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Ten rules for non-active shareholders

Peter May is founding partner of the INTES Academy for Family Businesses and head of the German chapter of the FBN.
Matthias Redlefsen is partner of the INTES Academy for Family Businesses.

The management of non-active shareholders needs careful consideration. Training, ­dividends and compensation policies are issues that frequently arise. Peter May and Matthias Redlefsen highlight the easiest way to avoid conflict and satisfy everyone

The collaboration of active and non-active shareholders is a key source of trouble in a family business. This isn't surprising, since the perspectives of family members with no role on the board and those exercising a formal management function are fundamentally different. As a result, active and non-active family members can find themselves at odds over matters as diverse as dividends, salaries, perks, information policy and risk management.
INTES Academy for Family Business, together with JP Morgan and the European Business School carried out a comprehensive study of 185 family businesses in Germany. The results are summarised below:

Rule one: Accept the potential conflict between active and non-active shareholders and tackle problems systematically. The study highlights the enormous importance of the issue in business practice: in 51% of businesses the majority of the shares was held by family members without a function on the board. In other words, family businesses are dominated by non-active shareholders.

Rule two: Ask your non-active shareholders for a positive engagement with the business and help them to acquire the necessary knowledge. Just like the shareholder of any business, non-active owners of a family business have a right to execute power and harvest revenue from their business according to their share quota. Non-active shareholders should be aware of the ­responsibility they hold for the business and its employees. This requires preparation for their co-entrepreneurial role. All family shareholders – not just board members – should have a basic understanding of strategic business management and corporate governance. In addition, non-active shareholders should be able read a balance sheet otherwise they will have to discuss matters they don't fully comprehend, which inevitably leads to a higher level of emotion.
German family businesses have an enormous deficit in this area. Indeed, more than half of non-active shareholders can't read a balance sheet while only 28% of family businesses have specific training programmes to help them cope in this area.

Rule three and four: Encourage family members who are unlikely to hold a management position in the firm to become financially independent from the business and respect existing financial dependencies when you deal with dividends.
Almost half of the passive shareholders in German family businesses depend on the dividends of their business. We found that 45% of the non-active shareholders obtain most their income from dividends. This dependency is risky because it increases the scope for conflict, not only with regard to dividend policies but on other issues such as information strategy or risk policy. These conflicts are further intensified if the management is executed by family members, as these active shareholders hold a second source of income with their salary, which gives them a higher degree of financial independence than non-active shareholders.

Rule five: Let non-family members on the advisory board decide about employment and remuneration of family members. Use the same criteria for family and non-family candidates. Employment of family members is a key area of concern when dealing with non-active shareholders. Scope for conflict tends to be wider among family members than non-family members. There are many reasons for this, some of which may include inconsistencies in business hierarchiy versus family hierarchy or share quotas. In order to avoid conflict rules must be crystal clear, especially in terms of how family members are paid.

Rule six: Restrict business relationships between non-active shareholders and the family business. Another flashpoint is when non-active shareholders maintain individual business relationships with their family business: for example, the daughter of a senior entrepreneur is running the family firm's marketing project through her own public relations company. Amazingly, some 42% of family businesses have no rules on such issues.
Rule seven: Set clear rules for perks and status symbols. Company cars, mobile phones and company mechanics fixing problems at shareholders' homes – can lead to conflict among shareholders. Many services are normal parts of compensation packages for managers. But in family businesses with active and non-active shareholders they can lead to conflict. Our study found that 20% of the family businesses allow perks to non-active shareholders while 85% offer these services to family members serving as board members. Some perks can be seen as powerful status symbols, so it's crucial to clarify who gets what.

Rule eight: Set clear rules for board composition. The advisory board is a key instrument to control how a family business is managed. Yet its efficiency can be disturbed and conflicts become much more personal, if family members are controlled by family members. Clear rules about personal and professional qualifications for management and advisory board members can help, to reduce this problem.
Rule nine: Govern your family as professionally as your business. Good governance requires systematic management of the family as well as the business. This includes formally empowered shareholders as well as their spouses and children. This means developing a family constitution, in which the values and goals of all family members are jointly defined, and organising family meetings to unite the family behind the business. But few German family businesses have discovered the advantages of professional family governance: only 30% have made formal moves towrds systematic family management.

Rule ten: Elaborate binding rules for conflict behaviour.
In most family businesses the existence of non-active and active shareholders is a fact that cannot be easily changed. Nor is there a desire by family members to alter that fact. A binding agreement or code of conduct can help narrow the scope for conflict. In doing so, ask questions. How does the family behave in public? How do we deal with each other when we have a problem? How do we deal with non-family management? How do we behave in situations of conflict? A code of conduct can offer answers. In German family businesses, this aspect of governance is woefully underexploited: only 5% have a binding code of conduct for family ­shareholders.

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