Family Business Webinar Series | Part II
- Oct 18, 2023
What’s the Right Governance Tool: Board of Advisors, Owner Groups or Family Councils?
You already have a governance structure. Governance is simply how organizations make decisions when authority is likely centralized in the hands of one or a few. However, as family businesses grow so does the number of decision makers (and opinions). We know from research and by working with families over the years that structures are a proxy for trust. This webinar will introduce you to the governance research and options that will support your family’s goals along with pitfalls to avoid.
Natalie McVeigh: Awesome, thanks Astrid. Hi, everyone. As she mentioned, this is our second session for the LMC Continuity Webinars, and so why are we talking about governance? Last time we talked about emotions and why family companies have emotions, and governance is the way that family companies become successful. Or sorry, continue to become successful. You're already successful today, you're wildly more successful than I'll ever be. And part of that was because one person usually started the company. Occasionally you have siblings who start a company together. Often in my experience with LMC members, there is a company that started with potentially family money. A parent lends it to a child and that one person who runs that entrepreneurial phase, if you remember The Three-Circle Model we were looking at in the last webinar, that person has all seven roles, gets to build the company exactly the way they want.
I ran my own company before and I often ask people, "How do you think my company went?" And I get some really interesting answers, but the one thing in common is it went however I wanted it to go. No one was my boss, no one told me what to do, and the structure was mine. I'm a morning person, I would wake up early and I wouldn't work as much in the evenings unless there were emergencies. And then later when you expand and you make more money and you become a more successful company than when you started, you'll actually have what we call the durability phase. That's where people like to talk about professionalizing the family business or family office. And I hate that phrase because it clearly was professional to begin with. What this means is standardization, we decide that there are certain ways that we're going to get these things done and we start codifying that.
We get job specs, we get SOPs, we get a lot of organization, and then we reiterate these, this is where those beautiful values, visions and missions show up in organizations. And then you usually hit a phase where that person who started it is getting a little tired, getting a little long in the tooth, and a lot of the people they built the company with are the same. In my experience with family entities you have founder entrepreneur has been leading that company for 30 some odd years and most of their management team has also been leading it for 30 some odd years, and that's that legacy building phase where it's already an incredibly successful company doing what it does well, it's already got some standards and procedures that fit the people who are there. And there are these three options that happen at the end.
One is you maintain the status quo, things stay the same, and it is okay to have a company that maintains for a generation or two, or you can gain, which involves some changes, some different ways that it's going to run, or it's going to drain. And that's what governance does. Governance says there's a sea change, it's already happening, we can't stop the tide, we know it's a problem, and how do we do it in a way that's going to work for us? Which is very different than the guy or gal who started it, because usually we're a group of people, we're a sibling group, or a cousin group, or a partner group, rather than one person who started it doing it my way is the highway. And of course they were incredibly correct, yet that causes some challenges. And these transitions take time. You wouldn't believe how many people call me to work on their family company and then they take some time.
This is just a research study that talks about this idea of transitioning and governance is a transition. It is a change from usually one person leading to more than one person leading. I think we talked about last time that a family enterprise is a group of people with joint decision making, usually in that first generation and that entrepreneurial stage it's not, it is one person with solo decision making and authority. And so we're transitioning from one to many, 2, 3, 20, some clients have that many in their family. There's usually some event that happens and it's usually a health event, heart attack often. Thank God, most of the time, not fatal, but we've had a hard event in a family and we're deciding, "What happens next? How do I make some room for the people at the table, because I might not be there long term?"
And there's usually some investigation of that. Do I start a board of advisors? Do I hire a family advisor? What do I do? And then usually we stop, because after that emergence scenario where I was in the hospital for a few weeks, I've realized that I'm actually okay and I'm healthy and I don't want to deal with my own mortality, so I'm not actually going to make a change right now. And this is the phase where families get a little antsy, where, "I thought you were ready finally to hand it off." And then we start exploring what these options are, we start playing with maybe making a governance document, and then finally... It takes a while, roughly 16 months to actually say, "This will be the governance entity that we create." So I want you to take away from this call today and we're going to talk about all the different governance entities that could possibly exist under the sun.
Which one's the best, which one's the best for you? It doesn't mean that you're going to leave this webinar today and implement your governance, it's probably going to take you 16 months, and that's okay. One of the things that happens in families when we're not prepared for the resistance of the change is we get really disappointed and we decide to not implement the change at all, or we don't do it well. And so I just want to you all to know that it's going to take a little time and today's just the start of that conversation for you. It's also really important to understand what are the potential leadership roles that can happen in a family enterprise? Because often when we think about what happens next, we're thinking about taking over that C-suite role, the CEO, or the business leader, or sales. Sales and product purchasing are huge in my LMC clients.
Your chief product officer, you might not call him that, or your chief sales officer, you might not call her that, but these are sales entities. And so that might be the role that you're thinking about when you're thinking of governance. We want to make sure that's taken care of, but there's a lot more than that. There's the ownership that is often represented by a board, and if it's not represented by a board, you're going to want to know who's going to be the majority owner, because probably today you have someone who is a majority owner that's making these decisions. And there's also the family system. Not every person needs to be involved in the company, because the more people making decisions together, the more complicated it can get or the more fun it can get. However you want to look at it.
And governance touches on these three circles. It's not at the center of this, but it is the piece that makes sure these circles don't bump into each other. I think I talked about in the last webinar that you can actually use this three circle model to help your planning. You can write real names in here and decide how that changes. And the thing is, governance keeps them looking neat like this, with these perfect overlaps. What happens without governance is one gets bigger than the other, maybe family gets the biggest. And what I mean by that is maybe we're paying all of our siblings in the company the same price, because that seems fair. And so family rules, you got the bloodline you're in, or sometimes the business rules where we're only paying the people who are in the company, we're not paying dividends. So governance helps keep these three circles from overtaking each other, it allows that order to happen as we go through this.
The interesting thing I hear when I talk to clients about governance systems is they don't want governance. It's too structured, it's too rigid. The way we do things now is we just get together in a room and we make decisions. That is governance. You are in fact doing governance if that's how you make decisions. The challenge becomes, what if one of the days you're all sitting at the table, one of the siblings isn't there and a decision is made and they feel a certain way about this? That's why codifying some of the governance is helpful. Also, this happens a lot with my LMC clients who have four siblings, three of which work in the company. If it's an ownership decision, that fourth sibling should probably have a conversation with you about those ownership related decisions in particular.
And if they're not having a conversation with you, someone needs to vote their shares on their behalf, usually that can be delegated to a board decision. So then the board is making that decision. And that's very different, because you might not have seen that before your father or mother or parents together might've been running this business where they made all the decisions in the room, but that's because they held all the ownership and the management all together. And what we find in these families, as your parents are no longer there, that gets more dispersed, you might not have all the managers be the same as all the owners. And that's where governance gets confusing. We might forget that, and I've seen this a lot in my clients. Well-intended, wonderfully loving families believe that business decisions are business decisions because they've always been made during nine to five.
Of course you never work nine to five, let's call it nine to seven, or actually with LMC it's probably six to four, six to four in a day inside of those closed doors. And so we mistakenly believe that those are business decisions and they're in fact owner decisions. Not all of them, a few. And we'll talk about what the owner's rights are in companies. And just so you know, this is a national webinar because LMC companies are for everyone. Some of the rights of owners do vary state to state, but there are three that stay pretty similar in the United States. So we are going to talk about those. And role confusion is the leading cause of conflict in family enterprises. We spent a lot of time talking about how to deal with conflict, how to normalize engaging with your siblings, your parents, your cousins in the last session.
But believe it or not, understanding how governance works, not abiding by those things that seem a little rigid and structured is the main reason you're going to encounter conflict. It's not always going to be because of things that happened when you were young. I want to remind everyone, we do have A Q&A. At the end of last session, some people were asking questions and we ran out of time a little bit, but you can ask your questions throughout the webinar and I can address that. You'll get these slides as well, so don't worry. But if you have a dying governance question, let's ask it. The reason I wanted to bring this study in is you've probably heard that 70% of family companies fail by the third generation. Some studies say it's 80% of companies fail within the first five years. There's a lot of why organizations don't do well out there.
And just like the WHO, the World Health Organization, in the nineties started studying not why families stay challenged, but why some people are successful in changing their social status, some family business researchers said the same thing. They decided to say, "Okay, fine. Some family companies fail. Not all, not even close to all, but there are those that we know that are successful." And not only have they been successful for a little while, they've been successful for a long while. We call them legacy companies. They've been successful for a hundred years. And these are the things they all have in common. And the cheating answer here, and I'll go through each one of these and explain this graph, but the short answer is they succeed because of governance. And so that's why we're talking about governance, because it's almost impossible to get to the fifth generation without governance.
This graph, if you want to look down G2 is this gold, it means the second generation. G3 is this color next to it that's light, that means the third generation. This dark color in the middle is what we call G3 and G4 because that third generation to fourth generation is a transition year. And then there's this red, which is G4. And then this dark terracotta maybe is G5. So that's how we're reading it, and it starts from the lowest up to the top. At the very bottom, in G2, there is no exit policy for most family companies, you're in and you're in and only death gets you out. By the third generation, 40% have it. By the fourth generation, 80% have it. By the fifth generation, a hundred percent of families have it. An exit policy does the opposite of what you would think it does.
An exit policy sounds like. "How do you get out?" But believe it or not, an exit policy is a pressure relief valve that allows families to say that we're opting in and we're opting in because we want to be here. And if we don't want to be here, there's a fair and equitable way to get us out, not under market, not painful to give up our shares. And so you get the best owners in there. But believe it or not, every client I've ever worked with that has a fair and equitable exit policy, no one leaves. Every client I've worked with who doesn't have a fair and equitable exit policy is the ones calling me, sometimes calling lawyers before they call me, to try to get out of the company because they feel trapped. So there are things that we're doing to try to keep our family there that actually make it seem like they're in prison rather than that we're partnering with them.
The next one is next generation education. You see that startled early in G2, a little bit less than 20% of the companies are doing it. But again, by G5, a hundred percent of the companies are doing it. Why? Because in succession, if I'm going to decide whether you can be a leader in the company, on the board, on the family council, and I don't even know if we have those entities yet, you have to know what that means, I have to know what that means. And we have to be educated and have prepared owners, and family council members, and business leaders take over in that way. The third one is a family constitution. This one sounds really terrifying and we'll explain what it is later, but I'll give you the short answer. The short answers are family constitutions just the compendium of these governance documents that you're going to have, whether it's a family values mission, whether it's the operating agreement for the company, it's literally just a folder and you would populate all the documents inside of it, you build that together.
And honestly, the work of building the documents is much better than the actual documents. You'll probably find some people out there who will sell you your own family constitution and they'll sell you a decent price to make it pretty and it's going to be beautiful. It's going to look like this, right? Real professional, but it's going to go in your drawer. One of the things that this means is a family constitution that's known, that's been worked on with a family, and that's referential and it grows with the family. A constitution is a living breathing document. Above that, it's family council. A lot of people start creating their family councils, over 60% of them in the second generation. Why? Because there's more than just mom and dad. But as you see in that transition year, G3 to four, and in G5, all of them have a family council.
Now, there is such a thing as too soon to create a family council. If it's two parents and two kids, two adult children and their children are babies, maybe we don't need a family council, and we'll get to that in a minute. But at the end of the day, when you have cousins involved, you need a family council. Partly because we've all grown up in different homes. Our grandparents were the same, but our parents were different. We spend differently, we save differently, we have different views for how the business should be run. Some of us are more or less risk averse, and so that's how we balance and discuss those. The other one that everyone hates, half of my LMC clients are going to sign off right now and they're going to be done with this conversation is an independent fiduciary board of directors. I get it.
You've watched the Uber TV series or you heard about Steve Jobs, boards come in and they take your companies away. They absolutely don't. A good board, an independent board, that means it's not populated with your best buddies, that means it's not family members, really is helping you think strategically. You can even set up your board where if you don't have someone who does social media, someone on there to do that and have expertise in that. If you don't have someone on your board that does high sophisticated finance and you don't have ACFO, but you have a great controller, you could fill your board with that. But same thing, an independent board by generation three helps add some rationale to the decision making, helps add some independence. And you bet, if you have two adult siblings or four adult siblings running a company and they're all in the C-suite and they can't get along, and mom and dad are no longer there, who's going to adjudicate that conflict? Well, the board will.
Now, not if it's high conflict, not if we're really mad, but at the end of the day, if the question is, "Do we expand or don't we expand?" And we're 50-50 deadlock. Four siblings, two say we should expand, two say we shouldn't. We go to that independent board and they're going to weigh the pros and the cons and they're going to say, "Here's the business case, here's what we think." And they're the ones that are going to say, "Yay, verily we expand," or, "No, we don't." Because expansion involves probably taking on debt, changing how profitable you are for a short period of time. It might also mean taking a haircut on our dividends, and that's the beautiful thing there. This last one is a non-family CEO. Now for most of my LMC clients, often their leadership team is a family member in the future.
And it can be. For a long time, look, that's the one that doesn't have the dramatic same shift in trend that we're seeing in these other ones. These other ones, it goes like G2, maybe G3, but three, that transition between three and four, four and five, it's like almost everybody to be successful. Whereas the non-family, CEO isn't the mark of a great family company. You can have a family CEO throughout it for years and years, as well as have the ability to continue to get rigor and outside perspective using a board, using this family education, et cetera. So that's the research, at the end of the day, if you want to be a hundred-year family, you're going to have to implement some of these solutions, because that's what it takes. The question is, "Which one do you want to implement?" I know this question's a little early. You have your next polling question, which I ask, which is the best governance structure? You tell me. None of you are telling me, so it looks like you're going to have to fill in those answers.
Great. And these are the other common themes that happened in this hundred-year study, these are intentional families who are thinking about this intentionally. The fact that you were on this webinar, we've got over 150 people on this webinar today, so that's telling me that a lot of you are starting to think about what's going on. You're also going to be balancing multiple goals. Sometimes the family needs, like I mentioned, that everybody gets the same salary, that it feels fair. It's not a really good business need. Imagine that that family CEO, it looks like most of these family CEOs, should that family CEO really make less money or the same amount of money as a family VP? I don't know. That doesn't sound very fair. So balancing those goals are important. That you're resilient to be able to handle these challenges and that these governance practices evolve. So like I said, if you buy some governance documents tomorrow, they're not going to be valid almost the next day.
What you're going to want to do instead is create your governance documents and check in with them. I use the example of you have two parents and you have two kids, and I said maybe they don't need a family council yet, but you know what? When each one of their two kids become of age, and that depends on the family, but of age might be considered 16, we might then need a family council. Even though we made a decision today, doesn't mean that the governance can't evolve at some point in time. That it's going to be collaborative and stewardship is the most important thing, and that stewardship says really that this isn't ours. And I think that's one of the things that's really challenging when we start the governance and legacy family conversation, that we're all waiting for it to be ours.
At some point in time I want to be the leader, I want to be the CEO and then it feels like mine. But if it's going to be to the fifth generation and be for other people, thinking about it as leaving that legacy for others and it is going to serve us today, but serve us in the future as well. And that's one of these things where governance can be helpful because even the best of us are imbued with our own biases and the biggest biases that we're imbued with is what's called egocentrism. You might not know what that means, but mostly that means we really like ourselves and we like the ideas that come out of our mouths and it's very hard for us to think that we might be wrong. And so stewardship is often done in a group, it's often done with people that we can hear, people who aren't us.
I think in the last conversation we talked about something called the closeness communication bias. It's when we say things to our family members.... Sorry. When we say things to our family members, they can't hear us because they're expecting what they already know to come out of our mouth. That's where those independent board members or independent advisors can really help you in this journey. Sometimes it just takes someone repeating what someone said, and I'm not going to go through all of this because you're adults and you can read and you'll get this later. I just wanted to touch on base on a few of these as we think about this. If you have a piece of paper, I'd like you just to jot down right now what you own and what ownership means to you. And I want to tell you a little story.
If I ask, "Do you want to be an owner of a family company and get million dollar dividends?" Hand goes up. "How about 5 million?" "Yeah." "500,000?" "Yeah, my hand's still up." "How about 5,000?" "Yeah, my hand's still up." "How about securing the debt of the business." And everybody's hands go down. Like, "It's not my jam. I don't really want to write the check when the business isn't going well," or the family office or you name it. But we also usually own a lot of things we don't think we own. For me, I own my dog, although some people might say they're family, they're not property. But my dad was in the Navy. He was enlisted first and then he became an officer, and he hadn't gotten his first civilian job yet. Just so you know, naval officers don't make a lot of money, he was making like 80K, and he hadn't found his job yet and he bought a boat, a boat that cost 80K. Except for my family that was a lot of money.
And my mom and dad, I thought they were going to divorce. It was the biggest fight ever. My mom, Pilar, was like, "Jack, what is wrong with you? You jerk. What are you doing?" And it was this whole big thing. And what finally came out of it, when my father could find the language articulated and when my mother could listen, those are two important things, he said to my mother that he's a naval officer, he had spent over 35 years in the Navy. It was his entire life. He has to have a boat.
Now, I'm not telling you my mother still didn't think it was insane and they weren't crazy nervous. My dad got a job three months later, became a vice president of a company. It was fine, they're fine. But ownership really does mean stuff to us and we don't tend to articulate it. We tend to think about P&Ls, balance sheets, distributions, but what we own means something to us. And so it's an inherently emotional conversation alongside the economic conversation that's there. Many shareholders will stay in a family company even though they've never worked a day in their life and that company because owning that company means something to them even if they're not working there. And that's what we need to understand about governance. Those governance entities allows those people who are owners who are risking their own capital to a company to get a return that makes sense, to get information that makes sense, to be involved in the decision making that makes sense, even if you're a minority shareholder, even if you don't work in the company.
If not, what happens is people try to get out, they try to use those exit policies, they try to sell those shares. If you have a family with four kids, that the parents gifted their stock to equally, a 25% sale of shares could mean something to families. Most family companies, most of my clients in LMC have very low debt. That changes when a quarter wants out of the equation. And that's what happens without governance. I want to just pause on The Three-Circle Model. We've seen this three circle model a bunch in this last webinar. I touched on it as well, but I want to help you all understand how these roles are different. We tend to say that families, that role conflict, I talk about it's usually called enmeshment.
Imagine all of these circles all on top, because that's what we saw mom and dad do, and we have a hard time teasing them apart. And so because we think they're the same, we create a lot of problems in that. And if you look at the ownership, the legal is an ownership role. The governance is an ownership role, distributions or reinvestment of capital in the company, the opposite of a distribution is reinvestment of the capital, owners get a say on that, the owners who are not working in the company get a say on that. The control of the family ownership is involved in the family and the continuity. Most executives in non-family company think in quarters, they're looking at quarterly returns.
Ownership is helping the executives and the family company to think about 10 year horizon. Not to say that... Let's use a stereotypical example. Your sister who doesn't work in the business of the LMC company and you do, gets to tell you what to do on the day-to-day, that's incorrect as well. When it comes to the money, when it comes to some other things they have a say, but a lot of this is the actual operators of the company, the values, the vision, the mission, the day-to-day of the business, most of who gets hired and fired outside of the C-suite, absolutely.
And as a family member, as much as you might have the same last name and you might be super charming, your rules are different. That's about the values of the family, that's about helping raise that next generation. We don't want to neglect that. Too often I work with families, I come in to a client and I say, "I want to also talk to the spouses." And I get a lot of pushback. "Why? They're not in the company." Well, they're raising your children, they're half of the equation of what people are going to think in the future when you have this shared decision making. We have our next polling question for your CPEs. I guess there were some challenges with the first one and we're checking your learning, if you absolutely understand what governance is.
Cool, 91% of you know already you can hang up if you want. A few percent of people don't know what it is. Awesome. I want to add in what governance looks like in The Three-Circle Model. You have the family, we already talked about the roles the family has. You have the business and you have the ownership, and they don't all happen at the same time. Some of you in your companies are already owners. Many of my LMC clients have given their shares to their kids sometimes as young as six months. Now, you're not voting as an owner because maybe the parents or the trustees still, but you may be an owner. Great, we got that. Who helps the family when the family gets big? And I've worked with some clients, where they have 800... No, sorry, 800. 80 family members. That's a lot of family members.
It's very hard to understand what 80 people want. Usually what happens is you create a family assembly. Again, this is for bigger families, we're talking about two parents, two adult children, young kids, you are not in family assembly area. If you have 30 family members, you might be in family assembly area. There's no hard and fast rule for when you start this, but usually when there are different voices in the family and differences of opinion, you create a family assembly. And a family assembly is the big group where everyone gets to come together, but they get represented by a smaller group.
What you have in the enterprise is you have officers and managers who often are the ones who are the decision makers in the company. You also have other employees, that's the larger group. In the ownership, you have either the shareholders or stockholders, that's the large group. And again, you can have, I was just working with a client a couple of weeks ago where they had 32 stockholders. That's a lot of people. To represent all of those people is difficult to do. So what you do... Sorry, the innovation is not working. Is you create these smaller voted in bodies that help represent them. Remember the family's large, 80 members, and although we have a family assembly that does do our family education, it does tell in general how the company's doing, also hopefully you have fun at the family assembly.
A lot of my clients help communicate the larger wishes of the organization that the family has. The culture piece basically is one of the things that that'll do, the company is often in the communities that the families live in. And that's important to a lot of these families. You guys might sponsor the little league team and that's one of those things that people want to keep seeing happening. You have the owner's council, which is a smaller group of owners who's voted in to help engage with ownership decisions, which usually have to do with liquidity, mergers and acquisitions, voting in the board. If you have 30 shareholders, those might not be decisions that the whole shareholder group does. It might be something that you delegate to the owner's council and the owner's council's job is to educate the larger shareholder body of what's going on. And then you have a board of directors, and the board of directors may also take some of the duties from the owner's council or the shareholders group.
I want to pause. Why I keep saying may in this, and it might be confusing, is there is not a family that I see that says, "We want governance." And I'm like, "Great, you're going to have a family council and owner's council and a board of directors." Because you likely don't need all of them, and especially not all at once. At a hundred years, you do, because there are so many stakeholders. But if we got together or you got together, forget me, I'm not coming in and working with your family, but if you all got together and you said, "Okay, we've got a company, we've got 150 employees and we've got five people at the top," call them C-suite or vice president, whatever you want to call them, that's the reason why you have five or so people at the top, because it helps organize that group of 150 employees.
In fact, a lot of tribes stop at the size of 150, that we've studied historically, and one of the reasons we believe that is it's the size that we could safely get information through gossip. At 150 people, I can ask if Steve's a good guy and John can tell me. At 151, it's too hard. And so you're thinking about the same thing in your family groups. So someone came to me and they said, "We have 150 employees and we have five executives." Great, you're doing governance in the business pretty good. Ideally you can solve all of those things, especially if there's a CEO who's a parental figure. If that is five people on top, nobody is a parental figure on CEO and people are fighting for who that should be, then we'd say, "Maybe we need a board. Maybe we need some other business people," that can help you organize your business needs and you would want to find those people and get those people to be independent.
It's possible that's not the challenge. Maybe everything in the business is running great. It's the 20 owners that haven't gotten a distribution in 10 years that have a lot of questions about what's going in the business. And sometimes we make up negative stories, that's how the brain works. So the story we're making up is the five people in the business are keeping it all for themselves and overpaying themselves, which in my experience and most of my clients, they often underpay themselves, but they might be spending a lot on capital expenditures. They might be growing a lot of value in the company, but people aren't aware that that's happening. So in that case, you might want a board of directors similarly to what we talked about that can help educate the shareholder group or you might want an owner's council. You might want a small group of owners who can ask some really good questions about this that can help understand why we might not be getting the dividends that we believe we're entitled to.
And that's where governance is really helpful, because in most cases, unknown information creates a negative story, creates distrust and creates conflicts. Now, that family that I'm talking about is pretty large, but like I said, we might only need a board for them. A board often with an operating company is the very first step and a lot can be solved there, because boards are really good at being outsiders who can share that information, they can cross collaborate with groups, which their board works for the shareholders so they can educate the shareholders and vice versa. You might though need an owner's council as I mentioned, because the owner's council can also help do the heavy lift of educating shareholders and there might be more interest in the owner's room or... Not and, or again, we're starting small. You're not going to have all three of these.
If you have your board, you are likely either going to want an owner's council or a family council. And you're likely going to want one of those, because what that does is help create appropriate education where you can help people learn how to read financial reports for non-financial managers. So to understand why even though the company's making lots of money, we might not have a huge dividend right now because reinvesting in the business. That also teaches about our business. Maybe we don't have a large profit margin and right now because the cost of goods goes up, we have a slimmer window, all of those components. So I wouldn't ever say to have all three of these at once, but you're likely going to want a board.
You can start with an advisory board because that doesn't have a fiduciary duty. The problem with advisory boards is I call them sometimes dummy boards. They can be really great transition boards. This is why I like an advisory board, because you're not ready to open up your kimono to everyone. People are worried about competition, but you're going to sign NDAs and board members have fiduciary duties, but I get it, you're nervous. So you can start with an advisory board. You still would like it to be independent, we're going to talk about this family with two adult children and two parents. You might have one parent and the two adult children on the board. That means you need four non-family board members to make it an independent board.
Now again, if it's a advisory board, that means they'll give you their advice and you can do what you want. But what I can tell you about really competent professionals who are going to be really honest with you about what's going on, they're not going to want to sign on a board where they get ignored. So you're going to want to try whenever you can to hear them out, learn from them as well. Someone asked a question, any advice for choosing a qualified independent board? Absolutely. The first thing is to create your own board charter. Be very clear on what you're doing with your board, even if it's an advisory board, and set that up and ask for the qualifications you want. Like I said, it might be you want someone with a little more finance background, you might want someone with more of an IT background.
Think about a gap that your company doesn't already have. You're going to want to pay them, and I know some people are like, "That's just too much extra money." But if you're paying a board member 40 to 80K a year, you could pay more, you could pay less, but you're getting that expertise and that thought process a few times a year at less than what it would cost an actual employee. Now, you're also going to want to make sure they have some if you're in a family company, which my LMC clients are, family business experience. Where they're not scared of the challenges you're going to bring that have some of the emotional components in. And you're going to vet them, you're going to create a certain set of questions. You're going to ask them do similar motivational interviewing style of what have they done before? Where have they been before? And you're going to create a matrix where you're comparing them side by side.
Similar to any regular employee, some of this is fit. At the end of the day, do they feel like they could be in a room with people who are clearly the majority owners to share their voice, share their perspective, and not back down? And this board, you would want to treat it the same, even if it's just an advisory board. The difference between the advisory board and the fiduciary board is the fiduciary board does vote. I mentioned earlier and I was joking about people being nervous about boards, but it's true. You would not believe how many privately held companies tell me the moment they have a board, someone's going to take their company.
You're not giving them your stock, they're not shareholders in your board and they don't want to take your company. Privately held board members often come from other privately held board companies or have exited their privately held board, or their privately held company, and they really want you to do better and they can also bring in the hard line when it needs to. If you're having a hard time as a parent deciding which one of your children to be as your successor and you've been watching them for years and it's a hair thin tie, you can bring it to your board and that's their job.
They're going to have to support you in that decision and hopefully do it rationally. And if you have a board, like I said, it's you, your two adult children and your four independent board members, that's seven people, the decision isn't only yours and hopefully it's done with rationale. I'm not going over these slides because they help describe the difference in what a board is, what a family council is, what a family assembly is, and what an owner's council is. As I mentioned, you're probably only starting with one of these entities, or two because the board doesn't represent the family, they work for the family, and dealing with 80 family members can be challenging. That's for your reference as we go on.
When I mentioned what is your family constitution, this is what a family constitution would consist of. Again, not all these documents, some of you are going to get off the call right now and be like, "I ain't ever doing that. No way, no how." You create the agreement when it makes sense. A code of conduct is perfect in a family company. It's one of the ones we start on. And it's the agreements of how we treat each other outside of closed doors. Inside of closed doors, a lot of my clients are loud, they use the F word, they scream at each other, it's part of their family culture. It's fine. My family gets loud too. Inside of closed doors you can do whatever you want, but outside of closed doors, do you really want your employees knowing that you two or you four siblings actually don't like each other and agree on each other?
And you create a dynamic in your company in which the employees know which parent to ask. Who's the cool parent? Who's the one who's mad about the other? Who's going to let me spend when I don't want to? One of the easiest agreements, and I can send you some forms on how to think about that, is the code of conduct. How do we as a sibling group, or a cousin group, or even parents with our children, you have in many of my LMC clients, you have a parent who hasn't left yet. So should the children also let people know how disappointed they are in that agreement? How do we talk about each other? Some families have social media agreements. A lot of my clients are really humble, so they don't like a lot of attention.
A family employment policy, if you don't have one, get one tomorrow. A family employment policy says when do families enter in the company, family members and who is family, our spouse's family, our cousin's family, our siblings' family, who counts as family when they enter in the company, who they work for, and ideally it's not another family member, but it could be under certain circumstances. How do they get reprimanded when they need to? How do they get fired if they need to? And one is, what perks exist?
And let me tell you all family companies have perks and they're not a bad thing. Maybe the perk is a company car. Maybe the perk is a company phone. The thing about enumerating that perks exist and codifying it and putting it in your employee handbook actually makes it simpler for employees to deal with. Now, if the perk is family members get paid a lot and don't work very hard, that's a challenge and I wouldn't encourage you to put that in your family employment policy, but the family employment policy says, "At some point in time, if we have to exit you, and hopefully you don't, there's a real rational reason for that." And even though you get to maybe have an accelerated rate to leadership, because that's our goal of having a family run company, there are still some things that are expected about you. Because that talent in the company that is non-family, you want to retain them too.
And when it seems like there's nepotism or favoritism, even if there isn't, the perception of that can be more damaging than it actually existing. Conflict resolution agreements are great, and I'm just going to tell you briefly and importantly, yeah, a lot of conflict resolutions, at the end of the conflict resolution agreement it says, if we can't agree outside of hiring a mediator, like me, that does family business work, often what they do is they go to the board to say whether we should go this way or go that way if we're at a stalemate. Even having a conflict resolution agreement says we're likely going to have some formal structure. And your articles of the organization, I hope already exist, but they might need to be looked at again.
I was just working with a client that hadn't had theirs looked at for 20 years and these first five documents actually, articles of organization, bylaws, shareholders agreement, distribution policy and reinvestment policy were all done by different attorneys at different times and in this family company they all conflicted with one another, which actually makes them less enforceable in case something happened. And so you're just going to want to examine some of these documents that you have today, really understand them in plain English to make sure they work. But we're not asking you to do all of this. I think if you see the three governance documents and you see this whole list of things, and do not hear from me today that you're going to create all of them always, because you probably have half of them already, but they need to be understood. You likely, as a family company, are reinvesting a lot of money in the company.
I rarely see that exception, but it makes sense to your adult children that you're reinvesting a lot in the company because they have trust in you as a parent who takes care of them, even though they might complain about the way you behave. If your son or daughter takes over that rule in the C-suite and does the same thing, they will not be afforded the same grace or trust, because siblings compete with one another. Instead, we will be thinking about how that person had treated us in the past, about how they think they're better than us. And so, even if your distribution policy and reinvestment policy are perfect and the best, you're going to want to do that family education, that second graph on that hundred-year study that explains these documents to the shareholder group.
You can see how governance in some ways is a fancy way to describe communicating what exists today. Because we trust our parents, even though we complain about them, to take care of us. And when it becomes our siblings in these roles, the immediate response is skepticism, the immediate response is something else might be happening. And those governance documents, or bodies, or a combination of the two can help you get this done. And a good board or good family advisor can support you in how you educate on these things. Even if you don't make any changes.
Personally, I can't imagine a world in which you aren't actually communicating with your family once there's a need for it. And that sounds cryptic, but I mean that if trust is implicit, you don't have to communicate as much. And so here's some of the communication structures you can use. If you say, "I'm never, ever, ever going to have a board, a board of advisors. You can't ever get me there." Not sure it's the best strategy, but you can have more executive meetings, management meetings, leadership retreats. You can have update calls from the company to the shareholder group. There are some very effective strategies that you can use to get you there. This is our last polling question around the transitions. To get your CPE.
My bias is that families know themselves better than we know them. If you were to ask me, yes, I could answer the question of how to get a qualified board member. The last piece I don't think I added to that, once you create the job description and those things is to reach out to your network. There's likely someone six degrees of separation from you that would be a great board candidate. And build your team. All of these people who you trust are going to be the ones who can also help you find your board. Now, should you have a financial planner and an attorney and a CPA? Absolutely. Should they be on your board? Absolutely not. Because those advisors need to stay independent in a different way than your board members are independent. Your board members are independent from you and from the entity, and by the nature of you having these types of advisors on your team means they're less independent because they're already involved.
We're just about at time. I wonder if there are any questions that everyone has. I can send some of the sheets I was talking about. You're just going to... For finding a board member and it's important to start this conversation early. To seat a good board member to get, again, let's call it the scenario in which you're getting four independent board members, it can take three to nine months to completely seat them, and you're going to want to have a board onboarding too, because you want to tell them about the company, you want them to not come in for nothing. That's the other thing I hear from my LMC clients about why they don't want a board member. "Our business is so complex they won't get it." I've worked with LMC people, I've worked with other manufacturers that have nothing to do with lumber, I've also worked with family offices.
It does take a while for someone to get to know your company, but at the end of the day, if you do a really good onboarding, they will understand what it is about your company and be able to add some value. You also do want someone who doesn't know the intricacies of your company because I mentioned that egocentrism at the beginning, there's another bias called sociocentrism, which means that I'm a lot like my group, so there's a way that other lumber guys are going to think about lumber and that might not be the best for your board. There's a great book called Range by Epstein Daniel, I think, where he talks about the outsider expertise is really important. In fact, there was an oil spill in the nineties or something like that, that they had a hard time cleaning up and there was an executive who'd just been hired and he felt actually like imposter syndrome when he was working for the oil company, and he had originally worked in construction. And he said, "When we can't move concrete, we use rebar."
And they basically created a very large example of what rebar would be to get the oil out of the ocean. That outside perspective and diversity of thought is actually incredibly valuable, even if they're not from your industry. And really helping them at the very beginning do a little board retreat for a day or two to orient them is going to be helpful for them to be successful. But if you forget that orientation, what'll happen is it'll take several board meetings for them to really get up to speed, and that's when people start saying, "My board is not terribly valuable."
Well, they're not oriented properly. They don't have the context which to be useful for you, and that's part of your job too, whether it's a board of advisors or a board of directors, you are together engaging to make this a useful proposition based on your relationship and it is front loaded. It does take more time at the beginning and it might take more money at the beginning. You might want to hire a search firm to help you with your board search. We've done that a lot with clients and we can tap our network to help support and find those as well. Great. I think we're about at time. Any questions?
Transcribed by Rev.com
Family Business Webinar Series | Part I
Family Business Webinar Series | Part III
What's on Your Mind?
Natalie M. McVeigh
Natalie McVeigh is a Managing Director in the Center for Individual and Organizational Performance and the Center for Family Business Excellence Group within the Private Client Services Group and has more than 10 years of experience as a consultant and coach.
Start a conversation with Natalie
Explore More Insights
DOT Weighs in on Budget; Two Proposals Relate to Nonoperating Foundations and Payout RulesRead More
Adapting to Market Volatility: Tax Strategies and Alternative Investments for Family OfficesRead More
Receive the latest business insights, analysis, and perspectives from EisnerAmper professionals.