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A "Family Council" is an executive body created and established by a business family. A Family Council enables a business family to agree and create governance rules and guidelines to regulate the interaction of the family and the business. A Family Council may be comprised of senior family members, and may, in large families, be a "representative council" where separate branches of the family are able to elect and be represented by representative council members.
Business families at a certain point, usually when the second generation contemplate a transfer of the business to the third generation, become concerned that the succeeding generation may not be able to agree a common approach to control and governance of the business; the informal way in which business decisions had been made by what would have been the sibling generation may not easily translate when applied to a greater number of family members (it's quite possible that a sibling generation may in time give way to a cousin generation of over 20 cousins. Coordinating the interests of more than 20 family members (excluding in-laws) can become a significant challenge).
Most family businesses are structured as corporations, in many cases this is for historical reasons. Corporate law generally does not differentiate between family owned and non-family owned businesses: shareholders are generally under no legal or other obligations to each other -corporate law generally views shareholders as disinterested individual investors and not connected family members.
Likewise, under corporate law, the office of director is not designed as a family forum but instead is supposed to perform a crucial business oversight and advisory role with respect to the company's CEO/management team.
Therefore, business families in transition or contemplating a transition of the business have no immediate answer to the basic question: how will the family control the business across generations? How will the family deal with potential and actual conflict? Corporate law generally does not provide an adequate answer, if any.
Most business families are aware of the risks: statistically 70% of family businesses fail to survive into the second generation, 88% fail to survive into the third generation, and an astonishing 97% fail to survive into the fourth and subsequent generations.
Lack of agreed family governance rules is a major contributing factor in business failure.
A Family Council is specifically designed to address this weakness.
A business family has four basic options when considering succession to the business:
- Sell the business and divide the proceeds;
- Liquidate the business and divide the proceeds;
- Split and divide the business amongst the family;
- Transfer the whole business to the following generation.
The first three options would not require a Family Council, the last option (option 4) would in a multigeneration family business benefit from a Family Council.
The following are additional circumstances in which a family may consider establishing a Family Council:
- prior to an IPO of part of the family business (the market value of the shares should reflect that the family business is thereby less risky);
- prior to entering into significant borrowing obligations (again, established rating agencies ought to take into account that the underlying family business would thereby be less risky);
- as part of an agreed settlement to a family shareholder dispute, provided that the family wish to continue in business together. There is generally no set business value below which it is not advisable to set up a Family Council, much depends on the individual family circumstances.
There are two aspects to consider:
- Administration of the Family Council and
- The substantive governance rules that the Family Council would typically create.
No two business families are alike, and therefore no two Family Councils are alike. The substantive administration rules governing the Family Council will reflect the individual wishes of the families involved. With that said, families will, at minimum, need to agree the following:
- Council Member qualifications and requirements;
- process to elect or nominate Council Members;
- whether Council Members are subject to any term limits;
- whether Council Members are subject to any automatic removal provisions;
- voting rights;
- quorum requirements;
- general administration procedures;
- funding requirements and budgets;
- powers to establish sub-committees, working groups and special interest groups;
- Family Council yearly timetable and agenda protocols.
The Family Council is designed to provide a forum for the family to agree high level rules regulating family participation and involvement in the business as well as key strategic business activities, and therefore a Family Council may at minimum consider creating governance guidelines in relation to one or all of the following:
- terms on which family members may join the business;
- terms on which family members may be terminated from the business;
- terms on which legal action may be taken against family members;
- terms on which employed family members may enjoy "benefits in kind";
- whether separate rules should apply to inlaws;
- director appointments and removals;
- approval of annual business plans (and significant departures);
- income retention policy;
- dividend distribution policy;
- significant capital disposals;
- significant capital acquisitions;
- connected party and anti-avoidance rules;
- information rights;
- change of accountant;
- change of accounting treatment;
- change of auditor.
Family Council may be established either in a family charter, or pursuant to the provisions of a shareholder agreement or by way of a formal separate legal structure. For the purposes of this booklet, we will concentrate on a Family Council created and established by a formal legal structure, with the ability to create legally binding governance rules, and administered by a professional third party.
The following pages illustrate a typical family business structure, and subsequent corporate reorganisation to accommodate a Family Council, constituted by a special purpose trust structure. The facing diagram shows an unstructured family business, with the following attributes:
- Mature family business, with cross generational ownership and involvement, though senior generation would retain overall control of the business;
- No formal family governance rules regulating interaction of the family and the business;
- The business would typically be in the process of modernizing its HR rules and practices to accommodate and prepare for greater reliance on third party professional executives and managers;
- Corporate governance rules would likely be default rules provided at original incorporation of the business, and may therefore not reflect current best practice.
- First stage of governance planning involves consolidation of the family business, typically by inserting an ultimate holding company (Consolidated Hold Co)
- Consolidated Hold Co would issue two classes of shares: participating non-voting shares, (Family Shares) and non- participating voting shares (Governance Shares). The Family Shares would carry full rights to dividends and to assets on a winding up of the company, but would not carry voting rights. The Governance Shares would carry voting rights, but would not be entitled to any dividends or to share in any assets on a winding up of the company.
- The Governance Shares would ultimately be transferred to and establish the Governance Trust.
- The Governance Trust is a form of special purpose trust. The Governance Trust does not have any beneficiaries, and is not intended to hold any assets other than voting shares (Governance Shares) in Consolidated Hold Co.
- The Governance Trust enables the family to establish separate decision making bodies. The principal bodies will comprise: a Family Council, Business Council and Enforcement Committee.
- The Family Council would typically be responsible for creating rules to govern interaction of the family with the business, while the Business Council would be responsible for creating rules to regulate key business activities.
- The Governance Trust would be administered by an independent trustee. The trustee would be responsible for enforcing the various governance rules created by the Family and Business Councils.
- The Enforcement Committee would be entitled to hold the trustee to account for enforcement of the various governance rules, and would have power to take legal action against the trustee for failure to enforce any governance rules.
- Each of the Family Council, Business Council and Enforcement Committee would be able to create Guidelines by which they will act.
- The Family Council and Enforcement Committee would typically comprise family members only, while the Business Council may also include non-family CEOs or executive directors.
- The various governance rules created by the Family and Business Councils would need to be made effective and enforceable across the family business.
- The trustee of the Governance Trust would be responsible for creating a form of master shareholders agreement termed a "Corporate Governance Charter" to which each of the family group companies would sign and adhere. The Corporate Governance Charter would contain all of the governance rules created by the Family and Business Councils.
- In practice each family company would then be obliged to follow the various governance rules, as a party to the Corporate Governance Charter, in conducting its business activities and affairs.
NOTE: trustee services is only provided in our offices that is licensed to such business.
The information in this document is not advice of any kind but general information only and should not be relied on as legal advice. Kensington Trust Group recommends seeking professional advice on legal or tax issues affecting you before relying on it. While Kensington Trust Group tries to ensure that the content of this document is accurate, adequate or complete, it does not represent or warrant, express or implied, its accuracy, correctness, completeness or use of any of the information. Kensington Trust Group does not assume legal liability for any loss suffered as a result of or in relation to the use of this document. To the extent permitted by law, Kensington Trust Group excludes any liability for negligence, for any loss, including indirect or consequential damages arising from or in relation to the use of this document.