Every Business Needs Good Governance, Including Small and Family-Owned Businesses

Corporate governance may sound like it is only for large, publicly traded companies, but the research clearly shows that all businesses benefit from good governance. A study by Morgan Stanley Capital International (MSCI) found that businesses with a good governance structure outperformed other businesses by 26.3%.

Governance structures of businesses differ dramatically in complexity based upon the size and nature of the business.

Small businesses, if they employ a formal governance structure, typically use a simple, basic model, often led by the founder of the business. For small businesses and startups, the focus is typically on survival, funding, and early-stage growth. The governance structure is typically minimal.

For mid-sized and growing companies, the focus is typically on preparing for potential expansion or an eventual initial public offering (IPO). Governance, compliance, and risk management become more critical for businesses in this stage of development as lenders and investors analyze the governance practices of those businesses and look more favorably on businesses with a good governance structure.

For large corporations and public companies, the primary focus is on value creation. A robust governance structure is mandatory, and strict adherence to regulatory filings (e.g., SEC), to corporate social responsibility, and to transparent shareholder communication is essential. Public companies are also required to abide by the rules of applicable listing exchanges (e.g., NYSE, NASDAQ).

For family-owned businesses, special governance structures are needed to address the unique challenges facing family-owned businesses. The governance structure must recognize the significance of running the business, while at the same time, recognize the significance of managing the family dynamics. If either aspect is ignored, the business likely will not succeed.

In this article, we will focus on the benefits of good governance for small to mid-sized businesses and for family-owned businesses. It makes sense to consider these types of businesses together because there is often considerable overlap. In fact, most startups (as one would expect) and most family-owned businesses start as small businesses. According to the SBA (US Small Business Administration), most family-owned businesses are small businesses with fewer than 500 employees. There are, of course, notable exceptions. For example, Walmart and Ford Motor Co. are both large, publicly traded companies that remain classified as "family-owned businesses".

Good Governance in Small to Mid-sized Businesses

It is important to start with the basics. Governance fails when it feels like lots of extra work. Good governance should align with making good business decisions, like defining clear roles and processes, and ensuring accountability. Even a small business can benefit from defining who makes decisions, how those decisions are made, and how the business holds itself accountable to stakeholders.

Start with the Basics

• Hold regular meetings. Even in a small business, use meetings to build trust and accountability.
• Keep good records. Maintain accurate financial, operational, and legal documentation. This helps track performance, meet compliance obligations, and makes the business more attractive to future investors or buyers.
• Emphasize ethical business practices. Foster a culture of integrity from the start. This might include producing a Code of Ethics & Business Conduct or policies addressing conflicts of interest. The vast majority of employees want to work for an ethical company and appreciate the business establishing an ethical culture.
• Consider engaging advisors. Many small business owners are opposed to creating a Board of Directors for fear of losing control. Consider creating an informal advisory board of trusted mentors or industry experts. They do not have to have voting power, but their guidance can help challenge assumptions, uncover blind spots, and improve the businesses' strategic direction.
• Consider developing a risk management program. Proactive risk management has a distinct role in good governance. Doing frequent risk assessments helps to reduce the possibility of a threatening event developing, or if it does develop, the business has plans to deal with the event. I have also found that risk assessments improve the business. The same process that identifies risks also identifies the best way to do things, so risk assessments, indirectly, improve the businesses' performance and productivity.

Small business governance is about more than just "checking boxes". Governance is a strategic asset that aligns people, processes, and priorities. Clarity around roles, systematic oversight of finances, and well-documented policies allow for good business decisions. Also, consistent communication maintains transparency and fosters a workplace culture of trust.

Good Governance in Family Businesses

Fact: Family Businesses are extremely important to the US and Global Economies.

Year after year, Family Businesses:

• Fuel around 85% of startups worldwide.
• Comprise around 35% of all Fortune 500 companies.
• Comprise around 90% of all North American businesses.
• Contribute around 57% of the US GDP ($ 8.2 Trillion).
• Create around 60% of the world's total employment.

And yet, as important as family businesses are to the US and Global economies, 90-95% of all family-owned businesses do not survive through the second generation of the family, and an even smaller percentage survive through the third generation.

"Most family businesses do not realize they have a governance problem until it has already become something else - a conflict that will not resolve, a decision that no one feels they can make, a non-family executive who quietly starts looking for another job, a next generation leader who feels excluded from conversations that will determine their future." – FamilyBusiness.org

"Governance is not a synonym for paperwork or formality. It is the set of structures, agreements, and processes that determine how decisions get made, who has authority over what, and how disagreements get resolved before they become conflicts." – FamilyBusiness.org

What are the Primary Goals of Family-Business Governance?

• Separating family and business roles by distinguishing personal relationships from professional roles helps ensure that emotional family ties do not cloud business decisions.
• Enhancing decision-making by establishing clear protocols and rules, and making decision-making processes more efficient and less biased.
• Mitigating conflict by providing mechanisms for resolving disputes before they escalate, protecting both family harmony and business interests.
• Ensuring sustainability across generations by supporting strategic planning and succession processes that are crucial for the long-term stability of the business and legacy of the family.

What Are the Primary Tools Used in Family Business Governance?

1. Family Constitution (or Family Charter)

The Family Constitution is a foundational, governing document that outlines the families' shared values, vision, and rules for governance. It often includes provisions regarding share ownership, employment policies, and guidelines for decision making, serving as a critical reference point for resolving disputes and providing continuity across the generations.

2. Family Council

The Family Council serves as the primary means by which the family can connect with each other about the business. Unlike the Family Constitution, which is the governing document, the Family Council provides an informal opportunity for candid discussion about topics of interest to the family. It can facilitate discussions on strategic and operational topics that impact both the family and the business, such as succession planning, governance policies, and shared assets like investment portfolios. The Family Council is intended to foster unity across generations, ensuring that family members feel they have a voice in matters affecting the family and the business.

3. Board of Directors, or an Advisory Board

The Board of Directors governs the business and ensures that its operations align with the company's strategic goals and governance standards. The Board's responsibilities include approving budgets, setting strategic direction, and holding management accountable, making it a cornerstone of effective governance. Advisory Boards are non-voting bodies composed of external experts who provide guidance on specific issues such as market expansion and technology integration. While their recommendation is not binding, their advice adds significant value by broadening the business's perspective and improving decision-making.

4. Family Policies

Some family businesses choose to establish policies designed to govern decision-making, provide more objective criteria for working in the family business, and create a framework for resolving disputes.

• Family Decision-Making and Authority Policies: Operating much like bylaws in a corporation, these policies typically set forth the way decisions are made in the family business. It is advisable to distinguish between operational decisions (which should be made at the operations level, not by the family), strategic decisions (which should be made by business management), and ownership decisions (which should be made by family owners).
• Family Employment and Compensation Policies: These policies typically address requirements for entry into the family business (e.g., education, work experience, etc.) as well as compensation decisions (e.g., salary commensurate with the market rate for that role in the business).
• Family Conflict Prevention & Resolution Policies: Governance structures, no matter how good, do not eliminate conflict in family businesses. Conflict is inevitable. Family dynamics are complex and operating a business is stressful. What good governance can do is provide agreed mechanisms for resolution that do not require permanently damaged relationships. The most important conflict prevention tool is clarity - clear policies, clear roles, clear decision-making authority (including non-family executives), clear expectations about performance, and clarity around accountability.

Where to Start if a Business Needs to Establish a Governance Structure?

I recommend that businesses start with a basic structure. Remember, governance fails if it feels like lots of extra work. The steps a business should take at the start are the steps necessary to answer the basic questions:

• How are important decisions to be made?
• Do we have a succession plan in place (TIP: what would the plan be if the founder did not return to the business tomorrow?
• What are the requirements or criteria for family members to work in the business?
• What authority do non-family executives have to make decisions in the business?
• Is there a mechanism for family members to be heard if they have a concern about the family business?

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