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The Importance of Separating Ownership and Management: 3 Steps to Get Families Started
As a family-owned business welcomes the next generation of incumbent heirs, various challenges may arise. In some instances, those employed by the company may ultimately be forced to serve multiple masters whose priorities are not always the same, or worse, compete with them for positions within the organization. In others, emotions and the confusion caused by family politics may threaten the continuity of business altogether.
These unique challenges present a significant level of risk to all involved. To preempt and mitigate this, family business owners need to address the potential for these issues head-on and consider practical ways in which to separate ownership and management.
When does professional management become necessary?
Businesses and the families that own and operate them, grow and evolve. As startups gain momentum, non-family staff are hired and assigned to various positions within the organization and external shareholders may enter the business. With each new familial generation, marriage, or partnership, the number of shareholders multiplies.
Families, by their very nature, add value to organizations through years of industry experience. They do, however, also bring added layers of relationship, complexity and risk to the businesses that they own and run as well as all involved. A fact that may not only make it challenging to secure investor trust and external capital investment when it is needed, but that may also ultimately compromise the company’s long-term sustainability if these elements are incorrectly managed.
Therefore, as a family business grows and professionalizes, employing both family and professional non-family members, it becomes necessary to formalize ownership structures, power and processes. Separating ownership and management control is often an integral part of corporate governance at this juncture to ensure the continued profitability and sustainability of the business. It is also at this stage where the family might choose to professionalize beyond just a single business and implement a fully fledged family office.
The advantages of separating ownership and management
The advantages of separating ownership and management control are numerous. Separation ensures the sustainability of the business through its management by a team of professionals with the diverse skills necessary to effectively run the company. This ensures continuity within the business, even when future heirs are not particularly interested in being part of its day-to-day operations.
Separation also facilitates the maximization of capital. While every shareholder within the business will naturally have investment preferences, it becomes management’s job to identify the optimal ones and identify ways in which business assets can be effectively managed to secure the highest profits for all shareholders.
Separation is, however, not without its disadvantages. These may include slower decision-making and reduced flexibility and agility when responding to change, as well as the principal-agent problem, which occurs when conflicts of interest or incentive arise between those who operate and manage the business. Still, in many instances, the advantages outweigh the disadvantages, most of which can be managed through implementing sound governance.
How to implement an effective separation strategy
Family business governance structures, when expertly designed, can successfully ensure the separation of the “business of the family” from the “business of the business.” This division can help on both fronts — driving company profits while maintaining family harmony.
Practical steps that may be taken to implement such structures include:
1. Draw up management and ownership agreements
The drawing up of progressive owner agreements that govern owner activity within the business and clearly outline the permitted and restricted activities helps to ensure the effective separation of ownership and management.
According to Dominic Pelligana of KPMG Private Enterprise, families generally require two sets of governance in this regard. The first set of rules, a family constitution, dictates how the family will behave and relate to the business. The second, a Shareholders agreement or possibly a Board Charter, dictates how the family will behave and relate within the company.
Once an agreement regarding these rules is reached, they must be followed by everyone involved in the organization.
2. Establish strong boards
According to McKinsey, durable family businesses tend to have strong governance through which the company is directed and controlled.
While the family is an asset to the business in terms of the experience and insights its members can provide to the management team, it is essential to complement this perspective with that of qualified professionals. Appointing a board comprised of both seasoned family business professionals and external ones is an effective way of separating ownership from management.
How a board is appointed may differ from one family business to the next. Some may have rules in place that external, non-family members must occupy a designated number of seats. Others may be independent, electing members and then seeking approval by the owners or a shareholder assembly. Regardless of how boards are appointed, potential directors that match the organization’s culture and skill matrix must be carefully and strategically identified, interviewed and recruited.
3. Implement corporate governance structures and policies
To minimize and deal with potential conflicts within the organization, implementing considered corporate governance structures and procedures is essential.
This includes structures and processes that ensure that directors are accountable to shareholders and the latter are protected as far as possible through the appointment of non-family executive directors and remuneration management committees. Policies for financial rewards and incentives offered should also be put in place to ensure alignment with shareholder interests, and that they are based on tangible factors such as share prices or organizational profitability rather than a position within the family.
These structures and policies can be designed to meet the unique needs of the family business but should be implemented and managed in such a way that they reduce risk.
Families and family offices that separate ownership and management through the implementation of effective governance measures can ensure not only the long-term success of their businesses but also family harmony. Such practices allow family members to not only remain actively involved, adding value through their long-held experience in a specific industry but also to circumvent the challenges that risk destroying shareholder value and the business itself.
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The contents in this article are being provided for educational and informational purposes only. The information and comments are not the views or opinions of Union Bank, its subsidiaries or affiliates.