This article suggests that one fundamental tool available to family firms is effective corporate governance and, in particular, offers specific advice about how to create a non-fiduciary council of advisors for a family controlled enterprise (FCE).
It also details many specific suggestions to both future council members and the family control groups who recruit them about how to utilise this governance tool to maximum effect.
Introduction
First, some framing of the problem: We are not writing about "family business", because this term has little analytic utility, burdened as it is with numerous misconceptions about what "family businesses" are.
To many people, family business equates to small business, or to owner-managed business or to unprofessionally managed business. All of these assumptions invoke models of management and are as true as all other generalisations.
Secondly, it is important to note the inherent barrier to establishing governance presented by most FCEs: primarily, an abiding commitment to privacy and to the specific culture of the FCE, rooted as it often is, in the unique, multi-generational history of the founding family.
Too often, advisors fail to understand why families are resistant to reducing barriers to their private business lives, even though the advisors may clearly experience that resistance. Explicit respect for the family's right to privacy and culture help to overcome this resistance.
To those advisors educated at the best law schools and business schools, the utility of governance may seem self-evident. But to a family that has controlled enterprises for generations, making crucial contributions to the community by creating jobs - all without formal governance mechanisms - the importance of enhancing governance is not self-evident.
How a council of advisors differs from a board of directors or family council
A council of advisors is significantly different from a board of directors and from a family council in terms of purpose, composition and fiduciary responsibility.
- Purpose
In a corporation, a board of directors is a governing body that makes decisions for the company. (In a limited partnership or limited liability company, the governing body is comprised of some or all owners. In a limited partnership, the decision maker for most issues facing the partnership will be one or more general partners. In a limited liability company, the governing body will be one or more managing members or a group of members.)
The purpose of a council of advisors is to provide informal counsel to the business, bringing the expertise and objectivity of individual advisors to the process. In times of crisis, the advisory council may function as an interim transition team or as chairpersons of a transition team. Rather than taking control away from a CEO, a council of advisors can and should balance the CEO's strengths.
We refrain from using the term "board of advisors", since a board (of directors) is a legal entity with collective legal duties. A council of advisors, by contrast, is a periodic gathering of a company's advisors acting in their individual, contractual roles.
- Composition
In an FCE, the board of directors is typically comprised of family members, key management of the business and advisers to the company who are compensated for their relationship with the business (such as the business' lawyer, accountant, insurance broker, banker or outside investor).
Often, the non-family members are part of the board of directors in order to have enhanced contact with the business (a) to further their ability to provide better services or, (b) in the case of a banker, investor or strategic partner, to protect their interests in the business.
Members of the council of advisors, however, have the sole purpose of enhancing the business' success. Optimally, they may achieve a positive impact equal to that of independent directors. But such impact is not a function of hierarchy or legal status.
The composition of an advisory council should reflect the mix of skills or experience needed in such advisors. Often, a council of advisors can complement a private FCE's board of directors with the same function and power as the independent directors serving on a public company board.
The experience of the advisory council members need not be limited to the business' particular industry. The key factor for membership in an advisory council is the willingness and ability to provide objective expertise to guide the business.
For example, the advisory council of a construction company poised for re-invention does not need to be comprised of construction company executives, but rather might consist of the CEO of a successful hotel chain, a former engineering company executive with experience in expanding their company's products and a finance expert not affiliated with the business - if those individuals have valuable expertise and advice to offer.
We recommend that a FCE review a matrix of skills that its owners and key managers possess, those that are readily available from compensated consultants and those areas of experience that are missing. The advisory council should provide missing experience at a broad level of oversight (rather than at the level that a paid consultant could provide).
In general, it is useful to exclude from consideration the following types of individuals:
- anyone who has a conflict of interest in being an advisor to the company;
- suppliers or vendors to the company;
- friends of the owners who have no relevant experience to offer;
- anyone who will be a "yes-man";
- anyone who is already over-committed and would not be able to devote attention to this role; and
- existing providers of service to the company (since their advice is available in other forms).
An advisory council should be of a size to facilitate discussion by its members. It should not be so large as to discourage participation. Rarely should the council exceed nine. Five advisors plus four owners and/or managers are ideal.
- Family councils
Unlike a board of directors and an advisory council, the purpose of a family council is to include family members who are not involved in the business in the oversight of the full panoply of family enterprises: operating companies, investment vehicles and foundations.
Family council meetings are typically held once or twice a year to update family members on the status of the business and to obtain input into certain strategic decisions that may affect them. For example, how to compensate successor generation members or whether to sell the business.
- Fiduciary responsibility
Directors (or general partners or managing members, as appropriate) have a fiduciary relationship to the company. Governed by the law of the state in which the company was formed (and by agreement in case of a limited partnership or limited liability company), this governing body has specific responsibilities to the owners of the company.
If a board of directors fails to uphold these fiduciary responsibilities, any owner of the company may enforce the company's rights against individual directors on behalf of the company.
Members of an advisory council serve as individual persons under contract to the company under a plan adopted by the board of directors to create a collective advisory process for management and the board of directors.
Therefore, they are unburdened by statutory or common-law fiduciary obligations to the company or its owners (assuming a well drafted agreement to provide services). Because of this lack of fiduciary responsibility, we address below the need for advisory board members to sign confidentiality, non-competition and non-solicitation agreements prior to joining the advisory council as protection for the company.
In order to provide protection for the advisory council members, it is important for the board of directors of the company to adopt resolutions appointing the advisory council members and defining their relationships to the company.
Inviting prospective advisory council members to join
Though the advisory council is technically an informal group of advisors, the invitation to join an advisory council and the use of the advisory council should be formal in order to maximise its usefulness. Seeking and engaging advisory council members should be as thorough a process as engaging independent directors.
We suggest the following process:
- Determine the company's needs as described above;
- Identify potential advisory council members who can fill those needs;
- Conduct one-on-one discussions between the company's President or CEO and each prospective advisory council member, outlining the role of the advisory council, the company's expectations of the advisory council members (including agreements that all members will be required to sign) and why the company would like this individual to join. Follow up with a second round of interviews for each candidate with all major stakeholders (family, managers, and directors).
- If there is mutual interest in the prospective member joining the advisory council, a formal letter should be sent from the company's President or CEO inviting the individual to join the council of advisors, repeating the role of the advisory council and the company's expectations, specifying the compensation for the advisor's participation, and asking for written acceptance of the position by the individual. The letter should also inform the new member of the advisory council's meeting schedule.
After acceptance by the advisors, the board of directors should adopt formal resolutions appointing the advisory council. These resolutions must make clear that council members are not directors and do not have the duties of directors and that they are not agents of the company (and, therefore, have no authority to bind the company in agreements).
The resolutions should require the officers and directors to obtain confidentiality, non-competition and non-solicitation agreements from the advisory council members.
The resolutions should specify one-year terms for the advisors. Terms benefit both the company and the advisors: they provide a limited obligation on the part of the individual advisors and enable the company to permit changes in the council's composition over time without awkward relationship issues arising.
All such resolutions should be included in the company's minute books.
Finally, it is crucial that the family/shareholder group and each member of the advisory council understand each other's expectations of the governance process.
The advisors should know that the family expects the same level of informed analysis, understanding, integrity, candor and loyalty expected of a director, even though the advisor can only recommend and will never have a vote. In addition, advisors must understand the role of the FCE's history and culture.
The family should recognise that they will only be able to retain the presence and participation of the very best advisors if matters of substance (including those that are emotionally charged) are on the agenda. The family should commit to listening and debating.
Both the family/shareholders and the advisors should recognise at the outset that for the advisory council to achieve mutual understanding and an optimal working relationship could require three to five years. And at the foundation of everything must be the common understanding that advisors advise, but family shareholders decide.
Read the article 'Why A Family Controlled Enterprise Should Have Effective Corporate Governance'
Read the article 'How To Create Effective Governance In A Family Controlled Enterprise - Advisory Council Meetings'