Governing the family company.

• Author: LANSBERG, IVAN

Both the business and the family are in need of governance. Here is how boards can organize themselves and how directors can approach their role to successfully take on this much broader responsibility.

MOST FAMILY COMPANIES are undergoverned. If they have legal boards, they exist largely on paper and lack directors with independent voices whose experience and expertise can help the company significantly with key strategies.

In large and complex family business systems, ownership may be indirect and difficult to untangle. The family holdings are often tied up in trusts that have the effect of giving a few trustees ultimate authority over the company's destiny. In many cases, the structure is designed not only to reduce taxes but also to prevent family emotions from disrupting the management of the business. The lawyers for the principal owner purposely design the trusts and write a shareholders' agreement that will block any effort by dissident family members to challenge the principal's control.

This containment strategy is, in my view, basically wrougheaded. It usually reflects the principal owner's unwillingness to deal with the human side of running a family business -- the messy emotions that come with the territory, especially in later generations when there are many more family members with varying interests and points of view. No matter how strong the legal dam erected by the principal owner, it is likely to give way under pressure from members of succeeding generations.

My view is that interests and emotions can be successfully managed, and that it is essential to do so in order to ensure continuity in a family business. Keeping the shareholders happy and committed to the business is good for both the business and the family. And the best way to accomplish that is to establish forums where the separate issues and concerns of the business, the shareholders, and the family can be openly discussed and constructively managed.

The three pillars of family business governance are the board of directors, the shareholders' assembly (see box on page 47), and the family council (see page 49).

The board of directors

While the responsibilities of directors of public corporations have been defined in volumes of statutes and case law over the years, there are few legal guidelines defining the particular responsibilities of directors of family companies. What, for example, is the fiduciary responsibility of a board in a family company for seeing that the owners prepare for a transfer of leadership to the next generation or do proper estate planning? Are the directors legally liable if a business loses much of its value after the death of a dominant leader who refused to plan adequately for his or her succession? Can they be blamed for going along with an owner who creates a partnership of his offspring in the next generation even though the successors are incapable of functioning as a team?

Whether they like it or not, independent outsiders on family business boards are often called upon to intervene in situations that are above and beyond the normal obligations of overseeing the direction and operation of the business. The shareholders they represent, moreover, differ in significant ways from the relatively anonymous mass of investors who buy stock in public companies but have virtually nothing to do with the companies they invest in.

Legally, the board of directors exists to protect the interests of the shareholders. In practice, the board in a family company plays a much broader and more positive role in guiding the business and the family.

Just as in a public corporation, the board of a family company is charged with overseeing the operation of the business. It is the directors' responsibility to see that the business is managed as efficiently as possible and earns optimal returns for the shareholders. The board's duties include:

* Reviewing corporate objectives.

* Monitoring the performance of the enterprise.

* Approving major acquisitions and divestitures of businesses.

* Approving the strategic plan and operating budgets.

* Advising the CEO and his or her management team.

* Approving debt/equity ratios.

* Guiding succession planning.

Too often owner-managers of family companies are so focused on the policing functions of the board that they tend to overlook the fact that strong boards with experienced independent directors can be an enormous resource for senior executives. The directors can bolster management by bringing an array of skills and expertise to the company. In addition, they play a vital role in keeping managers focused on the big picture, on the long-term goals and strategic direction of the company, and the overall performance of the company in meeting those goals.

Beyond its fiduciary duties in overseeing operations, the board in many family companies has another function that is just as important to the owners: It makes sure that the management of the enterprise is guided by social and ethical principles that the family deems important.

Contribution of independent directors

Surveys of business owners done in the United States by the Massachusetts Mutual Life Insurance Co. and by Arthur Andersen suggest that most family companies that have lasted for more than one generation have a minimum of two or three independent directors on their board. Another study by Louis Barnes and Marc Schwartz of the Harvard Business School shows that the usefulness of a board, as perceived by owners of the company, increases with each new outsider that is added, up to a total of three.

Many business owners are reluctant to have an active board with real responsibilities and qualified outsiders, fearing that they will lose control of the company. They worry that their decisions will be challenged and that privacy will be compromised. However, experience suggests that owners who have boards almost always conclude that their initial fears were unfounded and that outside directors have added to the quality of board decisions. S.C. Johnson & Son, worldwide distributors of Johnson's Wax, Raid, and other household products, has a majority of independent...