LCV

NEWS ABOUT CORPORATE GOVERNANCE -

The Board of Directors on the Agenda^®

Year I – No. 2

Editor: Luciano Carvalho Ventura

“The Board of Directors and the Family Business”.

1 – The Origins of the Family Business

Since the beginning of time, human beings have accumulated wealth, in addition to developing means of defense and of transferring this wealth to future generations. This process of accumulating wealth has always been challenging and no less testing is the process of protecting and transferring such gains. History abounds in examples of nations, countries, companies, families, and individuals whose wealth has vanished over time.

These setbacks in maintaining and transferring wealth have grown in proportion to the increasing complexity of today’s world and to the many different varieties of wealth (property, financial investments, etc.), and the process of protecting and transferring companies to the next generation has, by far, been the hardest and complicated of all. Here, we are talking about the family business, one that, as a rule, is born of the success of a single entrepreneur, whose chief personal characteristics, among others, are the capacity for risk-taking, dedication, persistence, and a degree of independence well above the average.

But, these above-average qualities do not become automatically absorbed into the companies thus created, since few family businesses survive their founders.

Statistics show that most family businesses have a short life span, since only thirty percent (30%) continue into the second generation and, of these, a mere ten percent (10%) survive a third generation. Clearly, the succession process is the leading survival risk faced by this type of company.

Only a carefully planned and controlled succession policy will ensure the transfer of a company by its founder to the successors/heirs. Here, a board of directors of exactly the right size and a core of good corporate governance play a vital role in this complex and hazardous process in the cycle of any family business, as we shall see further on.

2– Definition and Importance of Family Businesses

Strictly, speaking, no specific definition of a family business will ever meet with everyone’s agreement. However, the majority of individuals who have made in-depth studies of this type of organization agree that a company can be thus defined when a) its values coincide with those of a particular family, b) majority control is in the hands of one or more families, c) some shareholders/partners are members of the board of directors or of the executive management, and, last but not least, d) a younger generation is involved thus, guaranteeing the intent of continuity.

If, on the one hand, no specific feature defines a family business, there is a general consensus that family businesses play a significant role in the economy of any country. This is more than confirmed by the statistic on family businesses in the US, where 95% of companies producing half the country’s GDP are family businesses and also employ 42% of its entire work force.

3 –Succession Process - the role of the Board of Directors.

As pointed out above, one of the greatest, if not the greatest, risk faced by any family business, is its process of succession.

An effective board of directors and one that includes some outside members allows the founder to securely monitor his/her company’s business progress, with the reassurance of being able to gradually withdraw from its day-to-day operations, without undue risk to the company; the recipe for lowering the risk factor in the process of succession.

Moreover, in the hands of this type of board of directors, the successor can be trained and the chances of the company’s stability and business operations are increased as well, upon the exodus of the founder, regardless of whether this was planned or is totally unexpected.

Another important benefit arising from the board of directors of a family business is the opportunity to improve the quality of its management thanks to the contributions of highly qualified outside board members. Given that it is virtually impossible to bring together the ideal combination of knowledge and experience, or even a serious interest in becoming involved in the business among the members of a single family, outside directors’ inputs can be of vital importance in filling these professional gaps, thus greatly enhancing the company’s overall efficiency. This is already happening in Brazil since, side by side with innumerable family businesses that have availed themselves of this type of contribution, there are professionals in the market exclusively dedicated to working as members of family business boards.

A further benefit of a board of directors in a family business is that it enables the majority shareholders or partners to play a role in the management of the company, without necessarily becoming actively involved in its day-to-day operations. It is a known fact that, as from the transition from the second (2^nd) to the third (3^rd) generation, most companies cease being a company of individuals and are transformed into corporations. It is precisely at this moment, where ownership becomes separated from management, that the majority owners not involved in the operation need their own forum of action to monitor their business. And it is here that the board of directors, the main Corporate Governance tool, is vital and extremely effective.

The image of a family business can be significantly enhanced with the formation of a board of directors, since certain market agents tend not to hold such companies in very high regard. The presence of external members on the board of a family business greatly improves the company’s image in the eyes of these agents, be these customers, suppliers, the government, or banks.

However, many Brazilian family businesses are seeking associations with other companies, some of them pressured by the rapidly growing trend to globalization and others, seeking synergy in their business, to face the challenge of increasing competitiveness, or as a means for resolving family conflicts. Still others see no alternative solution to problems arising from incompetence or the directions of their shareholders’ or partners’ interests, other than sale of the company. In any of these cases, the actions of a professional and effective board of directors can make a company more attractive for associations or even sale.

Lastly, as a rule, the trend for a family business board of directors with some external members is to introduce good Corporate Governance practices. It is worth noting that recent surveys in the US have shown that billings and returns between 1994 and 2000 of the largest Fortune 500 family businesses were substantially higher than that of other organizations, and also that they implemented more highly developed Corporate Governance practices. It is quite likely that these high levels of Corporate Governance were significantly responsible for this increased billing and returns, and contributed to avoiding the corporate conflict so common and so threatening in family businesses. In other words, these family businesses always observe the three basic principles of Corporate Governance - transparency, fairness, and accountability. A more detailed examination of these aspects frequently reveals a scenario where family members with no involvement in the business are deliberately barred from knowledge of operations by those who actively involved. These “mystery box” companies are more likely to be plagued by insoluble corporate conflicts. The second cause of conflict in family businesses is the inequitable treatment of the shareholders or heirs, and the third, is the absence of accountability. This last flaw is common in businesses where family members involved in the operation neglect to account for their actions to those who are not, a guarantee that corporate conflict will occur sooner or later. Thus, the presence of a board of directors including some outside members can also ensure that the company implements a minimum of transparency, fairness, and accountability, thereby avoiding these corporate conflicts.