Why some family constitutions fail

By Vijay Sathe , Alfredo Enrione and Donna Finley
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Family constitutions, sometimes called family charters, differ in details but generally specify the family’s values and vision, criteria for family member employment and ascent to leadership, and the rights and responsibilities of family members involved in the business and those who are not. Family constitutions are popular and have served many family businesses well over the years.

But some family constitutions fail to deliver the benefits the family hopes for. (See sidebar for an example of a failed constitution.)

In all of the cases we studied, the family business leader initiated the process of creating a family constitution with the help of an external adviser or facilitator. The document was developed in consultation with the family members who ultimately ratified it.

As we dug deeper, we discovered that what was described as “consultation” involved dramatically different levels of engagement and openness. In the less successful and failed cases, family members were informed about the purpose of the constitution and what it contained and were asked to review and comment on the document before it was signed. If there was discussion among family members, it was perfunctory and did not surface any tensions or controversies.

In the successful cases, family members had respectful but candid conversations about what they really wanted to do with their lives, including whether NextGen members wanted to work in the family business or not. It was not easy to reveal options and preferences that may be painful for others to hear (e.g., a son does not want to work in the company that the family leader “built for him”), but they found ways to be honest with each other and to disagree without being disagreeable.

There were five areas of inquiry that these family business leaders pursued patiently with their family members until answers were found that everyone felt genuinely committed to. Plans could then be developed based on the answers to these questions. We recommend the same process for anyone seeking to create a family constitution that delivers on its promise.  

If the family business leader has no interest in such inquiry — or if the leader dies before these conversations take place — we recommend that the descendants jointly pursue these areas of inquiry in order to develop a constitution they can “own” and live by.

We call these areas of inquiry “probes.” They are questions to discuss, new ideas to test and scenarios to explore with honesty and compassion so family members can find common ground. They are journeys of the mind and the heart.

Probe 1. “Do one or more of us want to stay together as a family business?” If all say no, ask: "What do we want to do?" in order to discover what that means in terms of the shared assets. If two or more say yes, ask them: “What do you see as the benefits and challenges of shared business ownership?"

Follow-up questions such as these may be helpful: “Do we acknowledge that staying together as a family business means committing to loyalty and mutual support for each other?” “Will we identify shared values and shared culture that we intend to live by, preserve and pass on to the next generation through stories and rituals?”

Probe 2. “Do two or more of us want to work together?” If the answer is yes, the people involved should consider this question: “What will be the benefits and challenges of working together?”

These follow-up questions might be appropriate: “What does ‘working together’ mean?” “Do we enjoy working together?” “Will working together strengthen or weaken our bonds of affection for each other?” “Who wants to work with whom, and why?” “If one or more of us prefers not to work with other family members but wants to remain part of the family business, how do we deal with that situation?”

Socioemotional wealth (SEW), or the family’s nonfinancial assets, is explored in the next probe. Ultimately, this boils down to the family’s emotional attachment to the firm, which is similar to the concept of “emotional value.”

Probe 3. “Do we want to create both economic and socioemotional wealth by working together? If yes, why? How will this happen?”

Additional questions such as these might be helpful: “How do we make decisions concerning key issues such as leadership, governance, structures, policies, practices and succession planning?” “How do we deal with potentially sensitive issues like performance expectations, needed skills and competencies, compensation and rewards, hierarchies in the workplace and definitions of roles, rights, responsibilities and accountability?”

Probe 4. “In order to create both economic and socioemotional wealth, what do we do jointly? Why? How? What do we do independently? Why? How?”

Some potential follow-up questions: “What is each family member’s opinion of the industries in which our enterprise operates?” “Who in the family would be involved in decisions about investing in or exiting from businesses?” “What are the advantages and disadvantages of owning joint assets?” “Are our legacy assets sacred and not to be abandoned? Should other assets also be considered sacred? Why?”

Other questions might include: “What estate planning issues might arise if a family member has no descendants?” “How high of a priority should we place on minimizing taxes, and what challenges might this priority level pose?” “Does anyone in the family have an estate that is difficult to divide because it is illiquid or for other reasons? How do we address this challenge?” “Should we use venture capital to encourage entrepreneurship in the next generation?” “How do we accommodate our different needs, different views on risk and liquidity, and different stages of life (wealth accumulation phase versus wealth distribution phase)?” “How would we address sensitive issues, such as mistrust, that might prompt a family member to seek an exit from our business partnership?”

Probe 5. “Does every family member feel that they are getting a fair share of the family’s total economic and socioemotional wealth?” If no, revisit Probes 1 through 4 and continue cycling through the probes until all family members feel that they can candidly answer “Yes” to this key question. 

Follow-up questions like these may be helpful: “What would we do if we have an underperforming business whose future viability is uncertain?” “What are the options for family members who feel they receive economic rewards but no benefits in terms of socioemotional wealth, or vice versa?” “What can we do to manage conflict or frustration or to address a perception of unfairness?” “If one or more of us are not getting sufficient economic rewards or benefits in terms of economic or socioemotional wealth, why should we continue of business partners?” “Should we conduct an annual family survey to measure whether each of us feels that their benefits in terms of economic and socioemotional wealth are adequate?”

It takes time — months or even years — for these journeys of discovery to reach desired destinations, as family members learn to communicate openly and respectfully. In order for a family constitution to deliver on its promise, the process of drafting the document must involve courteous, candid and courageous conversations among family members. 

Case study: A family constitution that failed

Bob Brown built a successful enterprise, Brown Engineering. His oldest son, Paul, grew up in the business and became the CEO. Two of Paul’s siblings, Rod and Irene, also worked in the company.

Bob decided to create a family constitution. Under his leadership, he and his family worked with an adviser for over a year to create a 40-page document that reflected his family values and outlined how to deal with the risks and potential conflicts. All his children signed the document and received equal shares in the company. They seemed happy and committed to the family constitution.

The constitution emphasized continuing education. Accordingly, Rod and Irene joined executive programs in a top local business school and Paul headed to one of the world’s top executive programs for family business leaders.

They came back full of exciting new ideas, but their visions did not converge. Rod wanted to grow his own division exponentially, while Paul wanted to invest the available resources to diversify into a new line of business. The board supported Paul’s position, and the diversification proved to be a success. By the end of 2007 the company revenues hit a record: They had grown 10-fold since Paul became CEO. Family members received a record dividend. It was a happy time for the Brown family.

The differences between Rod and Paul grew bitter after Bob died in 2009. In 2010 massive floods hit the region, and Brown Engineering’s biggest projects suffered delays and cost overruns. For the first time in almost 30 years, the company recorded losses and the family saw no dividends.

In early 2011, Paul’s siblings (all now outside the company) changed the composition of the board. Rod and Irene were elected to the board, along with two new independent directors. In mid-2012 they asked Paul, who was CEO and chair of the board, to relinquish his position as CEO so that they could appoint a non-family member as CEO.

In mid-2013 Paul’s son asked to join the company upon fulfilling all the requirements set out in the family constitution (including an MBA from a top business school). His request was denied when his uncles and aunt on the board, and the two newly appointed independent directors, voted against the proposal.

By the end of 2013 Paul had resigned from the board and started a new company with his son. He felt betrayed and hurt because he had made his siblings rich and they paid him back by easing him out the door. He told his siblings, “I will never divorce my wife; but now I am going to divorce you.”

The family constitution that Bob had expected would guide the family’s decision making and maintain family harmony had failed.

 

Vijay Sathe is the C. S. & D. J. Davidson Chair and professor of management at the Drucker School in Claremont, Calif., which recently launched the Global Family Business Institute. Alfredo Enrione is the PricewaterhouseCoopers Professor of Corporate Governance at ESE Business School in Chile and chancellor of the International Academy of Management. Donna Finley is the founder and senior strategist at Finley & Associates in Calgary, Canada, and senior fellow at the Drucker School. 

Issue: 
May/June 2021

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