled, and corporate governance is just as important for a family business as it is for any non-family business.  Indeed, for family business owners, ensuring the business is running property is perhaps even more of a priority than for large businesses, as it can have direct consequences for the family regardless of whether they work in the business or not.

This becomes an even more important consideration as family businesses start to span multiple generations. In this situation you may have various involvement of different family members who may (or may not) work in, or have an ownership interest in, the business, as well as when families are considering their exit options (such as sale of the business, or listing on the Australian Securities Exchange ASX).

The ASX has a more formal definition of corporate governance, defining it as ‘the framework of rules, relationships, systems and processes within and by which authority is exercised and controlled within corporations.  It encompasses the mechanisms by which companies, and those in control, are held to account’.

The ASX has established eight Corporate Governance Principles and Recommendations.  While these have been drafted with listed companies in mind, these principles are relevant and applicable to all businesses.

Principle one: Lay solid foundations for management and oversight

This relates to establishing the respective roles and responsibilities of the management and the board about how their performance is monitored and evaluated. The separation of ownership and management is a significant change for many family businesses as they grow, and may include the appointment of non-family members to key management roles.  Ensuring the responsibilities of each role are clear will add value, strength and transparency to your clients’ business.  By delegating responsibility of the day to day running of the business with managers, this will enable more time for the owners and board to work “on” the business rather than “in” it.  This can further assist if your clients do have family members in key management roles to ensure they are accountable and have relevant key performance indicators for their position.

Principle two: Structure the board to add value

The board should be of an appropriate size, composition, skills and commitment to be able to effectively discharge it’s duties.  There is no “one size fits all” approach to governance.  Some families may want to set up a formal board of directors, whereas other families may wish to start with a family council.  Whether the approach to governance starts out small, or takes a more formalised approach, it is important that the size and composition of leaders and advisers is right.

Principle three: Act ethically and responsibly

All businesses have a responsibility to their stakeholders for ethical and responsible decision making.  Stakeholders include owners, employees, customers, suppliers, lenders, and the community, whether family members or not. Whilst this may seem an easy principle to adhere to, there have been a growing number of examples in recent times where businesses have acted unethically and irresponsibly.  The business should be committed to this principle and the tone should be set from the top management team and this can be done with ‘Code of Conduct’ documents for all staff.

Principle four: Safeguard integrity in corporate reporting

Family businesses have family members working in the business, and other family members that do not.  Those involved in management are accountable to those who are not, to ensure that the financial reporting is independently verified to avoid conflict within the family.  The larger and the more multi-generational the business is, the more this becomes important.  While listed companies are required to be audited, many private businesses do not require an audit.  If considered a ‘large’ private proprietary company, it should be audited and lodge an audit report with ASIC.  In basic terms, a proprietary company is considered large if it (grouped) meets two of the following three criteria:

  • Over $25 million in turnover
  • Over $12.5 million in gross assets
  • Has more than 50 employees

Principle five: Make timely and balanced disclosure

The timeliness of reporting of material matters to all relevant parties is imperative to the success of all businesses.

Principle six: Respect the rights of security holders

In many family businesses, the shareholders are involved in the management of the business.  Shareholders, as the ultimate owners of the business, must always be considered.  Family businesses may have shareholders not involved in the business, and/or non-family shareholders, and their rights must not be ignored.

Principle seven: Recognise and manage risk

All businesses should establish systems to reduce risk.  Systems to tighten internal controls will increase transparency and competitiveness of the business, and can reduce the abuse of so called family privileges.

Principle eight: Remunerate fairly and responsibly

Many families in business have a policy, formal or not, regarding family members working in the business.  Family members employed may expect to be remunerated at commercial rates, however an excess of what is reasonable may cause conflict with family members who are not employees.  It is important remuneration is clearly linked to performance to provide transparency and credibility to family members not employed, and non-family shareholders and employees.  This transparency may also assist with any perception among the employees of the business, or any other family members who do not work in the business, that there has not been any favouritism or nepotism.  The ASX has some guidelines that you may wish to follow or consider with regards to executive remuneration and non-executive remuneration.

Many family business owners don’t do anything about corporate governance due to fear.  The main things they fear are losing control of the process – or of the business itself, fear of the unknown – as this may be the first time they have attempted to do this, or fear of the additional work involved.  However, this should be outweighed by the fear of not doing anything.

By not addressing governance your clients may be lessening the value of their business, falling behind competitors or leaving behind problems for the next generation.

The governance procedures set up for your clients’ family business should be designed around achieving the goals and ambitions for the business, as well as the goals and ambitions of the family, which may change over time, and particularly where a business may have been passed from one generation to the next.

Governance of a business is an ongoing process, it is not a project that will have a start and end date.  Family business owners will need to face their fears and embrace the changes that will be involved with implementing governance procedures within their organisation.   It’s all about creating value in the business, for the long term wealth of the family.

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