Matters Column

Creating a Family Constitution to avoid consternation

March 6, 2015
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Most family businesses fail by the third generation, but few family business owners anticipate or acknowledge the risk of failure, according to data compiled by the Family Business Institute.

According to the Institute, only 30 percent of family businesses survive into the second generation, 12 percent survive into the third generation and just 3 percent into the fourth generation and beyond.

Despite the discouraging data, the institute found that 88 percent of current family business owners believe their families will continue to own and manage the business in five or more years.

Clearly, there is a disconnect between the success rates of family businesses (or lack thereof) and the optimism of the family business owners.

What obstacles prevent the continued success of family businesses into future generations? In addition to traditional succession planning, what can families do now to foster success in future generations?

One obstacle to continued success is a marker of success itself: growth. As families and their businesses grow and develop over multiple generations, the number of family members involved in the business increases, introducing new challenges and dynamics. Maintaining open communication with all involved family members can be challenging — stifling the flow of information may leave expectations regarding the business and its future muddled. Or those expectations may diverge, leaving relationships increasingly complicated and fragmented.

Moreover, a fundamental difference between family and business are the varying levels of formality. By nature families are characterized by informal relationships. There is no membership fee to join, no contract to govern relationships and no termination agreement removing individuals from the family. A business is much more formal, with scores of legally binding documents defining relationships, rights, obligations, benefits and the resolution of conflict. Absent clear direction, this dichotomy may lead to confusion and inconsistency among family members and their business.

Savvy family business owners will want to proactively address these obstacles and mitigate the risk of family discord in future generations. One option that is gaining traction is to create a Family Constitution.

A constitution is, in simple terms, a governing instrument. Though most frequently associated with national governments, the form and function of a constitution translates well to the family business context. A Family Constitution can be broadly described as a comprehensive written statement that seeks to memorialize the core principles, values, rights and obligations of the family and their business.

The Family Constitution is unique among business documents (think of an operating agreement, or a buy and sell agreement) because it is not legally binding. Rather, it imposes a moral obligation on the family to honor its content, which has been carefully chosen by the family.

A key feature of the Family Constitution is its malleability. The Family Constitution is not a standard form — there is no “one size fits all” format. Instead, the Family Constitution is specifically tailored to fit each family’s needs after thoughtful input and deliberation. It can be short or long, general or specific, and can adapt to meet the evolving needs of the family and their business.

Many times the greatest benefit resulting from the implementation of a Family Constitution comes from the process of family members brainstorming, deliberating common issues and developing policies and procedures. The crafting of the document is a thoughtful and time-intensive process, one that requires a clear sense of purpose and honest reflection on the history, current condition and future of the family and its business. This process opens a dialogue that frequently brings families closer as they define, together, their shared vision, objectives and dreams.

The Family Constitution often begins with a history of the family, the business and their traditions, and describes the mission, values and philosophy of both.

Describing these core familial principles lays the foundation to guide specific planning. The remainder of the Family Constitution sets forth detailed policies and procedures to guide the current generation and future generations in this planning.

Although each family is unique, the conflicts family businesses face and decisions that must be made tend to be predictable. While you may not be able to pinpoint when these matters will arise, the Family Constitution provides a mechanism to anticipate and plan for these common issues in a calm environment. Many of the situations addressed by these guidelines are particular to the ownership and management of the business, and often include:

  • Code of conduct for individuals and groups (e.g., board of directors, family council)
  • Leadership and succession plans, exit strategies, sale of the business
  • Hiring, compensation, evaluation, retirement, termination of family employees
  • Information sharing and confidentiality
  • Process and manner of dispute resolution
  • Benefits available to active and non-active family owners
  • Estate plans or trust arrangements, prenuptial agreements, divorce
  • Role of non-family members in the ownership and management of the business
  • Procedure to amend the Family Constitution

A Family Constitution can be a useful tool to preserve the legacy of your family business and sustain the business for generations to come.

Engaging a neutral party such as an attorney or other trusted advisor to assist with the preparation of the Family Constitution can be beneficial in several respects. The advisor will facilitate the dialogue in an objective and focused manner, resisting the urge to walk down unproductive or hurtful paths that may damage family relationships. Moreover, the advisor will handle the administrative tasks of organizing and structuring the fruits of the dialogue to craft a functional document, leaving family members free to concentrate on its content. 

If you believe your family and its business could benefit from a Family Constitution, I urge you to contact your attorney or other trusted advisor to begin this process.

Kellen E. Elliott is an attorney with Warner Norcross & Judd LLP. She focuses her practice on estate planning for individuals and families, as well as comprehensive succession planning to transfer ownership and management to next generation owners of family-owned and closely held companies. She can be reached at (616) 752-2721 or kelliott@wnj.com.

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