Poland family business conference

Researchers and practitioners have established that family businesses are not exactly the same as non-family businesses. The differences lie mostly in the fact that the owning family’s involvement brings with it a unique set of influences on the process of running the business. As a result we can see a growing body of knowledge created by academics and practitioners studying these observed differences. However, given the fact that this body of knowledge only began to gain critical mass in the 1980s, not all aspects enjoyed research beyond scratching the surface. Of the least researched elements are boards of directors in family businesses. Abdullah Adib Al Zamil, researcher on family business governance, UK and KSA, argues that a board of directors is probably the most important governance body in any company, as it sits on the apex of its structure. His article looks into the meaning of this, the expectations set on boards and the functions it normally undertakes, and sheds light on the issue of board composition; introducing outside directors and family directors selection.

Boards of Directors as a Governance Body

Family businesses typically evolve in the following manner: founder(s) stage, followed by sibling partnership, and finally cousins consortium. More often than not, during the first stage the entrepreneurial spirit is dominant. Establishing and growing the business by exploiting all opportunities is the ongoing theme. As the company evolves into the next stage, owners normally benefit from their strong sibling ties to take them through the challenges associated with owning and running such a partnership. However, the final stage of the evolution almost never exists without some sort of family and corporate governance to mitigate the risk of the associated challenges. Luckily, this evolution from one stage to another is, by definition, gradual. This allows individuals to prepare the company and successors for the next stage. This preparation is typically and ideally a result of corporate governance.

Corporate governance concerns the systems and structures put in place to establish control, direction and accountability. The ultimate governance body in such a structure is the board of directors. In their book Corporate Governance, the authors Robert Monks and Nell Minow list five primary functions of boards of directors described by The Business Roundtable that represents the largest US corporations:

1. Select and evaluate the CEO, determine management compensation, and review succession planning.

2. Review and approve the financial objectives and major strategies.

3. Provide advice and guidance to senior management.

4. Select candidates for shareholders to elect into the board of directors. Evaluate board processes and performance.

5. Review the compliance of systems with all applicable laws and regulations.

To those we can add:

1. Protect shareholders‘ interests.

2. Oversee management performance.

3. Monitor and mediate family involvement.

4. Act as custodians of the family values in the business .

The last two functions above are obviously unique to family businesses.

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Family Reluctance

One may ask: if the benefits are so evident then why are there so many family businesses without a board of directors? Why is there so much reluctance? We can find the answer in tracing the evolution described above.

If we take a typical case of an entrepreneur in the Arabian Gulf region, we would normally find that he starts with a core business and diversifies his interests based on the opportunities presented to him. Every decision has to go through him and he very likely has absolute authority. As his children join the business, typically each of them heads his or her own subsidiary or division, reporting directly to the founder. Each of them has their own fiefdom, acting as businesses within the business, yet, finding unique ways of combining their efforts, often unconventionally. Capitalising on their family ties and their deep understanding of each other, the siblings can operate in a casual, informal manner often draped in a high level of secrecy.

This informality and privacy is often considered by many families to be a competitive advantage, providing the family with agility and flexibility in decision-making and reaction to market changes. While this is something that distinguishes family businesses from their non-family competitors, the presence of an effective board is more likely to add more benefits to the company than to ruin this ‘familiness’ it enjoys.

In some cases families find themselves forced, by regulation, to establish boards of directors. In this case the board would often consist only of family members and its duties would be limited to meet the minimum regulatory requirements. This can cause the family to miss out on the benefits an effective and functional board provides.

Outside Directors

Many of the benefits of having a functioning board of directors can only be realised when having independent, empowered outside directors. The author, Cristina Bettinelli, describes four benefits of having external directors on the boards of Italian family businesses: Firstly, the presence of well-selected outside directors increases the level of effort expected from each board member. Family board members will put in more effort in order to be taken seriously by those outsiders, thus, demonstrating the meaningfulness of the board as a governance body. This heightened level of motivation increases the functionality and benefit of the board.

The second finding was the increased level of board cohesion: The presence of outside directors adds to the degree to which board members positively engage with each other. This reduces the risks of interpersonal conflicts as well as heightens team performance. Family members are less likely to expose their personal differences in the presence of outsiders, which encourages them to manage those differences constructively. Moreover, independent outsiders are serving the interest of all stakeholders, as opposed to representing shareholders, which makes them more likely to work towards a more cohesive board.

Thirdly, outside directors are found to increase the effectiveness with which the knowledge and skill of each board member is being exploited. In a board composed of only family members, discussions would often flow towards shared skills and knowledge. Having outsiders on the board should stimulate discussions that address beliefs and assumptions often taken for granted by family members as well as increase the level of awareness of the collective human capital sitting on the board.

The final finding relates to the role of outside directors as moderators of the effects of the family business‘s growth in age and size. Organisational structures and processes change as businesses evolve from one stage to another and grow in size. Research has found that boards get more involved as companies grow and become more complex. With this growth we would of course expect the challenges to grow in complexity as well. Thus, the benefits of outside directors can best be seen as the family business grows both in size and age.

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Director Selection

The reality of family businesses, particularly those in the MENA region shows that family board members are selected, in most cases, by order of seniority. This is often the case during the founder(s) and the second generation and is aided by the relatively smaller number of senior family members, as they can all be accommodated on the board. However, such privilege cannot last forever, particularly as more young family members start joining the business over time.

It goes without saying that when choosing board members from within the family, they need to have a minimum level of knowledge and experience to be able to conduct their duties competently and to engage with the outside directors (if there are any). It is also a good idea to avoid assigning young members whom have just started their career to the board. This would cause confusion between them and their superiors in terms of who reports to whom. It could also overwhelm them with information, some of which is confidential, which could hinder the development of their own decision-making skills. It is advisable to allow them to progress in their careers until they reach senior managerial levels.

Things become a little bit more complicated when choosing outside directors. The pool of good candidates in MENA markets is relatively small and the best ones are often snatched by large listed companies. When asked, a senior member of a large successful Saudi family business said:

“It wasn’t a question of ‘who should we get?’ but more ‘what do we need?’. We wanted former ministers, CEOs of large companies and respected businessmen. They had to worry about their status and reputation enough to take their roles seriously.”

He also conceded that this would bring with it the fact that they will challenge some of the ways the family are used to do things. But as he put it: “we had to adapt!”

In their book The Family Business: Its Governance for Sustainability, Fred Neubauer and Alden Lank list five types of people a family should not invite to the board:

1. Professional consultants, to avoid conflicts of interest.

2. Very close personal friends. They may have the trust of the family, but this closeness may stop them from being fully honest in their opinions.

3. Retired managers. Although some may still have a lot to offer, many have given it all during their tenure at the business and have no more to add.

4. Individuals sitting on many other boards. A family would want their board members to devote sufficient time and attention to their duties.

5. Competitors.

The authors go on to suggest that suitable candidates include owner-managers of other family businesses; they often face the same challenges and are able to bring in their expertise and insight when tackling them. Division heads of large public companies are also good candidates. They are often younger, yet very knowledgeable and experienced in their markets. Lastly, those with a broad business sense and experience benefit the board more than those specialised in one field, such as academics, whom can be brought in when needed to serve a specific purpose.

The Magic Ingredient…

…is family buy-in. In order for the family business to have a functioning effective board of directors the controlling owners have to concede to the fact that they will be challenged and their ways will be questioned. The secrecy and informality they enjoyed will be replaced by transparency and professionalism. But they should not worry, as more likely than not, the better outside directors will recognise the value the family ties bring in and will be able to assist the family in capitalising on it. For the perpetual growth and sustainability of a family business, a strong, solid governance structure is essential with an effective functioning board as its central body.

Tharawat Magazine, Issue 12, 2011