Share |

How a formal family agreement can benefit your business

Daniela Montemerlo is a professor at Bocconi University. John Ward is Wild Group Professor of Family Business at IMD in Switzerland and Professor of Family Enterprises at Kellogg School of Management.

A family agreement can be a powerful tool for any business owning family. It can secure and perpetuate an enterprise but it should be a distinct reflection of a family's culture and experience, argue Daniela Montemerlo and John Ward

The two most strongly promoted prescriptions to protect and preserve a family businesses are to empower an independent board in order to strengthen the business and to draft a 'family agreement' to fortify the family. This article, drawn from our forthcoming book, examines the family agreement.
A family agreement is any kind of written understanding that regulates the relationship of a family with its business. For example, before one family developed its agreement several questions were tugging on people's time and energy. They asked themselves several questions such as what rules would be applied for next generation family members to work in the business or whether the family was committed to next-generation business involvement and ownership. Questions on how the family would make such decisions and how it could go about learning enough to address such subjects arose. There was also the issue of who would participate in the learning and decisions. Maybe it would be more a question of relying on the family's values and past experiences? Or is it better to write clear rules, even legally binding understandings? The family went on to ask: "If family members are expected to gain meaningful outside experience and higher education, can we still expect them to start at the bottom of the company like past generations have recommended? In addition, depending on their backgrounds, we probably would need different compensation systems than in the past? What about those who are not qualified to work in the company? What will keep their interest? What will be their roles as owners? What if a family owner wants to sell his shares?" A family agreement addresses all these questions and many more.

We have studied more than 30 family agreements that have been in place for more than ten years and believe that family agreements serve three purposes. The first is to foster the company's development. The second is to assure family ownership unity and commitment. The third is to reinforce a family's strength as a family.

Meanwhile, there are four key benefits of family agreements. First, family agreements help forge a broad and strong commitment to the future of the business. Second, they build the confidence of non-family managers and business partners by showing that the owning family is united and ready for the future. Third, they shape the next generation's expectations for their roles in the company and as owners. Finally, they help prevent family conflicts over unnecessary misunderstandings.

The process of developing family agreements provides additional advantages to the business owning family including, learning decision-making and problem-solving skills; developing communication skills; knowing each other better; developing trust; understanding the business's history and governance system; and testing the family's capacity to work together long-term.

What ingredients
Comprehensive family agreements address several topics, specifically who, why, what, when and how. These include:

- Introduction to the participating parties (Who?)
- Statement of family values and beliefs (Why?)
- Family business principles (What?)
- Policies to govern family and business relations (How?)
- Conclusion with method of review and amendment (When?)

The relative emphasis on these various topics defines the type of pact. We propose four types of family agreements. First is the 'shareholders' contract' where the focus is on the legal, contractual rights and responsibilities of shareholders (buy-sell agreement, redemption process, dividend rights). Second is the 'family business protocol' where the primary focus is on formal policies that address family member interactions with the business (employment rules, retirement guidelines, family member compensation, family communications with the media). Third is the 'family statement'. The focus here is on what is important for successful family continuity (family mission, family values, family meeting procedures). Fourth is the 'family constitution', which aims to provide a well-balanced and integrated mix of all of the previous types: the family statement, business protocol, and shareholders' agreement.

Later we will encourage the family constitution as the eventual goal for all families in business as we believe a balanced and integrated attention to philosophy, principles and policies is important to long-term family success.

What origins
So why are families prone to draft family agreements? There are three reasons. The first is respect for the inevitable change and increased complexity that comes as family ownership grows larger through the generations. Second, there can be concerns that historical troubles – family splits, succession struggles, ownership greed – might recur. Third is to respond to current tensions among the family or between the business and the family. We offer two cautions: when the family agreement is written as a reaction to past problems, be careful not to overreact. Overreaction can lead to bad policy or too rigid regulation. And family agreements are not the solution to family dysfunction. It is better to address emotional issues first with counsel.

What influences
The character and makeup of any particular family agreement is a factor of each family's and business's special circumstances. The family's culture, the country's legal environment, and the nature of the business all shape the agreement. National laws determine, for example, whether firms can have different classes of shares, can buy back their shares, or whether trusts or foundations can control the business. The business's strategic environment dictates the ability to raise debt, the skills required of managers, or the capital intensity of the firm and so on. Because the business and legal context are important to the policies of the family agreement, it's good practice to include the firm's independent directors and advisers in the family agreement formulation.

We have found, however, that the most powerful factor influencing a family agreement is the family's basic assumptions about how family and business affect each other. Some families have a strong predisposition to draft family agreement policies that are 'business first', protecting the welfare of the business from family misconduct. Other families have a strong disposition for 'family first' policies that protect the family's harmony from being hurt by business challenges and differences.

We find that whether a business-owning family approaches decisions from a 'business first' or 'family first' perspective comes from their fundamental belief on whether family ownership is a threat or opportunity to the business's performance and whether owning a business together is a threat or opportunity to the family's welfare. The more the family perceives family ownership as risking business success, the more the policies will be contractual, rigid, and difficult to amend. The more the family is seen as a source of strength to the business, the more flexible, guideline oriented and easily amendable the agreement will be.

What success
We believe a family agreement is successful if three factors occur. First, the family implements new, effective structures or processes (new board, a family council or a succession process). Second, the family implements the family agreement consistently, making exceptions based on principle, not personal needs. Third, the family remains committed to joint ownership, not dissolution.

In addition, the successful family agreements we have studied  typically share common characteristics or 'the six Ps'.

- Positive. They were motivated to draft their family agreement mostly for positive, not defensive reasons.
- Philosophic and principled. They articulate the specific values and beliefs that underlay each family agreement policy.
- Personal. They write a family agreement that is uniquely theirs – not replicating a general template or copying another family agreement.
- Process and project driven. In the family agreement draft there is a blend of attention to the process of the decision-making as there is to making concrete, discernable policies.
- Participative. A large percentage of the family was actively engaged in the formulation and oversight of the family agreement.
- Paradoxical. The family agreement offers to balance, or better, a win-win synthesis as having a 'family first' versus 'business first' orientation. The family believes the welfare of the business and family are greatly enhanced by the existence of the other.

The family agreement is a powerful tool for the business-owning family. It should be a distinct reflection of your family's culture and experience. It should be developed without haste and will be strengthened by active involvement of most or all family members. Balance is the key. It should reflect a healthy balance in its business versus family orientation, in its amenability versus constancy of policy, and in its emphasis on philosophies and principles versus policies and protocol.

Families and their business requirements are constantly changing. Balance provides for the durability of the ­agreement.

Click here >>