• Wealth planning
  • 14 November 2017

Blood is not always thicker than water: Why families need governance

In the Ishikawa Prefecture of Japan, there is a small inn called the Hōshi Ryokan. It looks like any other inn in Japan, with simple furniture and a quaint tea room.

 

But the basic architecture holds a deep history that has run for over a thousand years. The Hōshi Ryokan is one of the oldest - possibly the oldest - family businesses in the world today. Set up in 718, the Hoshi family has been running the inn for more than 1,300 years. The current owner is the 46th generation in charge.

 

Hoshi Ryokan is probably one in millions to have lasted so long. Many other family-run businesses have not been so durable.

 

Research shows that seven in ten of family-owned businesses fail or are sold before the second generation gets a chance to take over. And after that, just one in ten remain active companies for the third generation to lead.

 

There are many reasons for this situation. But one factor that is unique to family-run businesses is that the family itself can be a source of tension, and the reason for failure.

 

Un-complicating the issue

 

To be clear, there are many strengths inherent in a family-run business. Decisions can be quickly made, especially since family-run businesses tend to also be more stable.

 

But family ties can also wreck the company, if they are not properly managed.

 

A big part of the issue is that while many family businesses may have strong corporate governance, the family that runs the business tends to be governed by informal structures.

 

For the most part, if these informal structures result in a clear sense of direction, strong values and proper management, then there is no need to change.

 

More often than not, however, these informal structures break down, resulting in the loss of direction and clarity on the roles of family members in the business.

 

One clear example: Succession planning, or the lack thereof.

 

Over the past few decades, the strong growth in Asia has seen many family businesses thrive. As a result, many founders of the company may have taken for granted the harmony and stability of the business, and pay little attention to succession planning.

 

Part of the problem is cultural, as discussion on death and mortality remain taboo subjects in this part of the world.

 

At the same time, the second, and even third generation, of the family may have very different ideas about business, having been brought up in a different environment. Many would have studied overseas, absorbing different influences and keen to bring new ideas to the table.

 

All of this comes to a head when the patriarch passes on. Without a proper succession plan in place, fighting within the family is likely to occur.

 

And even if there is a smooth transition between the first and second generation of leaders, families grow over time and space. With more family members added, decision making becomes much more challenging.

 

This complexity is compounded by the fact that some family members may be pure shareholders, others are managers and some may be employees - often there are family members who occupy all three roles.

 

Family businesses today are also complex organisations, having morphed over time to become sprawling business empires that are spread out across continents.

 

There is also a further need to manage the family wealth generated by the business. The challenge here is the rapid and deep shifts in the tax, legal and regulatory landscapes. Proper management of these affairs is therefore crucial.

 

Family governance: a rules-based approach

 

Like corporate governance, family governance is based on the simple idea that rules give clear roles for people managing the company.

 

In this manner, good governance contributes three fundamental ingredients for family businesses to function well:

    • Clarity on roles, rights, and responsibilities for all members, including the decision-makers, family employees of the company and the company executives;
    • Encouraging family members, business employees, and owners to act responsibly;
    • Regulating appropriate family and owner inclusion in business discussions.

 

At its most basic, family governance helps to articulate the reasons and remind family members why they wish to stay together. Among other things, family governance recognises that it is not always easy for families to remain together; it requires a strong sense of commitment and duty to make it work.

 

At the very heart of the issue is identifying the family’s core values, its vision and its mission. For instance, a family that champions social causes will have very different priorities from one that supports entrepreneurship.

 

A second critical component of family governance is establishing proper forums for regular interaction and communication. These channels are crucial to ensure constant information flow between family members.

 

A third key element is setting out the rules of engagement and accountability. This sets the tone for how members should behave, and how conflicts are resolved.

 

Many of these rules are enshrined in a family constitution, the key document that records the agreed rules and roles of the family members.

 

Achieving this is difficult. They have to be consensus driven, and agreed upon by all the family members. It is not uncommon for the process to take years to achieve.

 

That is why it is important that the process starts early, before the family becomes too big and complex.

 

I have seen a much greater interest in setting up family governance structures among businesses in Asia today. Many are realising and telling us that there is a need for proper management of both the family and its wealth.

 

Not all family businesses can last more than a thousand years or even half a century. But with the right structures in place, we can at least ensure that families will stick together and thrive through the generations.

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