Family businesses are complicated, and the roles that family members play in them usually evolve from non-planned events and circumstances. When conflicts arise in a family business, they are often more complex and difficult to resolve than in a non-family business. A family business constitution is one way to address this complexity.
A family business constitution is a written agreement between family members that formalizes the norms that govern softer elements of the business. According to PWC, 71 percent of family firms have not adopted procedures, like a constitution, to proactively resolve family disputes. Unlike an operating agreement, a constitution is a non-legal document that addresses policies, practices, and procedures to help define how the family interacts with the business and each other as shareholders. These documents can help address awkward issues before they arise and provide a foundation to resolve the ones that do.
A good constitution relies heavily on the family’s input because each family has a unique culture and business. Creating a constitution has three general stages. First the family collectively identifies individual needs. Then the family drafts the constitution together. Finally, the family commits to continual review and adjustment, ideally at set annual intervals. Typically, it takes two to three months to create a 20- to 30-page constitution, with biweekly meetings and take-home assignments that explore personal values, strengths, weaknesses, and business styles.
Often it is a good idea to use an objective third party in the formation of a constitution. Constitutions often address sensitive issues like ownership interests, passive family members, dispute resolution procedures, compensation plans, and even arrangements for exiting the family business. Having an individual, or organization, that is an outsider can help guide the family through the steps with open and honest dialogue that might otherwise not occur.
For equally good reasons, it makes sense for the family members to have the family legal and accounting professionals review the constitution before it is adopted. A constitution, despite being a values-driven document, can also have important legal effects.
Below is a list of example issues that a family business constitution can address:
- When is the right time to tell heirs about the business?
- What are guidelines for hiring and firing family members?
- Who will lead the family business?
- What is the criteria for selecting leadership positions for the business?
- What are the rights and responsibilities between family members who are active in the business and family members who are inactive in the business?
- Who serves on the board of directors and how are they selected?
- What is the compensation policy for family members active and inactive in the business?
- What happens to ownership shares when the share owner marries, divorces or dies?
- Should ownership shares be given to non-family executives?
- What are the long-term goals of the business?
- When, if at all, should the business be sold?
- How is the performance of the family business being measured?
- How do the values of the family influence the running of the business?
- How are family members active in the business held accountable for their actions?
- How is the family business constitution amended?