TheFamily

Business

Constitution:A

Roadmapfor

Business

Continuity&

FamilyHarmony

TenKeyInsightsintotheprocessofmakingyour

ownFamilyConstitution

ChristianG.StewartManagingDirector

FamilyLegacyAsia(HK)Limited

www.familylegacyasia.com

1

Contents

1. IntroductiontotheFamilyConstitution.............................................................2

1.1 FamilyBusinesses:PredictableProblems........................................................2

1.2 WhatIsFamilyGovernance?...........................................................................4

1.3 FamilyGovernanceStructures........................................................................5

1.4 HowFamilyGovernanceStructuresHelp........................................................6

1.5 HowFamilyPoliciesCanHelpAvoidPredictableProblems............................7

1.6 ExamplesOfFamilyPolicies&Agreements....................................................7

1.7 WhatIsAFamilyConstitution?.......................................................................8

1.8 WhatAreTheBenefitsOfHavingAFamilyConstitution?..............................9

2. TheKeyInsightsintotheprocessofcreatingaFamilyConstitution....................11

2.1 ItstheProcessThatCounts..........................................................................11

2.2 NotaLegallyBindingDocument...................................................................11

2.3 TheFamilyMakeTheirOwnRules................................................................11

2.4 FamilyProjectLeader....................................................................................11

2.5 TheConceptOfFairProcess..........................................................................12

2.6 AChangeProcess..........................................................................................13

2.7 ASocialContract...........................................................................................13

2.8 WhatAreTheExistingArrangements?.........................................................14

2.9 HowLongDoesItTake?.................................................................................14

2.10 WhatIfTheyDontFollowTheRules?.......................................................15

1. IntroductiontotheFamilyConstitution

1.1 FamilyBusinesses:PredictableProblems

Whatisafamilybusiness?Onecommonaspectofthedefinitionoffamilybusiness

is an intention to continue the business under family control. Another way of

definingafamilybusiness is to refer toabusiness inwhich there isasignificant

overlapbetween(i)afamilyemotionalsystemand(ii)theownershipsystemand(iii)

thebusinesssystem.

Notwithstanding that a family business, by definition, is one where there is an

intentionofkeepingcontrolinthefamily,thechallengesofsuccessfullyperpetuating

afamilybusinessarewellknown,leadingtotheoftenquoteduniversalproverbthat

wealthonly lasts for threegenerations,or from shirt sleeves to shirt sleeves in

threegenerations.1

Research into Asian family businesses2 has concluded that the majority of family

businesses inAsia fail as a result of internal factors, rather than external factors.

Theseinternalfactorsincludefailuretoplanforsuccessionandfamilyconflicts.Yet

thesurprisingfact isthatmanyfamilybusinessconflictsarepredictableandcanbe

plannedfor.

1ThisisthestartingpointofthepopularbookFamilyWealth:KeepingitintheFamilybyJamesE.

HughesJr.,BloombergPress2TongCheeKiong,NationalUniversityofSingapore,FeudsandLegacies,ConflictandInheritancein

ChineseFamilyBusinesses,InternationalSociology,March2005,Vol2091);4570.

3

Onereasonforfamilybusinessfailurecanbetracedtoshareownership.Overtime,

the number of shareholders increases, share ownership becomes fragmented,

resulting in it becoming harder for the family to make decisions concerning the

business.Itissaidthat:Familiesgrowfasterthanbusinesses.

Over time,as the shareownershipbecomes fragmented, the shareholders start to

loseemotionalcommitmenttothefamilybusiness.3Emotionalcommitmenttothe

business4andhavingactiveowners5hasbeen identifiedasafeatureofsuccessful

multigenerationalfamilybusinesses.

It is alsopredictable thatover time, therewillbemore familymemberswho are

ownersratherthanmanagers,andthattheinterestsoftheseoutsideshareholders

willbe inconflictwiththe interestsoftheinsidemanagers. Againsuchconflicts

arepredictableproblems.

There are examples of successfulAsian family businesseswhere the business has

beencontinuedasaresultofaconsolidationofshareownership.Thispointstothe

importance of having a mechanism for allowing for share ownership to be

consolidated. The need for such a mechanism (often called an Exit Plan or a

familyshareholdersagreement) ishighlightedbycaseswhere (i)afamilyconflict

startsovertheissueofhowtovaluethesharesinthebusinessor(ii)theexitofone

familyshareholdercreatesaliquiditycrisisforthebusiness.6

Another challenge for the family business is the basic inconsistency between the

goalsandvaluesofthefamilysystemontheonehandandthegoalsandvaluesof

thebusiness system. Anexampleofa familypolicydesigned toaddress sucha

conflictbetweenfamilygoalsandbusinessgoalsisthefamilyEmploymentPolicy,

whichwillsetoutclearrulesforentryintothebusinessbyfamilymembers.

3WongSiuLun,FamilyBusinessReview,volVI,no.3,Fall19934Carlock&Ward:StrategicPlanningfortheFamilyBusiness,Palgrave5Responsibleownershipofthefamilyfirm,LorraineM.Uhlaner6TongCheeKiong.

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1.2 WhatIsFamilyGovernance?

Ifthegoalislongtermbusinesscontinuity,thispointstotheneedtoinstitutionalize

therolesandrelationshipsthatarepresentinthefamilybusiness,ratherthansimply

to rely on current relationships. In short, long term business continuity requires

theretobeclarityastohowthefamilybusinesswillbegoverned.

Governance isconcernedwithallof theways that the interestsofowners

arereflectedand implemented intheorganizationalsystemIngeneralthe

purposeofgovernanceistoformalizetheinvolvementofkeystakeholdersin

thedecisionmakingprocessattheapexofafamilyenterpriseGovernance

isinherentlyaboutinstitutionalizingcontrol.7

Governanceinafamilybusinesscanbethoughtofintermsof:

(i) Structures for example, deciding to create a family learning and

developmentcommittee;

(ii) Processes forexample, creatingand runningongoingownershipeducation

programsandtheannualpreparationofapersonaldevelopmentplan;and

(iii) Policies for example, an aspectof the FamilyEmploymentPolicy couldbe

that family member employees are expected to participate in the family

learninganddevelopmentprograms.8

Foranotherdefinitionofgovernance,takenfromthecontextofafamilycontrolled

listedcompanyinHongKong:

Corporategovernance canbebroadlyunderstood as the interrelationship

among the companys stakeholders, including shareholders, the board of

directors, the management, and other relevant partiesGood corporate

governance depends largely on the separation of ownership and

7TraditionandAdaptationinChineseFamilyEnterprises:FacingtheChallengesofContinuity,Ivan

Lansberg&KelinGersick.8YoucanalsoaddAgreementstothislist,e.g.theshareholdersagreement.

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management. Under a good corporate governance structure the

responsibilitiesofdifferentunitsinacompanyareclearlydelineated.9

Thispoints to the importanceofensuring that there isacleardistinctionmade

betweentheroleofownershipandtheroleofmanagement.

1.3 FamilyGovernanceStructures

Another form of predictable problem in a family business is where an issue or

concern from one dimension of the family business system (for example, an

ownershipissue)arisesinthewrongcircle.

Iftheneedsofonedomainhavenowaytoberepresentedtheydont just

evaporate, they find another outlet. This is like the displacement of an

emotion.Forexampleifthereisnowayforownershipissuestobeexpressed

expressed they may appear in the board and board meetings turn into

shareholdermeetings.10

Thispoints to the importanceofhavingappropriatestructuresand forums so that

the interests of the family circle and the interests of ownership can be properly

expressed. Anexampleofthiswouldbethecreationofafamilycouncilorofan

ownerscouncil.

One of the most pervasive lessons we have learned is that when the

legitimate interestsofownershipdonothaveaforumforexpression, issues

ofcontrolandreturnon investmentwillfindawaytoemerge ineitherthe

familyortheoperatingbusiness. Whenthose issuesdocometosurface in

the wrong circle, they are almost always disruptive and sometimes

destructive.11

Basicgovernancestructuresinafamilybusinesscaninclude(i)afamilyassembly(ii)

afamilycouncil;(iii)itmightincludeaseparateownershipcouncilorforum;(iv)the

boardofdirectors;and (v)perhapsalsoanadvisoryboard.Fromthereaparticular

9100YearsofLi&Fung,byFengBanYan.10GettingAlonginFamilyBusiness;theRelationshipIntelligenceHandbook,Hoover&Hoover.11GenerationtoGeneration,HBSPress.

6

family might decide that it also needs one or more committees (see the below

diagram)or,forexample,acareerplanningcommittee.

Asimplediagramreflectingabasicgovernancestructureforafamilybusinesscould

beasfollows12:

1.4 HowFamilyGovernanceStructuresHelp

Wellfunctioningfamilygovernancestructuresaimat:

(i) Communicatingthefamilyvalues,mission,andlongtermvisiontoallfamily

members.

(ii) Keeping familymembers (especiallynonexecutives) informedaboutmajor

businessaccomplishments,challenges,andstrategicdirections.

(iii) Communicating the rules anddecisions thatmight affect familymembers

employment, dividends, and other benefits they usually get from the

business.

(iv) Establishing formalcommunicationchannels thatallow familymembers to

sharetheirideas,aspirationsandissues.

(v) Allowingthefamilytocometogetherandmakeanynecessarydecisions.

12AdvisingtheFamilyBusiness:AGuideforProfessionalsDavidBork,DennisJaffe,SamLane,Leslie

Dashew,andQuentinHeisler,JosseyBass

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1.5 HowFamilyPoliciesCanHelpAvoidPredictableProblems

Becausefamilybusinesshavepredictableproblems,theseproblemscanbeplanned

forandfamilypoliciesdevelopedtoaddressthe issuesbeforefamilyconflictarises.

Accordingly another aspect of family business governance is the creation of an

ongoing process for the creation of relevant family policies and for their periodic

review.

Familypolicieshavemanyadvantages.Makingfamilypoliciescan:13

(i) avoidproblemsorsolvethembeforetheyoccur;

(ii) reducefuturefamilytension;

(iii) strengthenthefamilywithexperienceincomingtoagreement;

(iv) clarifyyourfamilyspositionsandreducemisunderstandings;

(v) helpthefamilysortoutitsvaluesandwhatitstandsfor;

(vi) improvefuturedecisionsbyensuringthatpolicyformation is informedand

objectiveratherthanmadeintheheatofbattle;

(vii) createmoreenthusiasmforandknowledgeofthebusiness;

(viii) increasethelikelihoodoflongtermbusinessandfamilysuccess,survivaland

prosperity.

1.6 ExamplesOfFamilyPolicies&Agreements

Examplesoffamilypoliciesinclude:

anEmploymentPolicy aDividendPolicy aRemunerationPolicy ajobdescriptionfordirectors alearninganddevelopmentcurriculum aCodeofConduct apolicydealingwithConflictsofInterest aCharity/PhilanthropyPolicy aStatementofFamilyValues

13DevelopingFamilyBusinessPolicies:YourGuidetotheFuturebyCraigAronoff,JosephAstrachan

andJohnWard,FamilyEnterprisePublishers.

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a family shareholders agreement (note, unlike the above policies, this isnormallyalegallybindingagreement)

anoperatingagreementforthebusiness(again,thismightbealegallybindingagreement)

1.7 WhatIsAFamilyConstitution?

Thefamilyconstitutiondefinestherulesoftheroadforthefamilywithrespectto

itsrelationshiptothebusiness.

Insimpletermsafamilyconstitutioncanbethoughtofasacollectionofkeyfamily

policies. It would also reflect the mission vision and values of the family and

importantprinciplesforworkingtogetherorforthebusiness.

Itcouldalsoincludeadescriptionofthecompositionandroleofthefamilycouncil,

andhowthefamilycouncilmakesdecisionsandresolvesconflicts.

Itcouldincludeadescriptionoftheothergovernancestructuresthatgotomakeup

the family business (or thewider family enterprise if youmake reference to the

family foundationand the familyoffice, forexample). There isno fixeddefinition

andthereisnoonewaytodoit.Herearesomemoredescriptionsofwhatafamily

constitutionis:

AFamilyConstitutionisaformaldocumentdevelopedcollaborativelyby

familymemberstoencapsulatethevalues,beliefsandobjectivesofthe

family,asafamily,withspecificreferencetothefamilysrelationshipand

dealingwithitsfamilybusiness.

IvanLansberg,SucceedingGenerations

AFamilyConstitutionis.alegal,orquasilegal,guideforfamilybehavior,

decisionmaking,andsettingupthesuccessionfromonegenerationto

another.Beginningwiththemissionstatement,theconstitutionthen

extendsthemissionintopracticalactions.Itsetsupaframeworkanda

forumforagroupofequalstodeliberateissues,createpoliciesand

procedures,clearlydefinefamilymembersrightsandobligations,andmake

decisionsabouttheimportantissuestheyshare.

DennisT.Jaffe,PhD,StewardshipinyourFamilyEnterprise

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1.8 WhatAreTheBenefitsOfHavingAFamilyConstitution?14

Whatarethebenefitsofhavingafamilyconstitution?Asyoumightexpectthereare

actuallytwodimensionstothisquestion.First,youshouldask,whatarethebenefits

ofgoingthroughtheprocessofcreatingafamilyconstitution?Second,whatarethe

benefitsofhavingafamilyconstitution?

(i) What are the benefits of going through the process of creating a family

constitution?

The process can help to include or involve family members or family

branches thathavenothada role toplayor thathave started tobecome

distantfromthefamilybusiness.

Itcanbefun.Itcanstrengthenfamilybondsandfamilyunity.

It shouldhelp to improve family communication andproblem solving and

conflictresolutionskills.

Ideallyitshouldhelptoimprovethelevelofindividualselfawareness.

Itmakes the familymembers think about how they need to develop and

whatnewskillstheyneedtolearn.

Itprovides anopportunity to talk about and toplan for the future.Often

without a structured platform to have such discussions, families tend to

avoidsuchimportantbutdifficultconversations.

It helps to bring the family members /shareholders onto the same page

together.

(ii) Whatarethebenefitsofhavingafamilyconstitution?

FamilybusinessguruJohnWardsaysofthefamilyconstitution:

TheFamilyConstitution,acomprehensivearticulationofphilosophy,

14Source:CreditSuissePrivateBank

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principlesandpoliciesforthefuturethatbalancesandsynthesizesthe

welfareoffamily,ownersandthebusiness,isamongthemost

importantstepsabusinessowningfamilycantaketosecureand

strengthenitsbusinessand,mostpreciously,itsfamily.

DanielaMontemerlo,PhDandJohnL.Ward,PhD

Afamilyconstitutionhelpstoavoidfamilyconflictsandpreventunnecessary

misunderstandings.Byclarifyingroles,thishelpstoavoidroleconflicts. By

providingforumsfordiscussionoffamilyandownershipissues,thisprevents

such issues from exploding in the wrong forum. By providing an exit

mechanismthisprovidesawaytoletoffsteam.Havingthings inwriting

helps ensure family members are all on the same page. The family

constitutionwillnormallyincludeaprocessfordealingwithfamilyconflicts.

Thefamilyconstitutionhelpstoshapetheexpectationsofthemembersof

thenextgenerationwithrespecttotheirrolesinthebusinessandasfuture

owners.15

Havinga familyconstitutionhelps togive thebusinessastrong foundation

andtobuildtheconfidentofnonfamilymanagersandbusinesspartners.16

Withrespecttofamilyownershipthefamilyconstitutionhelpstokeepthe

ownership united and to forge family commitment to the future of the

familybusiness.

Finally, the preservation of family wealth across generations ultimately

comes down to having the best possible process for joint family decision

making.17Theheartof the family constitution is a fairprocess formaking

jointdecisionstogetherasafamily.

15CreditSuissePrivateBankWhitePaper16CreditSuissePrivateBankWhitePaper17JamesE.HughesJr.FamilyWealth,KeepingitintheFamily.

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2. TheKeyInsightsintotheprocessofcreatinga

FamilyConstitution

Thefollowingpointsareworthkeepinginmindwhenpreparingtoworktogetheras

afamilytocreateafamilyconstitution.Akeyconceptthroughoutisthatthefamily

gettomaketheirownrulestherulesthatmakesenseforthem.

2.1 ItstheProcessThatCounts

Itisoftensaidthatwhenmakingafamilyconstitutiontheprocessismoreimportant

than theoutput. Theprocessgives familymembers the chance towork together

andmakedecisionstogetherandtalkinastructuredlogicalwayaboutthefutureof

thefamilybusiness.

As such there is very limited value in modeldocumentsor templateswhichare

likelytobeput inthedraw. Thegoal istocreatesharedunderstandingamongthe

familymembersandcreateasetoffamilynormsofbehavior.

2.2 NotaLegallyBindingDocument

Familyconstitutionsarenotnormallylegallybindingdocumentsalthoughafamily

shareholdersagreement isusually legallybinding. Again it isaboutclarifyingroles

andexpectationsandcreatingfamilynorms.

2.3 TheFamilyMakeTheirOwnRules

Thefamilymembersshoulddecideonwhatgoesintothefamilyconstitutionaswell

astheapproachtobetaken,andtheonthetermsofpoliciesetc. Ithastobethe

familysproject.Thereisnodefinedlistforwhatmustbeinafamilyconstitutionso

itshouldbetailoredbytheindividualfamilyforthemselves.18

2.4 FamilyProjectLeader

Ideallytherewillbeoneormorefamilymemberswhodrivethefamilyconstitution

project(thefamilytaskforce).Themorethefamilymembersowntheprojectand

18Ontheotherhanditwillbehelpfultohaveachecklistofissuestobeconsideredforinclusion.

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andputtheirownthinkingintoit;themoreeffectiveandrobustitwillbe.Itoften

makes a lotof sense tohaveone familymember at leastwho is chargedwith (i)

actingasthecoordinatorandliaisonbetweentheoutsideconsultantand(ii)whois

responsibleforcoordinatingtheworkthatneedstobedonebythefamilymembers.

2.5 TheConceptOfFairProcess

(i) In working on a family constitution the concept of fair process is very

important.19 Ifapersonfeelsthattheyparticipated inmakingadecision, if

theyhaveavoice, iftheybelievetheprocessformakingadecision isfair

andtransparent,theywillaccepttheoutcomeofthatprocessevenifitmay

notreflecttheirownpersonalview.

(ii) Fair process is about participation and having a voice in the process.

Howeveryoumaybeable toget the inputandparticipationofagroupof

personswithouthavingtocededecisionmakingauthoritytothem.Decision

Decisionmakingauthorityandparticipationcanbedifferentthings.20

(iii) Theprinciplesof fairprocessmightdictate thatnormaldecisionmaking

processesofa family shouldbe suspendedwhileworking togetheron the

familyconstitution.21

(iv) Inthecontextofafamilybusiness, itwillalsobe importanttoconsiderthe

nonfamilymemberswhoshouldbeaskedtogivefeedbackontheproposals

and policies the family members develop, e.g. non family directors and

seniormanagers; and to consider how&when their feedback should be

obtained.

19SeeBlueOceanStrategy,byHarvardBusinessSchoolPress.20ProfessorRandelCarlock.21FamilyGovernance,BeyondtheBasicsBarbaraHauser,STEPJournal

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2.6 AChangeProcess

(i) Workingonafamilyconstitutionmight involvemakingachange intheway

the familydo things. For example if anownership council is formed and

startstomeetandstartstogetreportsthatwerenotgiveninthepast,this

wouldbeachange.Itisimportanttounderstandthatchangetakestimeand

isusuallymetwithresistance.

(ii) Ifnewconceptsareinvolved,ifachangeiscontemplated,inpracticeitmight

benecessary fornew informationor feedback tobepresentedmore than

oncetothefamily..

2.7 ASocialContract

(i) If, for example, you are asking a familymemberwho is a shareholder to

participate in the family council and to abide by its decisions, to put the

interestofthefamilygroupinfrontoftheirownpersonalselfinterest,then

you are talking about forming a "social contract".22 A "social contract"

means that people are willing to give up some of their own personal

freedoms"for thegreatergood".23The theory is thatyouaregoing tobe

"safer" and better protected as a member of the group, even though it

involvesgivingupsomeofyourpersonalfreedom.24

Everyattempttocreategovernancebyandforafamilygroupwill

of necessity involve an accommodation or curtailment of the

individualsfreedomforthegreatergoodofthewhole.Accordingly,

each individual must be convinced that this accommodation will

result in an overall benefit to the individual by being part of the

largergroup.25

(ii) Inpracticaltermsitfollowsthatitisveryimportanttogeteveryonetothink

carefullyaboutthebenefitsofhavingafamilyconstitutionandwhatarethe

22GenerallyseeFamily:TheCompactAmongGenerationsbyJamesE.HughesJr.23SeeJohnLockeandhisSecondTreatiseonCivilGovernment1689.24Thisissubjecttotheprovisothattheleadershipofthegrouphastobeseenasgoodleadership.25FamilyGovernance,BeyondtheBasicsBarbaraHauser,STEPJournal

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benefitsofworking togetherasaunited familygroup.26Working together

mightholdup thevalueof the familyvotingbloc.Working togethermight

providetheopportunitytoensurethatthefamilycompanycontinuestobe

runinlinewiththefamilyvalues.

(iii) Socialcontracttheorypositsthatthereisgovernmentbyconsent;byfreely

given consent. Membership of the family group therefore has to be

voluntary.27

(iv) Inorderforittobevoluntary,therehastobeawaytoexitthegroup.This

points to the importance of (a) a voluntary commitment to the family

constitution, (a) having a way to amend and modify the family

and(c)havinganExitPlan(forexampleafamilyshareholdersagreement).

2.8 WhatAreTheExistingArrangements?

Workonafamilyconstitutionwillnotoccur inavacuum. Thefamilybusinesswill

alreadyhave itsexistinggovernancearrangements inplace,even if theymightbe

relativelyinformaloreveniftheyarenotdocumented.

2.9 HowLongDoesItTake?

How longdoes it take? Just like there isno set formula forwhat shouldgo intoa

family constitution, there is no one right answer for the question of how long it

wouldtake.

(i) Some families hold a series of family meetings over a period of several

monthsandcreateafamilyconstitutionwhichreflectstheirsharedviewon

a listof importantquestions thatcan impacton familybusinesscontinuity

(for example, Can in lawswork in thebusiness?or Whatwillwedo if

there is a dispute?. Theywould then plan on reviewing it at an annual

familymeetingandifnecessaryupdatingit.

(ii) Somefamiliesfocusonformingafamilycouncilandarticulatingtherulesfor

26ArelatedconceptisthatofexaminingEmotionalCommitmenttothefamilycompany.27Family,TheCompactAmongGenerations,JamesE.HughesJr.BloombergPress.28Thoughamendmentsshouldnotbetakenlightly.

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participation inthefamilycounciland itsroleandpurposeandtheprocess

bywhichthatfamilycouncilwillmakedecisionsandresolveconflicts.Thisis

isdocumented in the familyconstitution. They thenholdquarterly family

council meetings which debate important family agreements, policies &

issues.Thisthenbecomesanongoingprocess.

(c) At theotherendof the spectrum, there isawelldocumentedexampleof

one Indian family, theGMRGroup, thatspentconsiderableeffortovera3

year period developing a comprehensive family governance structure and

familyconstitution.29

2.10 WhatIfTheyDontFollowTheRules?

Thisisacommonquestion.Therearetwoaspectstothis.Thefirstisthatthefamily

shouldconsiderthealternativesandmaketheirowndecisionasto(i)whetherthere

will be any express consequences for a breach of the family constitution and (ii)

whatthoseconsequenceswillbe.Thefamilyshouldmaketheirownrules.

Forexample,thereisafamilyconstitutionpreparedbyawealthyJapanesefamilyin

1722,calledtheMitsuiConstitution,whichcontainsthefollowingclause15:

Inprinciple,theeldestsonistosucceedhisfatherasheadofthefamily;but

ifhisconductshouldcauseharmtothefamily,heshallbeexpelled,even if

heistheonlyson,andsentintothepriesthood.Insuchacase,asuccessor

will be adopted from among the other members of the House. Those

memberswhoproveincapableofmaintainingtheirfamiliesorwhoconduct

themselvesimmorallyshallalsobesentintothepriesthood.

The second aspect to this question though is the question ofwhether complying

with the family constitution and being a member of the family group is an

attractivepropositionornot. Thisalso includes theconceptof fairprocessagain;

i.e. has there been an adequate opportunity provided to participate in the rule

makingprocess?

29ThiscaseisreferredtoinFamilyBusinessTheEssentialsbyPeterLeach.