Family shareholder agreements and family-practice fit: What works for your family?
This blog is based on the research paper “Addressing the theory-practice divide in family business research: The case of shareholder agreements”, published in the Journal of Family Business Strategy in February of 2021. Read the article >>here (open access).
Families often struggle with developing family (governance) policies that not only work for the long term, but that also adequately reflect and reinforce the family’s values and objectives. Unfortunately, families often create policies in reaction to some negative experience when they should be using a hopeful depiction of a united and loving future for the family as their benchmark. The consequences of such ill-fitted policies are too commonly harmful to the family; for example, leading to further disenfranchisement or spiraling conflict. This happens with many policies, like family employment policies, compensation policies, family council and board membership policies, and, family shareholder agreements – which is the topic of this blog.
What is a family shareholder agreement?
Family shareholder agreements (FSAs) are contractual, legally binding (albeit not easily enforceable), and typically confidential agreements between family shareholders. At a minimum, FSAs usually define the conditions under which shares can be bought, sold, and transferred, and generally outline voting rights and process (e.g., majority and super majority votes) as well as the valuation process. Sometimes, FSAs describe mechanisms to resolve conflict (e.g., arbitration or mediation process).
What is the purpose of a family shareholder agreement?
Most families put in place FSAs either to avoid unwanted ownership dispersion, to prevent future conflict, to insulate and protect the business, and to protect the right of all shareholders (including minority shareholders). Understanding the ‘why’ is key in developing and implementing effective FSAs that fit the individual family. If you lack a crystal-clear understanding of what you are trying to achieve (or prevent!) with this contractual agreement, it might be shaped by fears that rigidify the very thing you are trying to prevent. For example, families that had significant conflict because of unwanted ownership transfers might – in an attempt to avoid such a scenario in the future – opt for an overly restrictive FSA, which might then lead family members to feel ‘chained’ to the family business. The lack of possibility to exit – especially in the absence of measures taken to nurture group belonging and cohesion – can have devastating consequences for alignment and family harmony. No one wants a lawsuit from a disaffected shareholder seeking to leave, and when we feel unrealistically secure due to an overly formal agreement, we usually don’t see the size of our problems until it is too late.
What differentiates ‘good’ and ‘bad’ family shareholder agreements?
Very simply, a good FSA benefits the family, while a bad one, in the best case, adds no value, and in the worst case, cements and even exacerbates conflict. An FSA benefits the family when family-practice fit is achieved. Here, we refer to the unique context of the ‘Family,’ meaning its values, needs, and objectives, and the family’s ability to communicate and resolve conflict effectively, to instill a sense of committed stewardship across generations, and the effort it puts into making sure that family members are competent to make informed decisions that benefit and balance both family and business. ‘Practice’ refers to any governance mechanism – such as an FSA – put in place to formalize interactions within the family, or between the family and the business. And ‘Fit’ refers to alignment between the family’s unique context and the nature of the governance mechanism (the practice). In other words: If your FSA is not rooted in, and does not adequately reflect and reinforce your values, needs, and objectives, the policy, the family, or the business very likely will not last.
Families with low levels of trust, high levels of conflict and a limited ability to resolve conflict productively are well-advised to put in place safeguards such as a detailed FSA that outlines in detail the do’s and don'ts of ownership rights and responsibilities, and conflict identification and arbitration mechanisms. Families with high levels of trust, excellent communication and conflict resolution do not generally benefit from such formalization. If anything, such formalization can hasten the breakdown of the family and its supportive relationship with their business. If you are trying to nurture family harmony, belonging, and continuity, not just the content but the language of your FSA will look very different from a family that primarily puts an FSA in place to prevent conflict.
What should you pay attention to when developing a family shareholder agreement?
Leverage the process: Avoid any shortcuts – when developing an FSA, and any other family governance policy. Never, ever settle for an ‘off-the-rack’ family shareholder agreement to save time or money or to avoid conflict. Policies are made meaningful through the creation process: If you leverage the process – which means truly giving each family member the opportunity to make their voice heard – you help secure up front buy-in, instead of having to painstakingly secure it after the fact. Make sure the process is transparent and inclusive and well understood by all before beginning. Ask your family members about their concerns and hopes for both the process and the outcome, put in place a reasonable timeline (it always takes longer than you think) and talk to other families to get a feel for the challenges you might encounter along the way. Peer-to-peer learning is incredibly important and powerful in family governance work.
Assure fit: FSAs are effective and sustainable when they fit the family – but more than that, they must not just reflect your family, they must reinforce your family’s values and objectives. If you haven’t already, sit your family down as often as you need to gain clarity and alignment around your family’s values (what matters most to your family?), needs (what do we need from one another, what do we expect from the business?), and purpose (what energizes the family across generations and branches, what, beyond the business, keeps your family together?). Carefully assess your family’s ability to communicate effectively and resolve conflict, as this should shape your FSA (and any other family governance mechanism). Families that have a greater ability to communicate and resolve problems benefit from having more flexible policies. Clarity takes time so exercise patience with yourself you’re your family.
Keep it agile: Families change, and therefore the policies that shape family interactions and relations must be agile. Make sure you do not sabotage yourself by putting in place a policy that is impossible to revise. It is a good practice to have a regular review period for policies and to identify a procedure for reviewing and revising when needed, especially if those needs come between regular review periods. Policies must reflect the current state of the family, and if they do not, they cause more harm than good.
