TheFamily

Business
Constitution:A
Roadmapfor
Business
Continuity&
FamilyHarmony

TenKeyInsightsintotheprocessofmakingyour
ownFamilyConstitution

ChristianG.Stewart
ManagingDirector
FamilyLegacyAsia(HK)Limited
www.familylegacyasia.com

Contents

1.
IntroductiontotheFamilyConstitution.............................................................2
1.1 FamilyBusinesses:PredictableProblems........................................................2
1.2 WhatIsFamilyGovernance?...........................................................................4
1.3 FamilyGovernanceStructures........................................................................5
1.4 HowFamilyGovernanceStructuresHelp........................................................6
1.5 HowFamilyPoliciesCanHelpAvoidPredictableProblems............................7
1.6 ExamplesOfFamilyPolicies&Agreements....................................................7
1.7 WhatIsAFamilyConstitution?.......................................................................8
1.8 WhatAreTheBenefitsOfHavingAFamilyConstitution?..............................9
2. TheKeyInsightsintotheprocessofcreatingaFamilyConstitution....................11
2.1 ItstheProcessThatCounts..........................................................................11
2.2 NotaLegallyBindingDocument...................................................................11
2.3
2.4
2.5
2.6
2.7
2.8
2.9
2.10

TheFamilyMakeTheirOwnRules................................................................11
FamilyProjectLeader....................................................................................11
TheConceptOfFairProcess..........................................................................12
AChangeProcess..........................................................................................13
ASocialContract...........................................................................................13
WhatAreTheExistingArrangements?.........................................................14
HowLongDoesItTake?.................................................................................14
WhatIfTheyDontFollowTheRules?.......................................................15

1. IntroductiontotheFamilyConstitution

1.1

FamilyBusinesses:PredictableProblems

Whatisafamilybusiness?Onecommonaspectofthedefinitionoffamilybusiness
is an intention to continue the business under family control. Another way of
defining a family business is to refer to a business in which there is a significant
overlapbetween(i)afamilyemotionalsystemand(ii)theownershipsystemand(iii)
thebusinesssystem.

Notwithstanding that a family business, by definition, is one where there is an

intentionofkeepingcontrolinthefamily,thechallengesofsuccessfullyperpetuating
afamilybusinessarewellknown,leadingtotheoftenquoteduniversalproverbthat
wealth only lasts for three generations, or from shirt sleeves to shirt sleeves in
threegenerations.1

Research into Asian family businesses2 has concluded that the majority of family
businesses in Asia fail as a result of internal factors, rather than external factors.
Theseinternalfactorsincludefailuretoplanforsuccessionandfamilyconflicts.Yet
thesurprisingfactisthatmanyfamilybusinessconflictsarepredictableandcanbe
plannedfor.

ThisisthestartingpointofthepopularbookFamilyWealth:KeepingitintheFamilybyJamesE.

HughesJr.,BloombergPress
2

TongCheeKiong,NationalUniversityofSingapore,FeudsandLegacies,ConflictandInheritancein

ChineseFamilyBusinesses,InternationalSociology,March2005,Vol2091);4570.

Onereasonforfamilybusinessfailurecanbetracedtoshareownership.Overtime,
the number of shareholders increases, share ownership becomes fragmented,
resulting in it becoming harder for the family to make decisions concerning the
business.Itissaidthat:Familiesgrowfasterthanbusinesses.

Over time, as the share ownership becomes fragmented, the shareholders start to
loseemotionalcommitmenttothefamilybusiness.3Emotionalcommitmenttothe
business4andhavingactiveowners5hasbeenidentifiedasafeatureofsuccessful
multigenerationalfamilybusinesses.

It is also predictable that over time, there will be more family members who are
ownersratherthanmanagers,andthattheinterestsoftheseoutsideshareholders
will bein conflictwiththeinterestsoftheinside managers. Againsuch conflicts
arepredictableproblems.

There are examples of successful Asian family businesses where the business has
beencontinuedasaresultofaconsolidationofshareownership.Thispointstothe
importance of having a mechanism for allowing for share ownership to be
consolidated. The need for such a mechanism (often called an Exit Plan or a
familyshareholdersagreement)ishighlightedbycaseswhere(i)afamilyconflict
startsovertheissueofhowtovaluethesharesinthebusinessor(ii)theexitofone
familyshareholdercreatesaliquiditycrisisforthebusiness.6

Another challenge for the family business is the basic inconsistency between the
goalsandvaluesofthefamilysystemontheonehandandthegoalsandvaluesof
the business system. An example of a family policy designed to address such a
conflictbetweenfamilygoalsandbusinessgoalsisthefamilyEmploymentPolicy,
whichwillsetoutclearrulesforentryintothebusinessbyfamilymembers.

WongSiuLun,FamilyBusinessReview,volVI,no.3,Fall1993

Carlock&Ward:StrategicPlanningfortheFamilyBusiness,Palgrave

Responsibleownershipofthefamilyfirm,LorraineM.Uhlaner

TongCheeKiong.
3

1.2

WhatIsFamilyGovernance?

Ifthegoalislongtermbusinesscontinuity,thispointstotheneedtoinstitutionalize
therolesandrelationshipsthatarepresentinthefamilybusiness,ratherthansimply
to rely on current relationships. In short, long term business continuity requires
theretobeclarityastohowthefamilybusinesswillbegoverned.

Governance is concerned with all of the ways that the interests of owners
arereflected andimplementedintheorganizationalsystemIngeneralthe
purposeofgovernanceistoformalizetheinvolvementofkeystakeholdersin
thedecisionmakingprocessattheapexofafamilyenterpriseGovernance
isinherentlyaboutinstitutionalizingcontrol.7

Governanceinafamilybusinesscanbethoughtofintermsof:

(i)

Structures for example, deciding to create a family learning and

developmentcommittee;

(ii)

Processes for example, creating and running ongoing ownership education

programsandtheannualpreparationofapersonaldevelopmentplan;and

(iii)

Policies for example, an aspect of the Family Employment Policy could be

that family member employees are expected to participate in the family
learninganddevelopmentprograms.8

Foranotherdefinitionofgovernance,takenfromthecontextofafamilycontrolled
listedcompanyinHongKong:

Corporate governance can be broadly understood as the interrelationship

among the companys stakeholders, including shareholders, the board of
directors, the management, and other relevant partiesGood corporate
governance depends largely on the separation of ownership and

TraditionandAdaptationinChineseFamilyEnterprises:FacingtheChallengesofContinuity,Ivan

Lansberg&KelinGersick.
8

YoucanalsoaddAgreementstothislist,e.g.theshareholdersagreement.
4

management. Under a good corporate governance structure the

responsibilitiesofdifferentunitsinacompanyareclearlydelineated.9

This points to the importance of ensuring that there is a clear distinction made
betweentheroleofownershipandtheroleofmanagement.

1.3

FamilyGovernanceStructures

Another form of predictable problem in a family business is where an issue or

concern from one dimension of the family business system (for example, an
ownershipissue)arisesinthewrongcircle.

Ifthe needsofone domainhaveno waytoberepresentedtheydontjust

evaporate, they find another outlet. This is like the displacement of an
emotion.Forexampleifthereisnowayforownershipissuestobeexpressed
expressed they may appear in the board and board meetings turn into
shareholdermeetings.10

This points to the importance of having appropriate structures and forums so that
the interests of the family circle and the interests of ownership can be properly
expressed.Anexampleofthiswouldbethecreationofafamilycouncilorofan
ownerscouncil.

One of the most pervasive lessons we have learned is that when the
legitimateinterestsofownershipdonothaveaforumforexpression,issues
ofcontrolandreturnoninvestmentwillfindawaytoemergeineitherthe
familyortheoperatingbusiness.Whenthoseissues do cometosurface in
the wrong circle, they are almost always disruptive and sometimes
destructive.11

Basicgovernancestructuresinafamilybusinesscaninclude(i)afamilyassembly(ii)
afamilycouncil;(iii)itmightincludeaseparateownershipcouncilorforum;(iv)the
boardofdirectors;and(v)perhapsalsoanadvisoryboard.Fromthereaparticular

100YearsofLi&Fung,byFengBanYan.

10

GettingAlonginFamilyBusiness;theRelationshipIntelligenceHandbook,Hoover&Hoover.

11

GenerationtoGeneration,HBSPress.
5

family might decide that it also needs one or more committees (see the below
diagram)or,forexample,acareerplanningcommittee.

Asimplediagramreflectingabasicgovernancestructureforafamilybusinesscould
beasfollows12:

1.4

HowFamilyGovernanceStructuresHelp

Wellfunctioningfamilygovernancestructuresaimat:

(i)

Communicatingthefamilyvalues,mission,andlongtermvisiontoallfamily
members.

(ii)

Keeping family members (especially nonexecutives) informed about major

businessaccomplishments,challenges,andstrategicdirections.

(iii)

Communicating the rules and decisions that might affect family members
employment, dividends, and other benefits they usually get from the
business.

(iv)

Establishing formal communication channels that allow family members to

sharetheirideas,aspirationsandissues.

(v)

Allowingthefamilytocometogetherandmakeanynecessarydecisions.

12

AdvisingtheFamilyBusiness:AGuideforProfessionalsDavidBork,DennisJaffe,SamLane,Leslie

Dashew,andQuentinHeisler,JosseyBass
6

1.5

HowFamilyPoliciesCanHelpAvoidPredictableProblems

Becausefamilybusinesshavepredictableproblems,theseproblemscanbeplanned
forandfamilypoliciesdevelopedtoaddresstheissuesbeforefamilyconflictarises.
Accordingly another aspect of family business governance is the creation of an
ongoing process for the creation of relevant family policies and for their periodic
review.

Familypolicieshavemanyadvantages.Makingfamilypoliciescan:13

(i)

avoidproblemsorsolvethembeforetheyoccur;

(ii)

reducefuturefamilytension;

(iii)

strengthenthefamilywithexperienceincomingtoagreement;

(iv)

clarifyyourfamilyspositionsandreducemisunderstandings;

(v)

helpthefamilysortoutitsvaluesandwhatitstandsfor;

(vi)

improvefuturedecisionsbyensuringthatpolicyformationisinformedand
objectiveratherthanmadeintheheatofbattle;

(vii)

createmoreenthusiasmforandknowledgeofthebusiness;

(viii)

increasethelikelihoodoflongtermbusinessandfamilysuccess,survivaland
prosperity.

1.6

ExamplesOfFamilyPolicies&Agreements

Examplesoffamilypoliciesinclude:

anEmploymentPolicy

aDividendPolicy

aRemunerationPolicy

ajobdescriptionfordirectors

alearninganddevelopmentcurriculum

aCodeofConduct

apolicydealingwithConflictsofInterest

aCharity/PhilanthropyPolicy

aStatementofFamilyValues

13

DevelopingFamilyBusinessPolicies:YourGuidetotheFuturebyCraigAronoff,JosephAstrachan

andJohnWard,FamilyEnterprisePublishers.
7

a family shareholders agreement (note, unlike the above policies, this is

normallyalegallybindingagreement)

anoperatingagreementforthebusiness(again,thismightbealegallybinding
agreement)

1.7

WhatIsAFamilyConstitution?

Thefamilyconstitutiondefinestherulesoftheroadforthefamilywithrespectto
itsrelationshiptothebusiness.

Insimpletermsafamilyconstitutioncanbethoughtofasacollectionofkeyfamily
policies. It would also reflect the mission vision and values of the family and
importantprinciplesforworkingtogetherorforthebusiness.

Itcouldalsoincludeadescriptionofthecompositionandroleofthefamilycouncil,
andhowthefamilycouncilmakesdecisionsandresolvesconflicts.

Itcouldincludeadescriptionoftheothergovernancestructuresthatgotomakeup
the family business (or the wider family enterprise if you make reference to the
family foundation and the family office, for example). There is no fixed definition
andthereisnoonewaytodoit.Herearesomemoredescriptionsofwhatafamily
constitutionis:

AFamilyConstitutionisaformaldocumentdevelopedcollaborativelyby
familymemberstoencapsulatethevalues,beliefsandobjectivesofthe
family,asafamily,withspecificreferencetothefamilysrelationshipand
dealingwithitsfamilybusiness.
IvanLansberg,SucceedingGenerations
AFamilyConstitutionis.alegal,orquasilegal,guideforfamilybehavior,
decisionmaking,andsettingupthesuccessionfromonegenerationto
another.Beginningwiththemissionstatement,theconstitutionthen
extendsthemissionintopracticalactions.Itsetsupaframeworkanda
forumforagroupofequalstodeliberateissues,createpoliciesand
procedures,clearlydefinefamilymembersrightsandobligations,andmake
decisionsabouttheimportantissuestheyshare.
DennisT.Jaffe,PhD,StewardshipinyourFamilyEnterprise
8

1.8

WhatAreTheBenefitsOfHavingAFamilyConstitution?14

Whatarethebenefitsofhavingafamilyconstitution?Asyoumightexpectthereare
actuallytwodimensionstothisquestion.First,youshouldask,whatarethebenefits
ofgoingthroughtheprocessofcreatingafamilyconstitution?Second,whatarethe
benefitsofhavingafamilyconstitution?

(i)

What are the benefits of going through the process of creating a family
constitution?

The process can help to include or involve family members or family

branches that have not had a role to play or that have started to become
distantfromthefamilybusiness.

Itcanbefun.Itcanstrengthenfamilybondsandfamilyunity.

It should help to improve family communication and problem solving and

conflictresolutionskills.

Ideallyitshouldhelptoimprovethelevelofindividualselfawareness.

It makes the family members think about how they need to develop and
whatnewskillstheyneedtolearn.

It provides an opportunity to talk about and to plan for the future. Often
without a structured platform to have such discussions, families tend to
avoidsuchimportantbutdifficultconversations.

It helps to bring the family members /shareholders onto the same page
together.

(ii)

Whatarethebenefitsofhavingafamilyconstitution?

FamilybusinessguruJohnWardsaysofthefamilyconstitution:

TheFamilyConstitution,acomprehensivearticulationofphilosophy,

14

Source:CreditSuissePrivateBank
9

principlesandpoliciesforthefuturethatbalancesandsynthesizesthe
welfareoffamily,ownersandthebusiness,isamongthemost
importantstepsabusinessowningfamilycantaketosecureand
strengthenitsbusinessand,mostpreciously,itsfamily.

DanielaMontemerlo,PhDandJohnL.Ward,PhD

Afamilyconstitutionhelpstoavoidfamilyconflictsandpreventunnecessary
misunderstandings.Byclarifyingroles,thishelpstoavoidroleconflicts.By
providingforumsfordiscussionoffamilyandownershipissues,thisprevents
such issues from exploding in the wrong forum. By providing an exit
mechanismthisprovidesawaytoletoffsteam.Havingthingsinwriting
helps ensure family members are all on the same page. The family
constitutionwillnormallyincludeaprocessfordealingwithfamilyconflicts.

Thefamilyconstitutionhelpstoshapetheexpectationsofthemembersof
thenextgenerationwithrespecttotheirrolesinthebusinessandasfuture
owners.15

Havingafamily constitutionhelps to give thebusinessastrongfoundation

andtobuildtheconfidentofnonfamilymanagersandbusinesspartners.16

Withrespecttofamilyownershipthefamilyconstitutionhelpstokeepthe
ownership united and to forge family commitment to the future of the
familybusiness.

Finally, the preservation of family wealth across generations ultimately

comes down to having the best possible process for joint family decision
making.17 The heart of the family constitution is a fair process for making
jointdecisionstogetherasafamily.

15

CreditSuissePrivateBankWhitePaper

16

CreditSuissePrivateBankWhitePaper

17

JamesE.HughesJr.FamilyWealth,KeepingitintheFamily.
10

2.

TheKeyInsightsintotheprocessofcreatinga
FamilyConstitution
Thefollowingpointsareworthkeepinginmindwhenpreparingtoworktogetheras
afamilytocreateafamilyconstitution.Akeyconceptthroughoutisthatthefamily
gettomaketheirownrulestherulesthatmakesenseforthem.

2.1

ItstheProcessThatCounts

Itisoftensaidthatwhenmakingafamilyconstitutiontheprocessismoreimportant
than the output. The process gives family members the chance to work together
andmakedecisionstogetherandtalkinastructuredlogicalwayaboutthefutureof
thefamilybusiness.

As such there is very limited value in model documents or templates which are
likelytobeputinthedraw.Thegoalistocreatesharedunderstandingamongthe
familymembersandcreateasetoffamilynormsofbehavior.

2.2

NotaLegallyBindingDocument

Familyconstitutionsarenotnormallylegallybindingdocumentsalthoughafamily
shareholdersagreementisusuallylegallybinding.Againitisaboutclarifyingroles
andexpectationsandcreatingfamilynorms.

2.3

TheFamilyMakeTheirOwnRules

Thefamilymembersshoulddecideonwhatgoesintothefamilyconstitutionaswell
astheapproachtobetaken,andtheonthetermsofpoliciesetc.Ithastobethe
familysproject.Thereisnodefinedlistforwhatmustbeinafamilyconstitutionso
itshouldbetailoredbytheindividualfamilyforthemselves.18

2.4

FamilyProjectLeader

Ideallytherewillbeoneormorefamilymemberswhodrivethefamilyconstitution
project(thefamilytaskforce).Themorethefamilymembersowntheprojectand

18

Ontheotherhanditwillbehelpfultohaveachecklistofissuestobeconsideredforinclusion.
11

andputtheirownthinkingintoit;themoreeffectiveandrobustitwillbe.Itoften
makes a lot of sense to have one family member at least who is charged with (i)
actingasthecoordinatorandliaisonbetweentheoutsideconsultantand(ii)whois
responsibleforcoordinatingtheworkthatneedstobedonebythefamilymembers.

2.5

TheConceptOfFairProcess

(i)

In working on a family constitution the concept of fair process is very

important.19Ifapersonfeelsthattheyparticipatedinmakingadecision,if
theyhaveavoice,iftheybelievetheprocessformakingadecisionisfair
andtransparent,theywillaccepttheoutcomeofthatprocessevenifitmay
notreflecttheirownpersonalview.

(ii)

Fair process is about participation and having a voice in the process.

However you may be able to get the input and participation of a group of
personswithouthavingtocededecisionmakingauthoritytothem.Decision
Decisionmakingauthorityandparticipationcanbedifferentthings.20

(iii)

The principles of fair process might dictate that normal decision making
processes of a family should be suspended while working together on the
familyconstitution.21

(iv)

Inthecontextofafamilybusiness,itwillalsobeimportanttoconsiderthe
nonfamilymemberswhoshouldbeaskedtogivefeedbackontheproposals
and policies the family members develop, e.g. non family directors and
senior managers; and to consider how & when their feedback should be
obtained.

19

SeeBlueOceanStrategy,byHarvardBusinessSchoolPress.

20

ProfessorRandelCarlock.

21

FamilyGovernance,BeyondtheBasicsBarbaraHauser,STEPJournal
12

2.6

AChangeProcess

(i)

Workingonafamilyconstitutionmightinvolvemakingachangeintheway
the family do things. For example if an ownership council is formed and
startstomeetandstartstogetreportsthatwerenotgiveninthepast,this
wouldbeachange.Itisimportanttounderstandthatchangetakestimeand
isusuallymetwithresistance.

(ii)

Ifnewconceptsareinvolved,ifachangeiscontemplated,inpracticeitmight
be necessary for new information or feedback to be presented more than
oncetothefamily..

2.7

ASocialContract

(i)

If, for example, you are asking a family member who is a shareholder to
participate in the family council and to abide by its decisions, to put the
interestofthefamilygroupinfrontoftheirownpersonalselfinterest,then
you are talking about forming a "social contract".22 A "social contract"
means that people are willing to give up some of their own personal
freedoms "for the greater good".23 The theory is that you are going to be
"safer" and better protected as a member of the group, even though it
involvesgivingupsomeofyourpersonalfreedom.24

Everyattempttocreategovernancebyandforafamilygroupwill
of necessity involve an accommodation or curtailment of the
individualsfreedomforthegreatergoodofthewhole.Accordingly,
each individual must be convinced that this accommodation will
result in an overall benefit to the individual by being part of the
largergroup.25

(ii)

Inpracticaltermsitfollowsthatitisveryimportanttogeteveryonetothink
carefullyaboutthebenefitsofhavingafamilyconstitutionandwhatarethe

22

GenerallyseeFamily:TheCompactAmongGenerationsbyJamesE.HughesJr.

23

SeeJohnLockeandhisSecondTreatiseonCivilGovernment1689.

24

Thisissubjecttotheprovisothattheleadershipofthegrouphastobeseenasgoodleadership.

25

FamilyGovernance,BeyondtheBasicsBarbaraHauser,STEPJournal
13

benefits of working together as a united family group.26 Working together

might hold up the value of the family voting bloc. Working together might
providetheopportunitytoensurethatthefamilycompanycontinuestobe
runinlinewiththefamilyvalues.

(iii)

Socialcontracttheorypositsthatthereisgovernmentbyconsent;byfreely
given consent. Membership of the family group therefore has to be
voluntary.27

(iv)

Inorderforittobevoluntary,therehastobeawaytoexitthegroup.This
points to the importance of (a) a voluntary commitment to the family
constitution, (a) having a way to amend and modify the family
and(c)havinganExitPlan(forexampleafamilyshareholdersagreement).

2.8

WhatAreTheExistingArrangements?

Workonafamilyconstitutionwillnotoccurinavacuum.Thefamilybusinesswill
already have its existing governance arrangements in place, even if they might be
relativelyinformaloreveniftheyarenotdocumented.

2.9

HowLongDoesItTake?

How long does it take? Just like there is no set formula for what should go into a
family constitution, there is no one right answer for the question of how long it
wouldtake.

(i)

Some families hold a series of family meetings over a period of several

monthsandcreateafamilyconstitutionwhichreflectstheirsharedviewon
a list of important questions that can impact on family business continuity
(for example, Can in laws work in the business? or What will we do if
there is a dispute?. They would then plan on reviewing it at an annual
familymeetingandifnecessaryupdatingit.

(ii)

Somefamiliesfocusonformingafamilycouncilandarticulatingtherulesfor

26

ArelatedconceptisthatofexaminingEmotionalCommitmenttothefamilycompany.

27

Family,TheCompactAmongGenerations,JamesE.HughesJr.BloombergPress.

28

Thoughamendmentsshouldnotbetakenlightly.
14

participationinthefamilycouncilanditsroleandpurposeandtheprocess
bywhichthatfamilycouncilwillmakedecisionsandresolveconflicts.Thisis
is documented in the family constitution. They then hold quarterly family
council meetings which debate important family agreements, policies &
issues.Thisthenbecomesanongoingprocess.

(c)

At the other end of the spectrum, there is a well documented example of

one Indian family, the GMR Group, that spent considerable effort over a 3
year period developing a comprehensive family governance structure and
familyconstitution.29

2.10

WhatIfTheyDontFollowTheRules?

Thisisacommonquestion.Therearetwoaspectstothis.Thefirstisthatthefamily
shouldconsiderthealternativesandmaketheirowndecisionasto(i)whetherthere
will be any express consequences for a breach of the family constitution and (ii)
whatthoseconsequenceswillbe.Thefamilyshouldmaketheirownrules.

Forexample,thereisafamilyconstitutionpreparedbyawealthyJapanesefamilyin
1722,calledtheMitsuiConstitution,whichcontainsthefollowingclause15:

Inprinciple,theeldestsonistosucceedhisfatherasheadofthefamily;but
ifhisconductshouldcauseharmtothefamily,heshallbeexpelled,evenif
heistheonlyson,andsentintothepriesthood.Insuchacase,asuccessor
will be adopted from among the other members of the House. Those
memberswhoproveincapableofmaintainingtheirfamiliesorwhoconduct
themselvesimmorallyshallalsobesentintothepriesthood.

The second aspect to this question though is the question of whether complying
with the family constitution and being a member of the family group is an
attractive proposition or not. This also includes the concept of fair process again;
i.e. has there been an adequate opportunity provided to participate in the rule
makingprocess?

29

ThiscaseisreferredtoinFamilyBusinessTheEssentialsbyPeterLeach.
15