An introduction to family constitutions

In support of the Institute of Family Business's Family Business Week 2022, we are re-sharing some of our blogs that focus on how divorce and separation can impact on family businesses.  This blog was first published on the IFB's website in 2021. 

Managing family wealth, businesses and legacies can sometimes involve a divergence of views between family members as to how this may be achieved and the role individual family members, and others, are to play.  Certain events may result in further challenges, for instance the retirement or death of a founding member in the family business or a family member’s divorce.

Why have a family constitution?

Family constitutions aim to create a guiding protocol with regard to the governance of the family as a whole, although sometimes more specifically in relation to the running of the family business. A family’s philanthropic endeavours may also be covered within a family constitution in order to promote its legacy. The family constitution is a written document which establishes a set of rules and in turn illustrates the family’s core values, strategy and governance structure for navigating the family’s affairs.

Family constitutions are typically not legally binding documents or if they are, they are only legally binding in part. Instead they are more similar to a statement of intent.  They are agreements entered into by family members which represent the consensus view of the relationship between the family and their affairs.

In relation to the family business, family constitutions shouldn't be confused with shareholders’ agreements.  Shareholders’ agreements are normally legally binding. Some family members who are not shareholders, for instance beneficiaries of a family trust which owns shares in the business, might be a party to the constitution whilst there may be shareholders, such as external investors, who are not parties to the family constitution but will be parties to the shareholders’ agreement. The biggest difference is that a family constitution often deals with issues incapable of being the basis of a binding legal agreement.  

The content

The content and length of a family constitution will inevitably vary on the basis that family circumstances vary drastically.  For instance family businesses range vastly in size and complexity.  However, issues which are commonly addressed in relation to family businesses include the following:

Strategy

It's considered helpful to set out the family’s overarching vision for the business at the outset of the family constitution. This may be a broad statement, for instance that the business aims to preserve wealth for future generations. Alternatively, it may describe the long-term strategy in more granular detail. This may depend on whether the business is to be wholly owned by the family indefinitely or whether the family may contemplate external investment; if, and when, the family would consider selling the business and on what terms and the anticipated growth of the business.

Ownership

A family constitution will likely set out which individuals are allowed to own shares in the business – this may include all bloodline family members or only bloodline family members who are employed by the business and may exclude in-laws, for example.

The constitution should explore who has voting control and who doesn't, with the use of voting and non-voting shares, and whether there will be any restrictions on the number of voting shares an individual may hold.

A sensible issue to be addressed is who might be able to inherit a family member’s shares or what should happen to shares should a family member wish to sell theirs. Whether shares are regarded as a capital investment, which can be sold to raise capital, or as an asset to be passed on the next generation will inform the exit and succession strategy of the business.

Dividends policy

The dividends policy may take into account whether family members are dependent on dividends and whether all family members should be treated equally under the policy. Some family members may be more dependent on the dividends than others which might be reflected in different classes of shares, for example. The level of reinvestment required for the business might be covered and how this will be achieved.

Directors

The family constitution should set out the current or proposed board of the business and the designated chairperson. Other considerations may include the relevant criteria for the appointment of executive and non-executive directors; whether the chairperson or managing director should always be a family member and any entitlement to a seat on the board, for example, for each branch of the family.

Governance

Governance issues often include whether the entire family should meet from time to time, and if so, how frequently and on what basis. Some families establish a family council, depending on the numbers of family members involved or the nature of the family business. Sometimes a family council will include all direct family members once they reach a certain age.Where there is a family council, the council will carry out particular functions and take decisions, eliminating the need for the  whole family to do so. 

Employment

The constitution may record any appropriate criteria for employment in the business, for example if a family member must have a requisite period of experience to become an employee.  Other issues to be covered may include determining who is to be responsible for approving the employment of family members, deciding their remuneration and terms of employment or conducting performance appraisals, if any and whether there is an obligatory retirement age.

Disputes

The family constitution may provide for a specific dispute resolution mechanism should a dispute arise whether in relation to the business or between family members (for instance, a married couple having relationship difficulties which might affect the business). Provisions for mediation or arbitration could be included.  This seeks to avoid costly litigation which could harm the family business.

The process

As we have covered, family constitutions are unique documents tailored to the needs of the family, and family business, in question. Similarly, they evolve over time therefore it will be necessary to revisit the document over time to ensure that it continues to serve its purpose.

The exercise of producing a family constitution is often useful in itself as it will engage the whole family and provide a platform to explore all aspects of the family’s dynamic and circumstances.  An external family business consultant is often advisable when preparing a family constitution given the various strands such a document will draw in. Further, they can detect any underlying issues to be addressed and facilitate meaningful debate between family members to ensure that one individual does not dominate the considerations.

Here at Mills & Reeve, we have lawyers with in-depth experience of helping owner managers and family businesses achieve their long-term ambitions, for their business and themselves. Everyone we work with has different aims and their business follows different paths to success. Working with colleagues across our private wealth sector, you can build a long-term strategy to help ensure you make the best decisions for your business at every stage.