A constitution is a tool to preserve a family's legacy
As families and their businesses grow over multiple generations, the number of individuals involved in a family business naturally increases, family members’ expectations regarding the business may diverge and related conflicts may arise. An important way to manage and deal with these types of contingencies is by creating a document commonly called a Family Business Constitution.
Although constitutions are often written about and discussed by family business advisers, few family business owners have taken advantage of this useful tool. However, those families who have created and implemented a constitution have found the document to be instrumental in preserving the legacy of the business and helping to sustain the enterprise for future generations.
Professor John Ward, co-director of the Center for Family Enterprises at the Kellogg School of Management and author of several leading books on continuity in family businesses, describes a family business constitution as “a comprehensive articulation of philosophy, principles and policies for the future that balances and synthesizes the welfare of family, owners and the business, [and] is among the most important steps a business-owning family can take to secure and strengthen its business and, most preciously, its family” (Daniela Montemerlo and John L. Ward, The Family Constitution: Agreements to Secure and Perpetuate Your Family and Your Business, 2005). A constitution also engenders pride in the family and its business by connecting past, present and future generations with each other.
Purpose and form
Depending on the particular family, its business, its stage of development and the family members’ desires, a constitution can take many forms. It can be either a short document or a very long and complex one. Traditionally, a constitution serves the following main purposes:
1. It documents the mission, values, philosophy and principles that govern the family and its business, including the struggles of past generations.
2. It outlines the business’s strategy and its long- and short-term goals.
3. It defines dispute resolution processes to deal with potential conflicts affecting the business and the family.
4. It defines the roles, composition and powers of key governing and other constituencies of the business, including key management, directors, shareholders and family members.
A constitution is typically a formal, written document (or set of documents) that is reviewed, acknowledged and signed by all family members involved in the business. However, it is generally not a legally binding agreement. Rather, it is a statement of principles and guidelines for the business and the family members’ relationship with the business. In effect, a constitution creates a moral obligation among the family as relates to the business. Being morally bound in this way signifies the commitment of each family member to preserve the family’s legacy and grow the family business for the benefit of future generations.
Despite not being legally binding itself, the constitution could include or refer to other legally binding documents. For example, the constitution may suggest that each family member be a party to (if applicable) premarital agreements, employment contracts, shareholders’ and buy-sell agreements and estate planning documents. The constitution is not intended to alter the provisions of existing governing documents that provide for the legal structure and governance of the company (e.g., certificate or articles of incorporation and bylaws)—and this should be noted in the text of the constitution.
The process of creating a constitution is a helpful exercise for a family business. It forces the involved family members to discuss and define their shared vision and come to a common understanding as to how to document this vision, as well as any other matters addressed in the constitution. Again, depending on the family, its business and the management and governance structure, this process may be very simple or very complex. For this reason, most families choose to engage an objective outside adviser with experience in creating family business constitutions to lead and drive the process and, in some instances, to serve as a referee. Regardless, in most instances, it takes a family several months to create a workable business constitution that all involved parties are willing to sign.
The specific provisions of a constitution are unique to the family and the business, but a constitution usually begins with a statement or preamble relating to the mission, values, strategy and philosophy of the business as well as statements describing applicable history, life experiences and traditions. The remainder of the constitution then lays out rules and regulations to be used to govern how future generations should run the business and treat each other. These rules and regulations can cover any number of matters, including the following:
1. Composition and rules of conduct for the governing bodies of the business (which commonly include a traditional board of directors as well as a separate advisory council made up of only family members).
2. Leadership and succession plans.
3. The hiring, compensation, evaluation and termination of employees who are family members.
4. The identification, development, training, appointment, evaluation and termination of management and members of governing bodies.
5. Policies relating to communications and disclosures between the business and family members.
6. Processes and procedures relating to the resolution of disputes among family members.
7. The rights and obligations of shareholders and provisions relating to stock ownership, including benefits available to family shareholders not active in the business.
8. Guidelines relating to retirement, including retirement age and other matters.
9. Stock buy-sell processes and policies (including detail as to certain triggers, such as death, disability and termination of a shareholder).
10. Guidelines relating to the sale of the business or other exit strategies.
11. Policies relating to premarital agreements and estate-planning matters.
12. Policies regarding the provision of family financial support.
13. Policies regarding ownership and management by non-family members.
14. Procedures for amendment of the constitution.
As is likely evident, any of these matters could be addressed very simply or with much complexity.
It is important that any constitution be considered a working, flexible document capable of moving with the times. It should be regularly reviewed and updated to ensure that it remains relevant and to reflect any changes that time and circumstances necessitate. However, the constitution should also make clear that any changes made to the document should be consistent with the intent and goals set out in the constitution.
A family business priority
A family constitution has been shown to be an important tool in preserving and honoring the legacy of a family business for future generations while also defining the strategies and goals of the business. It also serves to engender pride and engagement in the strengths, talents and sacrifices involved in the formation and growth of the business. While a constitution may not prevent conflicts, it can establish a way to manage and resolve them, as well as a way to define the roles of individuals involved in the business. Each family business should treat the creation and implementation of a constitution as a high priority.
Frederick D. Lipman and Linsey B. Bozzelli are partners in the Philadelphia office of Blank Rome LLP. Lipman is also the author of The Family Business Guide (Palgrave Macmillan, 2010).
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