Foul play and feuds

Bengt Hallqvist serves as an independent board member of five family companies in Brazil and Sweden, also chairing one remuneration and four audit committees. He is founder of the Brazilian Institute of Corporate Governance

Families are melting pots for conflict. Add business to the equation and you have a fight on your hands. Bengt Hallqvist urges independent board members to take on the challenge of governance rainmaker, as he reveals his own worst-practice experiences

The issue of corporate governance is more thorny for family firms than for non-family corporations, and even more so for independent directors. They must navigate the intricate relationships, conflicts and emotions of the controlling family.
 
Even though one may pre-suppose a non-family member joining the board of a family business that seeks to perform good corporate governance by appointing independent directors must already operate in a professional manner, the first challenge a non-family member will face is simply to be accepted. Most family members may think, "what can this new guy tell us? We've been with the company all our lives".

Before you really start your work as a board member with a family business it is prudent to talk individually with key family members and directors. Get to grips with the history of the company, its culture and values. Find out about the ownership and board structures. Visit factories and other places of business, and if possible travel a few days with a salesman as far from head office as you can get.

In preparation for the first board meeting, you should be familiar with the company bylaws, any shareholder agreements, family protocol or constitution. Review the annual reports and the financial statements for the past few years. A common error made by independent board members in the first board meeting is to throw out a diagnosis on what is wrong with the company, and tell your colleagues what should be done to fix it. Instead, hold back: listen carefully and say as little as possible.

You will often find that the board meeting is very much a family affair. Directors and managers will have known each other since they were kids and they treat each other accordingly. It's likely that everybody will talk at the same time, and one meeting may become several as groups of members break off into their own conversations.
 
In my time as an independent director on the board of several family businesses – large organisations with between 1000 to 2000 employees located in Europe or Latin America, usually – I have seen some laissez-faire attitudes to board governance. Governance and practical structures on this point, such as taking minutes, can be poor.
 
At the board meeting of a well-known agricultural machinery manufacturer in Brazil, run by five second-generation brothers and myself as the only non-family person, proceedings began with the question from one of the brothers, "what are we going to discuss today?". It got worse – for the next board meeting he tried unsuccessfully to find a gavel to bring order to their chaotic meetings, but brought instead a club with a rubber head used to change car tyres. He made a joke of it handing it over to the youngest brother who was the chairman, but it had an immediate impact. Subsequently, a written "etiquette" agreement for board members was developed, and today every board member receives the meeting agenda at least one week before the board meeting. The members speak after having been recognised by the chairman, and each decision is registered in minutes with deadlines and responsibility clearly marked out. Such simple things as these really make a difference.

To their credit, in a typical family board of directors, each of the members will have an impressive knowledge of the details of their company – but only a vague idea of the bigger picture, which is gained by examining the company's balance sheet and income statement. Unfortunately, and worryingly, not many directors or managers both in family-run and non-family run companies can really read and understand these financial statements. Yet, it is only a question of a couple of hours for experienced businesspeople to get to grips with this essential part of their responsibilities. Just about every notable auditing firm runs seminars in accounting for non-financial executives; if you feel uncomfortable with financial statements it is highly recommended that you take this offer up. You will find that with this understanding, board discussions are more structured, and focused on the true priorities for the business.

One multi-family corporation on whose board I serve is made up of active members from the first, second and third generation. It is the leader in its industry, but competition is fast stealing market share. Family issues overriding smart governance attitudes are slowing the company down; despite everybody on the board agreeing on where the problems lie, the CEO, who is the only remaining member from the first generation, often vetoes decisions made by his cohorts to act on the basis of various ­family considerations. As a result, the company is losing value, and the wider shareholding family hasn't got a clue about the state of affairs because they are not kept informed, flouting family protocols and shareholder agreements that were set up.
 
Tragically, I have learned working for various family companies, this is a typical situation and it explains why less than 15% of family companies survive passage to third generation control. But the solution is fairly simple – family protocols should be updated and include, among other things, adequate transparency for all shareowners, and a family council should be set up to handle, among other things, conflicts between family members. With these two things in place, the chief executive would then have enough support to lead the necessary measures. Family protocols and councils are fundamental for family business operating in modern markets, both listed and private, and are the basic governance differences from that of non-family companies.

At the root of all these governance issues are, once again, family considerations – or more specifically, emotional considerations. As a business situation deteriorates, the more evident bad communication among families becomes, even speeding up the demise of their company. In a second generation industrial business in Argentina, whose board is composed of three brothers – the eldest also being the chief executive – a sister and two independent directors, this is exactly the problem. During the past 18 months company profitability has dropped and the business has fallen into the red. The family blame their CEO, and are vociferous about this at every opportunity, both at work meetings and at social or family gatherings, until he is in the room – at which point they fall silent. As a result, the CEO recently resigned, quite abruptly, leaving the business without a leader at a time of crisis. What I would have recommended to this family is a simple practice I have seen in many other, more professionalised families. Each board meeting starts with an "executive session", held by the chairman with his independent directors but without the presence of the managers or the CEO, at which performance is frankly discussed. The chairman is then charged with relaying the discussion and points made to the CEO and management, making for a non-emotional and constructive strategy, which usually leads to improved performance.

Wherever there is private management and ownership, coupled with a lack of transparent controls and accountability – and not much history of independent directorships – there is a heightened chance of patrons taking liberties with their company that can devastate the business and the family. Corbetta SA – a second and third-generation multi-family company – is a well-documented case of family conflict. Corbetta became the largest tannery in Brazil but could not sustain its growth without external financing. Banks were hesitant to extend their existing credit agreements in view of well-known family conflicts, and in light of the fact that the controlling family, who held just over half of the voting rights, managed for several years to exclude minority shareholders from the board, and suppress vital information.
 
Even when one minority owner finally got a place on the board, she failed to access this information. This class of shareholder eventually suspected foul play on behalf of the controlling family; later on, the company fell into financial straits, before going bust altogether. In another representative case, the founding family of a Mexican publishing house was split into two warring factions when a third generation board member launched a series of lawsuits against her brother, father and uncles, believing them to have looted the company via illegal party transactions.

Neither company had a system for conflict resolution. If these companies had family councils giving equal representation to all family groups, they could have had a fair chance to identify and solve these sorts conflicts before they got out of hand. However, the overriding factor in both cases was the same old story – a lack of transparency. Another simple rule for family-owned companies, then: if you hide information, it will one day come back and hit you.

The external independent director can play a vital role in supplementing the collective knowledge and experiences of the family company. He or she has to do their homework first in order to be accepted by the family and will then have the power to make the board meetings more effective and bring financial literacy to directors and managers. By using benchmarks and experiences – if you have or currently serve on more than a single board – you can contribute to an optimum corporate governance structure, help to implement executive sessions, implement rules for conflict resolution and for the development of the management function, making a lasting difference to the company, and the reputation of family businesses, throughout and beyond your term.