The Challenges of Governance in Privately-held Family Businesses

Before diving into a discussion of governance issues in family businesses, let’s begin by explaining what being a family business involves. It may appear to be a relatively simple, even obvious, concept; however, that is not the case.

First, we need to look at several aspects of any business, then consider what makes a family business.

A business held by a family member does not necessarily mean that it is a family business. There are three main dimensions that one should consider in deciding if a business is a family business: property/equity, family, and company/management.

Figure 1 illustrates these three main dimensions of family businesses, the so-called “three circles of the family business.”

The Property/Equity dimension has to do with control of the business by the family, whether total or partial. In the Family dimension, we see a succession of values ​​and roles/positions over the course of generations. The Company/Management dimension has to do with management by family members, through either direct executive activity or the management of a team of employees.

Family businesses are usually founded by family members in the first generation and consolidate through succession to the second generation.

Some scholars consider that the central criterion in the definition of a family business is the relationship between ownership and management, as family members exercise command precisely because they own a large stake in the company. Others consider the integration between family and management to be primary, given the influence of the family’s values ​​on the character of administration.

For the purpose of this article we will consider a family business one in which a family controls the capital and appoints the management, and some family members hold positions.

And what is a privately-held family business?

A privately-held family business is one in which access to capital is restricted.

Governance has gained prominence in recent years, and though it is required only for public companies, it has been adopted by many privately held companies, including family businesses. One of the great challenges for family businesses is to separate family members’ personal interests from those of the company, which is important for balance and business continuity. Thus, many family businesses are seeking to follow governance principles and good practice.

The difficulties of governance in family businesses include the decision-making process of top management, due to the familial relationships and potential conflicts of interest that exist among the main actors of the corporate governance system.

Governance in family businesses, as in any company, must be based on four fundamental principles: transparency, fairness, accountability, and corporate responsibility.

The most successful family businesses are those that maintain a balance between professional management, responsible ownership, and healthy family dynamics based on these fundamental principles.

Having worked with family businesses for several years, I have seen a number of challenges that naturally embody risks, as far as governance is concerned. The main ones are:

  • The necessity of attending to family interests
  • The dichotomy between company goals and family goals
  • The separation of business issues from family issues
  • The overlap between company and family equity
  • The use of company resources for personal/individual purposes
  • The entrenchment of the founder(s) or manager(s), i.e., holding onto power
  • The overlap of functions between shareholders and managers
  • A lack of formal mechanisms for conducting business
  • The making and evaluation of decisions occurring in informal settings
  • The absence of formal agreements between partners
  • The absence of a family council or board
  • The postponement of succession plans
  • The choice of successor(s)

Buy-in of family members for good corporate governance practices, so as to mitigate the aforementioned risks, is an especially delicate issue, but overcoming these challenges undoubtedly facilitates access to investment and increases the likelihood of business longevity. By adopting governance, family businesses communicate more credibility to the market and the financial system, allowing them to obtain capital more cheaply for their investment and expansion projects.

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