Constructing a Family Constitution

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1 Constructing a Family Constitution KPMG ENTERPRISE KPMG Enterprise Centre for Family Business Rags to riches to rags Starting a family business is easy, relatively speaking; sustaining it beyond a couple of generations is the hardest part. Indeed, it s often said that the typical family business goes from rags to riches and back to rags in three generations. Research in North America and elsewhere confirms the truth of this old saying. Fewer than half of all family businesses survive the transition from each generation to the next. Do the math only about 10 percent will make it to the fourth generation. It s a sad commentary on the reality that faces family business. The reasons for possible failure are complex; however, it s increasingly recognized that family issues more so than business issues determine the outcome of generational change in family businesses. This document provides an overview of an important step in managing this change the adoption of a family constitution. Feature Case Study So why am I not content? Two of my children are very capable managers and have proven their ability to lead the family business into the future. We are in the process of discussing the gradual transfer of the management controls from me to the two of them, allowing me to continue in the role I always felt I was best at. We are also talking about the major components of an ownership transfer plan and, from what I have heard to date, it sounds like what I am being provided with is a deal made in heaven. So why I am I not content? What is keeping me awake at night? The problem is that I cannot stop worrying about whether I am treating my other child fairly. He is not in the family business and decided years ago that he wanted to pursue his own career. Is he feeling slighted that he is not included in the future of the family business? Does he feel that I am giving something (ownership) to the others and nothing to him? Should I give him a piece of the pie? After all, he is my son and I want to treat them all equally. If I asked him, would he really tell me what he feels? This family business owner s fears and discomfort were put to rest when the family completed its family constitution. The process included dialogue with all members of the family and the development of a set of agreed upon roles for the future employment, leadership and ownership of the family business. She knew she had no further need to worry when her son (who was not active in the business) told her that one of the best investments the family ever made was the family constitution for which he was in full support and, as he further indicated, who knows, just maybe one of my kids will help continue your legacy.

2 2 Constructing a Family Constitution What is a family constitution? A family constitution is sometimes called a family creed, family charter or family agreement. Forget the terminology they re essentially the same things that serve the same purpose. That purpose is three-fold: It documents the values and principles that will underpin the conduct of the family business It defines the strategic objectives of the business It sets out the way in which the family will make decisions affecting the ownership and management of the business. Depending upon the circumstances of the family and the business, the constitution can be either short and concise or long and complicated. Developing a family constitution in itself is no guarantee that it will prevent conflict among family members over the family business. However, experience clearly indicates that constructing a family constitution can help minimize and, in many cases, eliminate much of the potential conflict that a typical family business will face. Not only does it provide a mechanism by which conflict can be successfully managed and resolved, it also forces the family to consider important issues about the future of the family business that might otherwise be put aside. Do we really need one? Many family businesses appear quite able to get by without concerning themselves with a family constitution. Of course, this doesn t necessarily mean these businesses and families wouldn t benefit from a family constitution. From our experience working with family business across the country, there are typically five common issues for a family business: Balancing family concerns and business interests Compensating family members involved in the business Maintaining family control of the business Preparing and training a successor Selecting a successor. Interestingly, these are all matters that are addressed in family constitutions. Second and successive generations of family business typically experience several important changes: The number of individuals, many of whom are family members, with an ownership interest in the business increases The demands of the business and the demands of the family members working in it begins to diverge As the business expands, it makes increasing financial and management demands on its owners.

3 Constructing a Family Constitution 3 A family constitution helps the family deal with these changes constructively. It requires the family to think about important decisions before they have to be made and find agreement on important family business goals. The importance of shared values and goals in family businesses has been explored at some length by family business authority John L. Ward. Professor Ward likens successful family partnerships to the bunch of sticks in Aesop s fable. If you take a bunch of sticks together, you can t break them. But, if you take the sticks one at a time, they snap. Shared values and common goals bind the business owners and sharpen the business focus. A family constitution should articulate this shared vision and goals. What will we find in it? Just as each family business is unique, so each family constitution will need to reflect the unique characteristics of both the business and the family to which it relates. Nevertheless, certain matters are commonly covered in family constitutions: Strategic business objectives reflecting agreed family values and aspirations for the business The process for hiring, assessing and remunerating family members employed in the business The rules for nominating, training, assessing and appointing management successors Processes for nominating and assessing individuals for appointments to the family company s board of directors and/or the family council (or equivalent), if one exists. The composition and rules of conduct for a family council or equivalent body Communication and disclosure policies between company and family The process for resolving conflicts about the business between members of the family The rights and obligations of shareholders in the family company Recommended or compulsory retirement age for family directors and managers Processes for buying out family shareholders in the business Policies concerning external, non-family ownership and management of the business Procedures for amendments to the constitution. A family constitution should be able to accommodate growth and change in the family business; for example, the business might reach a point where external management and independent external representation on the board are considered desirable. How will this best be achieved? Or growth in the business can create financial demands that can only be satisfied through access to external capital, either in the form of equity or debt. The family has to make several trade-offs here involving its appetite for risk (debt) and the extent to which it wants to maximize family ownership and control (external equity).

4 4 Making Family Communication a Top Risk Management Strategy When should we adopt a constitution? The short answer is as soon as possible. In practice, a family constitution is most likely to be adopted or revised at the time of generational change within the business. It can often be considered when the business is about to be passed on from the founder to his or her children. Suddenly, two or more branches of the family can find themselves in charge of the business and unsure of where to go next. The transition from the second to third generation can further increase both the number of owners and the diversity of ambitions for the business. Generational change can be unplanned, typically as the result of the unexpected death or disablement of the existing proprietor. This possibility strongly suggests that the constitution should be drafted and agreed well ahead of the expected transition. Formulating a family constitution will take time to develop and may require a number of family meetings. Even if there isn t agreement on all issues, it will form a good basis for family to work from when issues arise. Defining guiding principles Before drafting the constitution itself, the family needs to agree on some general guiding principles: Perhaps a decision will be taken to retain and manage the business so that it can provide jobs and financial support for future generations of the family Is ongoing family ownership and management in the best interests of the business? For example, can the business s future capital requirements be satisfied under continuing family ownership? Is continuing ownership of the business likely to create tensions and divisions within the family? Having answered these questions, the family can begin to articulate more specific principles and policies regarding the business, including the structure and ownership, its governance and the family s role in its management. In turn, these will feed into business objectives that will be reflected in the family constitution: Will we continue to grow and develop the business? Will we maintain family ownership? Will we seek to increase the strength of the family entity? All of the above?

5 Making Family Communication a Top Risk Management Strategy 5 Each objective or purpose gives rise to a range of specific issues that will need to be considered; a list of examples is outlined below. Purpose The continued development of the business Policies and procedures to be considered Assessing the skills and frameworks required at board and management level to ensure the best resources are available to facilitate the continued development of the business Agreeing on ground rules for planning for the succession of the business s leadership Processes for clearly defining family and business governance issues. Facilitating the continued family ownership of the business Policies for the inter-family transfer or sale of shares Dividend policies Policies in relation to the timing, participation and quantum of liquidity events Policies setting out the methods of communication of information to shareholders Policies in relation to the representation of shareholders at board and shareholder meetings Policies in relation to the nomination and assessment of directors Policies setting out the behaviours of and the relationship between shareholders Procedures for resolving conflicts. Bolstering the strength of the family Processes to establish and review unifying family values and vision for the business Mechanisms for the family to get together and provide and receive information in relation to the business Policies for making resources and/or services available to the broader family Ground rules for selecting and assessing family members to join the business Rules delineating family and business issues.

6 6 Making Family Communication a Top Risk Management Strategy Getting to grips with the process To understand the key elements involved in developing, implementing and reviewing a family constitution, contact your KPMG Enterprise business adviser. Beware of the pitfalls Constructing a family constitution is rarely a straightforward exercise. The steps we ve outlined can disguise the complexity of the process. It can be an emotional and stressful experience for all concerned. It s useful to start the process by agreeing upon some basic ground rules: How should the decision-making process actually work? Who is entitled to attend family meetings concerned with drafting the constitution? Who should chair the family meetings? What matters can be decided by a majority vote? What decisions will require unanimous agreement? Who should be responsible for translating the group s thinking and decisions into words on paper? You should also bear the following in mind: The decision-making process can become bogged down when the family fails to reach an agreement on one or two issues. It can help to take these matters off the agenda temporarily and move on to those matters where agreement is more likely. Allow plenty of time for consultation and decision-making. As we ve already noted, formulating a family constitution takes time. People will become disenchanted if they think the process is being rushed. If they are given plenty of time and space to consider the issues and, if necessary, obtain outside advice, individuals will often become more willing to compromise in order to obtain a consensus on the way forward. Start with general principles outlined and then work through to more detailed matters. Accept that no constitution can cover every conceivable eventuality; rather, it will explain what the family wants from its business and describe the procedure for resolving particular issues as they arise. It s important to recognize that the family constitution is a living document that will need to change and evolve as the family and the business does. The dynamics within a family business means that communication is not always effective. Improving communication amongst family members can assist the family in resolving both family and business issues. It is therefore worth assessing whether a family member is the right person to guide the process in an impartial and effective manner. It may be more appropriate to engage an independent and appropriately qualified adviser who does not have any bias. Such a person can give the family the benefit of their experience working with other family businesses facing similar challenges. They can also encourage dialogue among members of the family and help them reach agreement on issues. In addition, they can alert family members to relevant business issues that might otherwise be overlooked and that could affect the nature of the decisions reached (e.g. the tax implications of a particular business structure). Overall, the successful development of a family constitution often results in better communication and greater harmony with the family that can help the prosperity and longevity of the business. How we can help In addition to providing Accounting, Audit, Tax and Advisory services, we offer a range of services geared to the needs and dynamics of the family business: Transition planning, equity transfers and generational change Family business governance, including family councils, family constitutions, board structures, business decision making and assurance frameworks Strategic business planning Tax planning and compliance, including HST, capital gains tax and income tax Wealth creation planning and wealth preservation Asset protection Retirement planning, estate planning Sale and purchase of family businesses.

7 Making Family Communication a Top Risk Management Strategy 7 Why select us It makes sense to work with advisers who really understand how a family business operates. Having worked with family businesses for decades, KPMG Enterprise has the experience and know-how to help you achieve your business objectives and family goals. Some of our professionals come from family businesses themselves. Value for money KPMG Enterprise professionals seek to deliver value to their client beyond the fee charged. Our experienced family business professionals isolate the key issues quickly and efficiently. It means you re not paying for someone to learn on the job. Industry knowledge Our understanding of family business issues is reinforced by our in-depth industry experience across all business sectors, including manufacturing, automotive, transportation, retailing, food services, franchising, property and construction, communications and technology, and hospitality. Culture and values You want business advice that is relevant, timely and, most importantly, objective and independent. KPMG Enterprise values our integrity and independence above all else. We set out to build longterm relationships with our clients built upon mutual respect and trust. People Our experienced professional advisers combine strong technical capabilities with deep business insight and experience. They re proactive in raising ideas and know the importance of getting results in a timely, no-fuss manner. Multi-disciplinary approach Our family business clients can draw on our firm s extensive capabilities across a range of professional disciplines. We ve also forged alliances with academics, family business facilitators, lawyers, financial planners and business mentors. These resources can be mixed and matched to meet the specific needs of your business. It s an approach that can help avoid the expense and overlap of working with multiple advisers. Clear, actionable advice We know our clients don t have the time to wade through advice that is vague and impenetrable. Our advice is practical, jargon-free, relevant and timely. We work with family business clients to simplify complexity and isolate the key business issues. About KPMG Enterprise With decades of experience working with family businesses across the country and with many KPMG Enterprise advisers coming from family businesses themselves, we understand that the nature of a family business is inherently different from a non-family business. That s why we pulled together a unique team of professionals within our firm and developed an equally unique portfolio of services that address the specific needs of Canadian family businesses and their owners. About The Centre for Family Business Brought to you by KPMG Enterprise KPMG Enterprise s Centre for Family Business is dedicated to assisting family owned and operated businesses to effectively deal with their unique management challenges. Our goal is to help guide family businesses in their day-to-day operations with a focus on the continuity of the family business. It includes an open virtual forum where members of any family business can share experiences, gain insight into leading practices and obtain the essential support to grow and thrive in today s competitive economy. Visit kpmg.ca/centre-for-family-business.

8 kpmg.ca/centre-for-family-business Contact us For more information regarding the Audit, Tax and Advisory services offered by KPMG Enterprise, visit our website at kpmg.ca/enterprise or contact: Beverly J. Johnson, Partner National Chair, Centre for Family Business KPMG Enterprise (Saskatoon) T: E: British Columbia Mike Fahrmann, Partner T: E: Kelly Watson, Associate Partner T: E: Alberta Dean Gallimore, Partner T: E: Saskatchewan Sarah Tkachuk, Senior Manager T: E: Manitoba Norm Woltmann, Senior Manager T: E: Peter Miller, Partner T: E: Ontario Roger Bryan, Associate Partner T: E: Ruth Todd, Partner T: E: Perry Muhlbier, Associate Partner T: E: Grant Walsh, Senior Manager T: E: Quebec Daniel Gosselin, Partner T: E: Atlantic Canada Gordon Moore, Partner T: E: Luann Jones-Foster, Associate Partner T: E: Special Advisers: Don Zinyk, Special Adviser, KPMG Enterprise Centre for Family Business T: E: Bill Corbett, Special Adviser, KPMG Enterprise Centre for Family Business T: E: The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. 4929

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