March 26, 2018

Independent Directors in Family Business

By F. Douglas Raymond and Laura B. Fix

In a Successful Family Business, Do You Need (or Want) Outside Directors?

A successful family business often is successful precisely because of the brains, blood, sweat and tears of the family, or at least those members of the family who have devoted themselves to the enterprise. No one has as much invested, either financially or psychologically, in the long-term success of the business. So why should the family consider bringing outsiders into the business at all, much less as directors who could run wild in the boardroom? After all, the family understands the business and the dynamics among family members (and between the branches of the family) better than anyone else could. Nonetheless, for many companies there can be significant advantages to adding one or more non-family members as directors. Owners of family businesses should periodically consider bringing outside, independent directors on board, who may be able to provide valuable perspectives to challenges facing the company and the family.

A board’s core functions are often described as identifying the company’s strategy, hiring and, when necessary, firing the chief executive officer, and stepping up to help manage the company during important transitions and times of crisis. In addition to providing insights on day-to-day operational issues, an independent director can fulfill these core functions, in some ways, more effectively than a family member.

Diversity of Perspective

Most families have an established hierarchy, often with a single dominant patriarch or matriarch. This is true for highly functional as well as dysfunctional families. However, in family businesses, this hierarchy is almost inevitably carried into the boardroom, where it can create dysfunctions or other problems. Family members serving on boards often find it difficult to voice reservations or objections to the plans of the dominant family member, especially if he or she is the founder or has been a crucial driver of the business. For many people, it’s just not possible to openly disagree with Mom (or Grandpa). And Mom (or Grandpa) can often be dismissive of the concerns raised by younger relatives. But this is problematic from a corporate governance perspective. Such a situation, where some directors feel constrained and other directors may be dismissive, can be corrosive to good corporate governance, which depends upon free and open discussion among directors, including candid discussions of different perspectives. In a similar context, in recent years there has been a strong effort by institutional investors and others to separate the roles of the Chairman and the CEO. This separation of roles is designed to level the playing field and allow for more robust boardroom discussions by lessening the dominance of a single director and creating, in a non-executive chairman or lead director, a countervailing influence. In the family business, independent directors can provide a similar function and provide a counterpoint to the patriarch or matriarch. Having an independent director who is able to speak frankly, even in an uncomfortable circumstance, can also give other family members space in which they too may be able to express differing perspectives. Adding an independent voice can transform the boardroom from a primarily family dynamic to a more professional atmosphere where discussion is not cut off merely because “we’ve always done it that way,” or because “that was your mother’s favorite [whatever].”

Moreover, it has been conclusively demonstrated that the quality of a board’s deliberations can be meaningfully improved if directors with different perspectives are participating.1 Diversity of perspective helps the board to consider the challenges a company is facing from different angles, better identify unexpected risks and complications of proposed actions, and come up with creative solutions. In a family business, where dominant personalities often rule and many in the family have the same or similar background, this diversity of perspective may be absent. Particularly in “bet the company” scenarios, family businesses benefit from the different experiences, backgrounds and perspectives that an independent director can bring.

Diversity of Expertise

Most public companies, and many others as well, have adapted skills matrices where they identify the qualities and characteristics they seek in their directors. These address areas that present particular challenges or opportunities, and can be as varied as marketing, operations, international, regulatory or cybersecurity as well as gender, race and sexual orientation. In fact, the New York City Comptroller, together with many pension funds, recently launched the Boardroom Accountability Project 2.0, designed to push public companies to increase diversity in director composition. Recently, some prominent pension funds, including the New York State Common Retirement Fund, announced that they intend to oppose the re-election of boards that do not meet certain gender and other diversity standards.2 Although these initiatives are somewhat controversial, over time, companies do require different skills of their directors, and it is unlikely that the family will have a suitable expert waiting in the wings for every situation. For many companies, this need for different backgrounds, whether to capitalize on opportunities or navigate a perilous situation, has led to bringing on an outside director.

Conflict and Changes are Inevitable

The best time for an independent director to join the board of the family business is when the company is not facing any significant challenges. He or she then has time to learn the business and to gain the trust and confidence of the other board members and family constituencies without having to simultaneously address an urgent crisis. Developing a deep understanding of the business and the family and building trust in those relationships are very important if one day trouble arrives.

When disputes and conflicts arise, they are often colored by the established power dynamic among the family members, which can affect the quality of the board’s decision-making process. As highlighted by the cliché “family firms fail for family reasons,” one of the unique challenges faced by family companies is the potential for disruptive conflict among family members, sometimes for reasons not related to the business. Almost two-thirds of family businesses have multiple owners.3 This can, and often does, lead to conflicts among family members, particularly if only some of the owners are active in the business. Even if a family director’s views are sound, others may take opposing sides based on family or historical relationships rather than business reasons or the best interests of the company and all the owners. If conflicts arise, the business needs respected voices who can offer a perspective not colored by familial pressures and who owe their allegiance and fiduciary duties to the entire business and all of its stockholders – not just one family branch. And perhaps most important, the very presence of an outside director in the boardroom often helps the family directors to remain professional and focused, much the way having guests over for Thanksgiving dinner puts everyone on better behavior.

Change is inevitable, but transitions can cause friction and create strife among family members. Having a person in the boardroom who knows the business well and has managed other businesses during similar transitions can be a major asset for a family business.

Management succession and the transfer of responsibility between generations is one frequently difficult transition. PricewaterhouseCoopers (PwC) conducts a biannual survey of U.S. family businesses, and one of the important themes reflected in the most recent survey is that family businesses have “a blind spot about succession planning.”4 Indeed, according to the PwC survey, less than a quarter of family companies have succession plans in place. The problem is not so much that family businesses have “blind spots” — rather, the subjects of retirement and transition are sensitive issues that can be difficult to raise, much less press, with parents, aunts and uncles. An independent director is, with some diplomacy, able to raise these issues without offending the family hierarchy and can encourage reluctant elders to buy into succession planning. Further, an experienced independent director can help identify situations where a family member may be underperforming, or positions where an unexpected departure would cause turmoil in the business, and help define what competencies are necessary for a successor in that role. Furthermore, in a family business, several family members may have built careers at the company. This can be particularly tricky if different constituencies have different expectations about who should take over leadership roles at the company. In these situations, the outside director can play an invaluable role and influence the decision without being unduly impacted by family history or power struggles. For companies where there has been some succession planning, an outside director can drive consensus to formalize the plan. Building consensus around a succession plan helps to ensure that the family and management are working toward the same goal and avoids crises. When the time to implement a succession plan comes, the new leaders of the company may also find that having the backing of an independent director gives them legitimacy in the eyes of employees of the company.

While many families want family members to run the family business, that is not always the best choice. It can be hard for members of the family accurately to evaluate their cousin, daughter or nephew for leadership roles and even harder to tell the family that an incumbent employee may not be best suited to manage the company. In the 2017 PwC survey, only 21 percent of family businesses said they believe they do a good job of appraising next-generation family members against non-family members for promotions. An independent director is frequently in a better position to objectively evaluate family members for management positions, and can consider whether it is better for the business to bring in a non-family manager.

In addition to being able to help identify when outside talent should be tapped, independent directors make it easier for a family company to attract non-family managers. When a family business actively involves independent directors, others see it as evidence that the family business is focused on professionalization. The non-family recruit can be more confident that the family members are willing to welcome non-family members into the company, and can see that the family is putting its desire to grow the company ahead of its desire to micromanage the business.

In each of these moments of family conflict and periods of change, independent directors can make the conflict or the transition smoother by keeping all parties focused on analyzing the best business outcome. During periods of change, family members who have dedicated years of their lives to the family company may experience difficulty adjusting to the changes. A trusted independent director can be a valuable asset as a calming voice of reason in such circumstances.

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