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Saturday, Nov 23, 2019

Democracy or monarchy – which will family businesses choose?

Modern family businesses must decide if it is family first, or business first. They can then choose among various options to settle the future framework

analysis Updated: Aug 18, 2019 18:06 IST
Janmejaya Sinha
Janmejaya Sinha
Today, most of modern society draws from the ancient Greeks to define inheritance rules. It is now more common for estates to be split equally among siblings (regardless of gender). But this approach is not without its own challenges
Today, most of modern society draws from the ancient Greeks to define inheritance rules. It is now more common for estates to be split equally among siblings (regardless of gender). But this approach is not without its own challenges(Shutterstock)
         

The concept of inheritance is perhaps as old as civilisation itself. Historically, societies have taken one of two stances towards it. At one end of the spectrum, the ancient Greeks postulated that family wealth was to be shared more or less equally among sons (daughters were generally not beneficiaries of the estate at this time). Early Chinese civilisation ascribed to another school of thought, that of primogeniture. Here, the eldest son was entitled to inherit most of the estate. Primogeniture went on to become quite widespread in medieval times (especially among monarchic societies, which are inherently primogenital), but, as centuries have passed, it has come to be seen as unfair and its popularity has reduced.

Today, most of modern society draws from the ancient Greeks to define inheritance rules. It is now more common for estates to be split equally among siblings (regardless of gender). But this approach is not without its own challenges. In fact, despite being Greek himself, Aristotle was not an advocate of inheritance laws of his region. He even went as far as to opine in his treatise, Politics, that the constant division of family resources would eventually lead only to poverty and conflict.

One must also note that certain assets are more challenging to inherit compared to others. Money and land are easy to divide. Family members can take their share and be on their way. What they each decide to do with such inheritances is unlikely to impact their siblings. In contrast, a more challenging asset to successfully divide would be businesses owned by the family. While ownership shares in such ventures can easily be split, the business itself is an indivisible asset. While wealth may be divisible, managing the business is less easy to divide. As time passes, families grow and shareholdings fragment. Unless planned for in advance, such complex and fragmented ownership structures cripple the business’ ability to function.

In a monarchy, by establishing primogeniture (giving other siblings luxurious livelihoods but concentrating power in the monarch), the hope was that the country’s strength would not be diluted. In a democracy, this was not possible. But like there are many variants of democracy, there are many forms of family involvement.

A family business could be owner-managed where there is a head that is selected for a predefined time in a predefined manner (primogeniture, selected by an outside body or family council) with established decision rights. Other family members could also be in the business, but the chain of command is clear. Family heads may also consider splitting the business between siblings or give different parts of the business to be managed by different siblings. The family may choose to opt out of managing the business but exercise control through the Board (where they can also decide their level of involvement). They could choose to be more passive as shareholders, or create a Family Trust that has a defined purpose and clearly articulated decision rights in relation to the business, like appointing the CEO or giving direction to the Board members on certain topics.

It is imperative for a family to address and agree from among these choices. To begin with, modern business families must first ask themselves a basic question: “What is the purpose of the business”. Is it family first or business first? Families may decide that the business was created to secure the future of the family itself, in which case it is meant to be shared by all members equally. Under these circumstances, the family accepts that shareholding will continue to fragment at each generation, but also that they will share one fate. Alternatively, the founder may decree that his legacy is to be preserved by ensuring the business thrives and is managed in the most effective way to maximise its performance. In this case, longevity of the business becomes more important than equal treatment of family members. Family members may exit the business at each generation and control is likely to be more consolidated. Both these philosophies toward the business are completely fair for families to have, but it is important that they take a unified, explicit stance on this.

Based on their choice, families must be ready to establish principles by which they operate. If they intend to act as owner-managers and keep the business intact, then they must create rules on how they select managers and how they ensure fair wealth sharing to the full family. Selecting managers from within the family, and the control that goes with it, is never easy. It requires well established processes for successor identification. For families, which are by nature emotional, making such a decision rationally will be difficult, especially when more than one offspring is interested in being involved in the business. Offsprings who are not chosen to run the business must also receive their fair share of wealth or the family risks entering a phase of litigious conflict. This is difficult, because many large family businesses are worth thousands of crores. Buying out such large stakes is never trivial.

If they intend to manage collectively by their presence on the Board, again, they need to put in place clear forums and principles on how they agree on the portfolio and capital allocation towards different businesses and dividend policy. Running a successful democracy requires strong institutions and procedures. The family, which acts as the electorate, must define these rules. Only then can the inevitable challenge of fragmentation in ownership be overcome. But it requires careful thought from the entire family and a significant investment of time, effort and ongoing management. If not, they will implode.

Irrespective of the model family businesses choose, they will need to agree on the vision, create the governance, and spend time operating it, if they seek longevity. We focus the next two articles on managing family conflicts and creating institutions for family governance. Family businesses — pay heed or beware.

Janmejaya Sinha is chairman, BCG India. The article was written with the support of Varun Govindaraj. This is the third of a six-part fortnight series on family businesses.

The views expressed are personal