Family, business and ownership

Issue April 2014 By Stephen C. George

Multiple layers of family governance

Experts estimate that around 80 percent of all businesses in North America are family controlled, and family businesses account for approximately 70 percent of global gross domestic product (GDP). That said, less than one quarter of family businesses in the United States survive into the third generation. This gives attorneys good reason to understand the nuances that make family businesses different from other clients.

The oldest family-owned business in the United States, Zildjian, a cymbal-manufacturing company, pre-dates the United States itself. Founded in 1623 in the Ottoman Empire, Zildjian continues to operate as a 14th generation family business in Massachusetts. Such family businesses survive thanks in part to clearly established rules and policies regarding family involvement in and expectations for the business. It is important for lawyers advising family businesses to understand not only the elements of corporate governance, but also family governance.

The first point of overlap between corporate governance and family governance is generally a buy-sell agreement. The agreement may include to whom shares of a company may be sold, conditions for a shareholder buy-out and a method for determining the price of the shares. Family businesses will commonly want to provide a first right of refusal to the business and/or other family shareholders before a shareholder can turn to outside buyers in order to protect the ownership interests of the business.

Families further along in their dialogue about the relationship between the family and the business may want a more comprehensive shareholders agreement that includes additional business and ownership elements beyond share transfer conditions. Some sample elements of a family shareholders agreement may include: confidentiality agreements, conflict of interest and non-compete agreements, provisions concerning death or divorce of a family shareholder, dividend policies and board composition, among many others. An important point of practice is to carefully and conspicuously mark any certificated shares covered by a buy-sell or shareholders agreement as being subject to such agreement.

While shareholders agreements are generally legally binding documents, there are a number of other family ownership considerations that may be addressed in other documents that may not be legally binding. These documents may include family employment and compensation agreements, coordinated estate planning agreements, prenuptial agreement policies, codes of conduct, family philanthropy policies, public relations policies and future leadership or development policies among others. Some families consolidate these policies into a single family constitution. While a carefully drafted family constitution, or the separate elements thereof, may be legally binding if the basic contract elements are satisfied, most family business experts accept the family constitution as a non-legally binding document valued for the dialogue surrounding its creation. Often, dialogue and consensus are more valuable to the business and the family than a legally binding document that alienates one or more of the shareholders.

Family businesses generally have a longer-term focus than other businesses, which means their governance goals will likely differ from typical business clients. When dealing with family businesses, attorneys should ensure that the client is properly informed on which documents are legally binding and how non-binding documents could be made legally binding, but one should also accept that modifying documents to improve their legal efficacy is not always the best course of action for the family involved.