January 15, 2020
Protect the Future with a Family Constitution
In our previous post, we discussed the importance of a family mission statement and how it uses common family values to build harmony and unity within the family. It is especially valuable when the family also has a family-owned business.
A family mission statement is really only the beginning. It describes your family’s values and vision, which are essential to keeping your family on track, just like a business.
A family constitution is a document that expands upon the elements of a family mission statement. It would typically contain a section detailing your family’s vision and goals, governance structure of your family, outline of everyone’s rights, and lastly, a description of how it can be amended.
For a family-owned business, a family constitution can alleviate tensions and provide an effective way to plan for the future.
The Importance of a Family Constitution
Let’s return to Jim’s story, our avid runner and successful business owner. Prior to the next run with the group, he told his financial advisor, Dave, how well the first family meeting had gone and shared an initial draft of the family mission statement they created. They were soon joined by another group member, Alan, a lawyer with a specialty in corporate governance, who also read Jim’s mission statement and agreed that it was an excellent start.
That also prompted Alan to bring up the issue of a family constitution (click here to read this backstory or here to read the complete backstory). He explained how his law practice had been involved in many family-business disputes where a lot of pain and heartache could have been avoided by having a document in place that addressed things like:
- How family members should communicate?
- How decisions are made?
- How differences are resolved?
- Who gets to be part of the family business?
- How people are remunerated?
While Jim was a little skeptical at first, Alan explained that a family constitution wasn’t a legally binding document — it simply outlined important processes and a governance structure for the family and, implicitly, the family business.
Jim had already been experiencing issues with his share-holder in-laws, who had begun to question how the company was being managed and seemed to want a bigger role in the decision-making process.
Alan pointed out that a family constitution would be a great solution in that situation. Not only would the document outline how things were to get done, but by working on it alongside his in-laws, it was likely to help improve their relationship.
Alan further added that a family constitution was important because no one could foresee the future, making it prudent to plan for the unexpected, and a family constitution provided a framework to deal with those unexpected situations.
What Should a Family Constitution Include?
Alan then went on to explain that while processes outlined in a family constitution were an essential component for everything, from planning to the respectful resolution of differences, they required structure to be effective. For example, no matter how close-knit the family is, it’s still necessary to have someone with designated authority to make the final decision in the event of a deadlock.
Other matters that should be addressed in a family constitution include how family members are to be remunerated for the work they do in the company, how ownership is earned and how performance is evaluated.
Additional questions to be answered include, as examples, how someone who marries into the family fits into the business; or what age, education and experience would be required for future generations to enter the business?
Jim noted that his business already had formal documents such as shareholder and confidentiality agreements in place. Alan explained that the family constitution is built on those documents but provides much greater flexibility, in that legal documents can’t always address issues that can arise out of the blue in a family business in a fulsome way or timely manner.
To illustrate the point, Alan described one of his client’s situation where a husband and wife who both worked in a family business were going through a spiteful divorce. Fortunately, the family constitution they had in place addressed issues such as stock ownership and dividend payments in the event of a marital breakup. Without the constitution, the situation could have been far more unpleasant.
Alan went on to say that he usually recommends that family constitutions are formally ratified by all the family members who have the capacity to understand the purpose of the document. Jim agreed with Alan that, if everyone participated, no one could claim they didn’t know “the rules” or attempt to circumvent what the whole family had agreed to.
Do You Really Need a Family Constitution?
A family constitution might seem a little much, at first. After all, do you really need to formalize so many aspects of your family business with your own family? Many family business owners will tell you that the answer is “Yes” because you never know what the future may unexpectedly impose. The inter-relationships between family and business means unforeseen events and circumstances in one will affect the other. A family constitution will bring enable all family members to discuss important issues with mutual respect and understanding. Decision-making will be streamlined, and family relationships strengthened.