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Corporate governance: why it is crucial for family businesses

Having good corporate governance principles in place is essential to drive profitability and avoid disputes

‘Family businesses have aspects to them that make corporate governance particularly challenging.’ Photograph: iStock

‘Family businesses have aspects to them that make corporate governance particularly challenging.’ Photograph: iStock

 

Corporate governance is one of those terms that gets bandied about from time to time without much of an attempt to explore its full meaning. Indeed, many people, even at senior levels in business, confuse governance with management. But the two could hardly be more different.

Management is involved with the day-to-day running of an organisation while corporate governance sets the framework and parameters within which that activity takes place. Where adequate standards of corporate governance are not in place or are circumvented or ignored, bad things are almost guaranteed to happen.

And this principle applies to organisations across all sectors – public and private sectors, charities, not-for-profits, NGOs, sporting authorities and, of course, family businesses.

“Good corporate governance, and documenting it, is essential to help build shareholder value, drive profitability and avoid disputes,” says Edward Evans of law firm Beauchamps.

“Internal boardroom governance matters to family businesses as it does to any business,” adds Ken McCracken, Family Business, KPMG in Ireland.

“It’s as important for family businesses as it is in any business,” says AIB head of business banking Catherine Moroney.

“The purpose of it is to facilitate the prudent management of the business and help it succeed. No business wouldn’t want that. It also helps to make a business sustainable as new people from outside or family members are brought into the business. It ensures that happens properly. It’s about well-managed growth aligned to the purpose of the business. If you want a business to be purposeful, profitable and sustainable you need to govern the business well and use tried-and-tested and proven business practices.”

UCD professor Niamh Brennan is one of Ireland’s foremost experts on the subject. “Corporate governance is important for every business,” she agrees. “But family businesses have aspects to them that make corporate governance particularly challenging. The most obvious is the family business intertwine.”

What she’s referring to is the entanglement of family matters and interests and business matters which can frequently cause problems for all concerned. “Family disputes are a particular problem,” Brennan notes. “The family business intertwine means that things might be done informally, but formality is absolutely critical. You must have formal board meetings with proper minutes. This ensures that the directors carry out their fiduciary duties to run and manage the business with due care and skill.”

Particular challenges

But family businesses can face particular challenges when it comes to governance. Among these is the need for clarity in relation to what family members want from the business. “The board, especially non-family, must be clear about what success means for the family; or to put this another way, the overall return on investment that the family want,” says McCracken. “This is likely to be a combination of economic returns and other, non-financial, returns on investment to which the family attribute value. The family shareholders need to clarify what they mean by success and the board then has to help the company achieve it. This is very different from other types of business that tend to focus only on economic returns.”

Evans agrees. “It can often stretch resources and finding the time to build such governance, while trying to run the business, can be difficult. It also requires families to work together, professionally, to agree policies, procedures, and so on.”

And needs change as time goes by. “If the business is in expansion mode it may have to raise finance and this introduces potential challenges,” Brennan points out. “If a family business raises finance from a venture capital investor, a condition might be a seat on the board. That may create some difficulties. Family businesses tend to be reflective of the value system of the family. Families are very conscious of their good name. Venture capital may not have quite such a feeling for the family name.”

“In the early generations, family businesses often do not need or want much by way of formal governance,” McCracken notes. “But as the business grows, and ownership changes as it passes down the generations and the family become demographically more complex, the demand for some level of formal governance increases. Successful, multi-generational family businesses have one thing in common – they are well organised, or, to use another description, they are well governed.”

Damaging disputes

The potential for damaging disputes increases over time, according to Moroney. “In the early stages of family business, it is inextricably linked with family,” she explains.

“As the business grows it makes absolute sense to have a clear line of separation between family interests and business interests. It can be vital to the health and wealth of the business, as disputes can lead to value destruction. Good governance can make the difference between having an inter-generational family business and not. Disputes can destroy a business. If family members agree on the rules early on while everyone still gets on, it is best. If you want to bring in outside equity you will get a much better price if you can demonstrate best practice in corporate governance.”

“Early-stage companies need to set out simple, flexible but clear corporate governance norms but can often lack the knowledge or experience to do this,” says Evans. “Growing businesses then have to deal with a range of family and interpersonal challenges while also looking to the next generation to help and become part of the businesses growth. Clear lines of responsibility and reporting are very important for this stage. Mature family businesses will also have intergenerational issues and may also be in sale or transition mode with some founders or family members exiting. Clear exit rules and how to deal with transition are key here.”

But help is available in overcoming these challenges. “A clear and common set of agreements can be put in place, with outside assistance from relevant advisers,” Evans points out. “This can be rightsized for the stage and resources of any family business.”

McCracken advises family firms to research what other successful business families have done. “Work out what works for you, based in your family’s traditions and your aspirations for the future,” he says. “This takes time because each family will need a bespoke solution. There are no best practices. In fact, beware best practices – best-practice statements are most often excessive generalisations from selected examples leading to complex family businesses being reduced to facile slogans that are falsely presented as universal laws.”

Niamh Brennan sums up the importance of good governance. “If something goes wrong, you’ve got to be able to demonstrate that business was conducted properly. That’s where good corporate governance comes into its own.”