Fam­i­ly con­sti­tu­tions — how to pre­vent prob­lems before they happen

In Brief

Suc­cess­ful devel­op­ment of a fam­i­ly con­sti­tu­tion can help to ensure the pros­per­i­ty and longevi­ty of a fam­i­ly busi­ness. A fam­i­ly con­sti­tu­tion encap­su­lates the val­ues, beliefs and objec­tives of the fam­i­ly and defines the rela­tion­ship of the fam­i­ly to the business.

What is a fam­i­ly constitution?

Run­ning a fam­i­ly busi­ness is hard enough with­out the addi­tion­al pres­sures of wor­ry­ing about the out­come of gen­er­a­tional change. A fam­i­ly con­sti­tu­tion can assist with ensur­ing busi­ness mat­ters and fam­i­ly affairs are aligned and will help your fam­i­ly deal with gen­er­a­tional changes constructively.

Also known as a fam­i­ly creed, fam­i­ly char­ter or fam­i­ly agree­ment, a fam­i­ly con­sti­tu­tion is a doc­u­ment which sup­ports the fam­i­ly busi­ness. It sets out the val­ues and prin­ci­ples that under­lie the con­duct of the busi­ness, defines the strate­gic objec­tives of the busi­ness and sets out the way in which the fam­i­ly makes deci­sions affect­ing the own­er­ship and man­age­ment of the business.

A fam­i­ly con­sti­tu­tion should pro­vide a mech­a­nism by which con­flict can be suc­cess­ful­ly man­aged and resolved. The act of cre­at­ing a con­sti­tu­tion forces the fam­i­ly to con­sid­er impor­tant issues about the future of the fam­i­ly busi­ness that might oth­er­wise be ignored.

It is increas­ing­ly recog­nised that fam­i­ly issues rather than busi­ness issues deter­mine the out­come of gen­er­a­tional change in fam­i­ly businesses.

Why do you need a fam­i­ly constitution?

Fam­i­ly to busi­ness mech­a­nisms, such as a con­sti­tu­tion or fam­i­ly coun­cil, pro­vide a for­mal link between busi­ness mat­ters and fam­i­ly affairs. The advan­tage of a for­mal gov­er­nance mech­a­nism is that it facil­i­tates com­mu­ni­ca­tion between the fam­i­ly, the own­ers and the busi­ness managers.

As the fam­i­ly busi­ness evolves and suc­ces­sive gen­er­a­tions enter the busi­ness, sev­er­al changes occur. First, the num­ber of indi­vid­u­als with an own­er­ship inter­est in the busi­ness increas­es. Sec­ond­ly, the expec­ta­tions of these indi­vid­u­als begin to diverge. Third­ly, as the busi­ness expands, it makes increas­ing finan­cial and man­age­ment demands on its owners.

A fam­i­ly con­sti­tu­tion helps the fam­i­ly deal with these changes con­struc­tive­ly. It requires the fam­i­ly to think about impor­tant deci­sions before they have to be made and to agree on impor­tant fam­i­ly and busi­ness goals. Shared val­ues and com­mon goals bind the busi­ness own­ers and sharp­en their busi­ness focus. A fam­i­ly con­sti­tu­tion should artic­u­late these shared goals and vision.

A fam­i­ly con­sti­tu­tion will assist the fam­i­ly coun­cil, which effec­tive­ly acts like a board of direc­tors for fam­i­ly mat­ters, in man­ag­ing the fam­i­ly business.

What is in a fam­i­ly constitution?

Just as each fam­i­ly busi­ness is unique, so each fam­i­ly con­sti­tu­tion will need to reflect the unique char­ac­ter­is­tics of both the busi­ness and the fam­i­ly to which it relates. Nev­er­the­less cer­tain mat­ters are com­mon­ly cov­ered in fam­i­ly constitutions:

• Strate­gic busi­ness objec­tives reflect­ing agreed fam­i­ly val­ues for the business
• The process for hir­ing, assess­ing and remu­ner­at­ing fam­i­ly mem­bers employed in the business
• The rules for nom­i­nat­ing, train­ing, assess­ing and appoint­ing man­age­ment successors
• Process­es for nom­i­nat­ing and assess­ing indi­vid­u­als for appoint­ment to the fam­i­ly company’s board of direc­tors and/​or the fam­i­ly coun­cil (if one exists)
• The com­po­si­tion and rules of con­duct for a fam­i­ly council
• Com­mu­ni­ca­tion and dis­clo­sure poli­cies between the com­pa­ny and the family
• The process for resolv­ing con­flicts about the busi­ness between mem­bers of the family
• Com­mu­ni­ca­tion and dis­clo­sure poli­cies for fam­i­ly mem­bers not work­ing with­in the business
• The rights and oblig­a­tions of share­hold­ers in the fam­i­ly company
• Rec­om­mend­ed or com­pul­so­ry retire­ment age for fam­i­ly direc­tors and managers
• Process­es for buy­ing out fam­i­ly share­hold­ers in the business
• Suc­ces­sion policy
• Poli­cies con­cern­ing exter­nal, non-fam­i­ly own­er­ship and man­age­ment of the business
• Pro­ce­dures for amend­ments to the fam­i­ly constitution

A fam­i­ly con­sti­tu­tion should be able to accom­mo­date growth and change in the fam­i­ly busi­ness. For exam­ple, the busi­ness might reach a point where exter­nal man­age­ment and inde­pen­dent, exter­nal rep­re­sen­ta­tion on the board are con­sid­ered desirable.

Anoth­er pos­si­bil­i­ty is that growth in the busi­ness cre­ates finan­cial demands that can only be sat­is­fied through access to exter­nal cap­i­tal, either in the form of equi­ty or debt. The fam­i­ly has to make sev­er­al trade-offs here involv­ing its appetite for risk (debt) and the extent to which it wants to max­imise fam­i­ly own­er­ship and con­trol (exter­nal equity).

When should we adopt a fam­i­ly constitution?

It is nev­er too ear­ly to adopt a fam­i­ly con­sti­tu­tion. Ide­al­ly a fam­i­ly con­sti­tu­tion should be draft­ed well ahead of any poten­tial tran­si­tions. In prac­tice how­ev­er, a fam­i­ly con­sti­tu­tion is most like­ly to be adopt­ed or revised at the time of gen­er­a­tional change with­in the busi­ness. It can often be con­sid­ered when the busi­ness is about to be passed on from the founder to his or her chil­dren. Two or more branch­es of the fam­i­ly can find them­selves in charge of the busi­ness and unsure of where to go next. The tran­si­tion from the sec­ond to third gen­er­a­tion can fur­ther increase both the num­ber of own­ers and the diver­si­ty of their ambi­tions for the business.

Gen­er­a­tional change can be unplanned, typ­i­cal­ly as the result of the unex­pect­ed death or dis­able­ment of the exist­ing pro­pri­etor. This is a good rea­son to pre­pare the con­sti­tu­tion well ahead of any expect­ed tran­si­tion. For­mu­lat­ing a fam­i­ly con­sti­tu­tion will take time and may require a num­ber of fam­i­ly meet­ings. Even if there is no agree­ment on all mat­ters, it will form a good basis for the fam­i­ly to work from when issues arise.

Guid­ing principles

Before draft­ing the con­sti­tu­tion itself, the fam­i­ly should agree on some gen­er­al guid­ing prin­ci­ples. For example:

• What comes first, the fam­i­ly or the business?
• Is ongo­ing fam­i­ly own­er­ship and man­age­ment in the best inter­ests of the busi­ness? For exam­ple, can the busi­ness’ future cap­i­tal require­ments be sat­is­fied under con­tin­u­ing fam­i­ly ownership?
• Is con­tin­u­ing own­er­ship of the busi­ness like­ly to cre­ate ten­sions and divi­sions with­in the family?

Con­struct­ing a fam­i­ly con­sti­tu­tion is rarely a straight­for­ward exer­cise. It can be an emo­tion­al and stress­ful expe­ri­ence for all con­cerned, but the suc­cess­ful devel­op­ment of a fam­i­ly con­sti­tu­tion often results in bet­ter com­mu­ni­ca­tion and greater har­mo­ny with­in the fam­i­ly which can help to ensure the pros­per­i­ty and longevi­ty of the business.

For a copy of our fam­i­ly con­sti­tu­tion check­list or for fur­ther infor­ma­tion or to dis­cuss your spe­cif­ic fam­i­ly busi­ness needs, please contact: