The rise of the family business constitution

Family businesses are acutely aware of the danger they face. Most do not make it beyond two generations: power struggles between successors and dispersion of wealth and control are just two ways in which a budding dynasty can fall.

More such companies are drawing up family constitutions, also known as charters or protocols, to help them prosper and endure. These are statements that set out a family’s values, strategic goals and governance.

They are not new — the Mitsui merchant family of Japan created one in 1722 — but their use has expanded, especially in the past ten years. The financial crisis brought disputes over asset allocation and the direction of businesses, and helped boost their popularity. Other factors to have spurred the growth of constitutions include volatile oil prices, political turbulence and the spread of family wealth out of China and India.

“Where the goal of the family is to continue to manage the family business or the family wealth collectively across the generations, a constitution can be very helpful,” says Bernard Rennell, head of family governance at HSBC Private Banking.

The proportion of family-owned businesses whose owners have a written constitution ranges from 63 per cent in Finland to 4 per cent in Japan, according to a survey of 2,800 family enterprises by PwC. In India the figure is 36 per cent, Germany 19 per cent, US 18 per cent, UK 14 per cent and China 8 per cent.

Companies whose owning families have adopted constitutions include India’s GMR Group, an infrastructure and manufacturing business founded by GM Rao; Carvajal, a publishing and packaging multinational based in Colombia; and the Dachser logistics business in Germany.

China’s Sun family adopted a family business constitution in 2005 after Sun Dawu, founder of the Dawu agricultural business, spent six months in jail for a grain deposit scheme judged to have misused public funds: it concentrated his mind on the need for a governance system to ensure the company’s survival.

Typically, a constitution will set out issues such as a family’s values and vision, its criteria for selecting the business’s leaders and rights and responsibilities for family members involved in the business and those who are not. They differ in detail, however.

The bigger the body of people you are working with, the bigger the challenge. There is a need to have a very structured governance system

“They don’t really have a typical length or form or content and they are entirely bespoke,” says Mustafa Hussain, partner at law firm Taylor Wessing, who has written a lot of constitutions for families in the Middle East and Asia. These have ranged from six pages to 30, depending on the circumstances.

Apart from the mission statement, Mr Hussain says the most important provisions are those to ensure the family portfolio stays together. “Keeping the wealth and the portfolio together protects you from the threat of ‘rags to riches and back to rags again in three generations’,” he says.

Provisions are often unique to a company’s needs. For example, the Schurter family, which owns a Swiss electronic components business, commits to setting aside a percentage of revenues for innovation every year. India’s GMR constitution stipulates the make of car each family member is entitled to have.

Constitutions are usually not legally binding though they must be drafted carefully to fit in with shareholder agreements and take into account structures such as companies, foundations and trusts. Mr Rennell says it is important to ensure that decision-making procedures have legal effect.

Family constitutions are a growth area for consultants, lawyers and wealth managers. Families often bring in consultants to handle discussions about creating a constitution, which can provoke arguments about control and what happens to wealth.

Once agreed, however, constitutions help to avoid conflict. “They tend to stick to what is in the document. In later years, when people wonder where they stand if one of them wants to buy out or one person wants to leave, they refer back to the document,” Mr Hussain says.

Advisers urge families to keep their constitutions up to date. The UK’s William Jackson Food Group, owned by the descendants of the man who founded it in 1851, drew up a constitution in the mid-1990s and reviews it every five years.

“The bigger the body of people you are working with, the bigger the challenge. There is a need to have a very structured governance system,” Nicholas Oughtred, chairman, who is the founder’s great-great-grandson, told EY for a family business report.

Elizabeth Bagger, executive director of the UK’s Institute for Family Business, says more first and second-generation families are opting for constitutions. She believes they can be advantageous, although the thing to avoid is maybe “being too rigid and prescriptive”. Adopting a constitution is no guarantee of avoiding conflict.

“You still have to talk, you still have to have relationships. Communication is a key element as well. A good governance structure combined with communication is important,” Ms Bagger adds.