When it's no longer all in the family

The late managing director of Darrell Lea Chocolates, Jason Lea, once said that when looking for his replacement he mistakenly tried to choose someone like himself. He realised a new CEO was needed because new skills were required as the business grew. Family companies can easily make a similar mistake by recruiting directors who are too much like the founders.

Nowhere is the issue of choosing directors more vexed than in family companies. A second- or third-generation family may be wary of recruiting a non-executive director who may not understand the founder’s values or the nuances of family businesses. Instead, they might recruit directors who are too close to the business, such as an accountant or adviser, who lacks true independence.

The family company board might still be finding its feet and not have a nominations committee or established relationships with search firms that recommend professional, independent directors. Director nomination is still very much "word of mouth" and some might serve on the board for well over a decade, certainly longer than directors of most listed companies. The board might not yet have a formal evaluation process or use tools, such as skill matrices, when choosing directors. Such is the way for privately-owned family enterprises that can have very different governance structures.

Although it is dangerous to generalise, the issue for most family company boards is choosing the right directors, rather than finding replacements. The good news is that, anecdotally, many more family companies are starting to form boards.

Professor Ken Moores, founder of the Australian Centre for Family Business and a former Bond University Vice-Chancellor, says: "I am seeing many more family companies interested in forming a board and using a much more sophisticated approach when they do. There is a lot more demand from family companies for governance training and increasingly they are recognising the benefits of hiring professional, independent directors."

For some family companies, a board is about improving accountability within the business and dealing with intergenerational issues and family politics. For others, a board brings fresh skills, contacts and perspectives, and provides cost-effective, more accountable advice than higher-priced consultants who do not have the same legal obligations as directors.

The Dennis Family Corporation, a privately owned residential developer and home builder, gives an interesting insight into how successful family companies choose directors. Dennis Family Holdings is the parent company of Dennis Family Corporation, which in turn is the parent of several other entities within the overall business, including Dennis Family Homes.

Founder Bert Dennis says the family formed a board "to help build a long-term sustainable business". Like many family businesses, the Dennis Family Corporation, then a series of separate businesses in the 1980s, used to have informal board meetings that were more about providing information and dealing with family matters.

By the 1990s, the four Dennis children decided they wanted to run Dennis Family Corporation and build a business for future generations. "That decision triggered everything," says Dennis. "We knew from the start that if we were serious about building a long-term sustainable business that could last for generations, we needed to form a strong board. We knew we needed external members on the board, and that we needed to train family members who joined the board on latest governance practices."

Dennis’ foresight paid off. The Dennis Family Corporation is now one of Australia’s largest privately owned home-building companies, with 270 staff and thousands of sub-contractors. But as is often the way of family companies, the evolution to a modern, professional board took time.

"It took about eight years for the company to get all the ducks into a line," says Dennis. "There were family succession, business succession and ownership succession issues, and different parts of the business were in different ownership structures. Once we sorted out all the family issues, we felt ready to form a board and start recruiting external members."

By 2000, the Dennis Family Corporation had five family members on the board, an adviser and its first non-executive director, Ron Dennis (no relation), whom the family knew. The family felt the board was not ready for director they did not know. Soon after, a decision was made to appoint three non-executive directors who brought extra skills to Dennis Family Corporation.

The current board has five family members and four independent directors. Bert Dennis is still a director (and officially the founding board chairman) and his son Grant is the board’s executive chairman. The board has audit and risk and remuneration committees, also chaired by independent directors, but no formal nominations committee. Directors are appointed for a two-year term and the board had an externally conducted performance review in 2010. The company will continue with a program of annual internal board performance reviews and one conducted externally every three years.

As in other progressive family companies, Bert Dennis established a formal family council, separate from the board. It focuses on family matters, has a series of formal board meetings each year and its own external adviser to guide the family. This lets the Dennis Family Holdings board focus on business issues.

Bert Dennis says the board adds "enormous value". "I can’t believe how much information, experience and knowledge the company gets from its external directors for paying a board fee."

He says a good family director understands the difference between family companies and listed enterprises, knows the industry or has a particular skill set or expertise, and can embrace a long-term strategic view. "When we talk about long-term sustainability, we are talking decades and being a family in business across the generations," he says.

Bert Dennis is preparing for generational change within 20 years, and spending time mentoring the grandchildren on business matters. His four children, now aged 46 to 52, will be in their late sixties or seventies by then, and their 11 children will be in line to run the business if they choose.

"The next generation may or may not join the business in coming years, it’s their choice," says Dennis. "But having a board means the business is not going to disintegrate if the grandchildren decide to do their own thing. I know we have a sustainable governance structure and business."

The Dennis board approach is more advanced than many family businesses, which is not surprising given the company’s size. Bert Dennis says the company could even have an independent non-family chairman one day if the second-generation board members or the potentially future third generation do not want the responsibility.

The independence of family boards is becoming a bigger issuer.

Amplifi Governance Global founder and executive director Duncan Schultz FAICD does not favour family boards appointing advisers as directors.

"You often see family companies appoint their long-time accountant or tax adviser to the board," he says.

"A better approach is getting them involved as a company officer rather than directors. Someone who provides advisory services to the business can never be truly independent."

Schultz’s firm is benefiting from the growth in the number of family company boards through an innovative business model. It finds independent non-executive directors for family businesses and receives part of the director’s fee. The family business pays no search fee for a director Amplifi has vetted and provided with training and accreditation.

Schultz says his firm has placed about 20 directors on family business boards in the past two years and is growing quickly because of rising demand from family companies for independent directors. The firm has about 90 directors wanting to be placed on family business boards. Schultz, aged 43, is a member of the Australian Institute of Company Directors’ Queensland Division Council and has chaired at least 20 family company boards in the past nine years.

"I’m seeing a lot more family businesses recruiting independent directors for their board," Schultz says. "The main reason is accountability. The founder might think, ‘my son is not performing as CEO’ or ‘the accountant’s fees are too high’ or that ‘as founder I’m not performing like I used too’. He or she knows an external director can provide a much-needed independent perspective."

Schultz says he nearly always joins the board as an independent chairman, a strategy that runs counter to many family business boards, where the founder or a family member is always the chairman. "In my experience, the first board appointment a family business should be a governance professional, rather than industry specialist, to set up the board and establish the company’s governance culture. It can take up to two years for the chairman to build the governance foundations if the company has never had a board, or if there are significant family dynamics to deal with. There is no point bringing in other professional directors if the governance structure is not ready for it."

Schultz says the second appointment should been an industry specialist. "At this point, the family business should do a skills analysis and think about what it needs to grow the business, and whether recruiting an industry specialist can provide those skills. From experience, a family business should take it slowly with building its board and recruit directors as it needs them. It should get to feel comfortable with having more outsiders in the business, rather than recruiting them all at once at the start."

Schultz says family business directors tend to be heavily involved in finding their replacements, even though it not the right approach.

"Family business directors, if they perform, tend to stay on the board for longer periods than you see in listed companies, for example. When a director retires, it is a great opportunity for the board to refresh itself with another independent director and do an evaluation of board performance. It is also an opportunity to add another truly independent director if the departing director was very close to the family. Most family business boards never have a majority of independent directors, even though it makes a lot of sense."

Family Business Australia CEO Philippa Taylor says there should be limits on directors participating in recruiting their replacement. "The board needs to develop a matrix of existing talent on the board, and then a specification for the retiring director’s replacement. His or her skills may have since been duplicated by someone else and a totally different skill set may be required. It is helpful to then have a matrix of available family members from whom the board can draw."

Taylor says a danger is a departing director choosing someone too similar.

"Many of us tend to choose people in our own image – it’s natural but can be damaging. When a director is approaching retirement, it is a good opportunity to examine how the family business is changing, what new needs have arisen and what gaps exist in the skill set around the table."

Not doing so risks the family board "staying stagnant, and missing the opportunity to innovate and revisit the vision".

Taylor adds: "Beware of replicating what you already have; strive for diversity and don’t choose people because they ‘feel comfortable’. You need to ask the hard questions. Having said that, ensure that new directors are well acquainted with the company’s culture – share the history, meet the family and hear what their aspirations and expectations are."

Why some family companies form boards

1. Perspective: The founder wants a fresh look at the business and the cost and performance of management or service providers such as accountants.

The founder wants a fresh look at the business and the cost and performance of management or service providers such as accountants.

2. Accountability: The family wants management and service providers to be more accountable. Relationships may have become too cosy.

3. New skills: The founder lacks certain skills as the business grows and recruits directors with different expertise, contacts and industry perspectives. Hard-working, knowledgeable directors can be more cost-effective and accountable than consultants.

4. Intergenerational family issues: A board is formed to lift governance and help sustain a multi-generational family business over decades. Working with the family, the board helps shape the long-term strategy and ensures management executes it.

5. Succession issues: If future family generations are not interested in running a business, a board helps ensure management continuity.

6. Independence: A board provides independent thinking on issues that affect all family members, such as annual dividend payments, while internal family matters are dealt with through a family council that is separate from the board.

7. Family politics: A board can help formulate policies that reduce family politics, including for the recruitment, remuneration and performance evaluation of family members.

8. Management: A strong board is an important management resource. A structured, professional governance approach may help a CEO who previously dealt mostly with the founder. It may give the CEO new skills and networks to draw on.

9. The founder: Forming a board can reduce the founder’s workload and stress, and help in reducing or changing his or her role in the business over time as he or she nears retirement.

10. Family values: A good board will ensure the family’s values are always present in key decisions, and the family culture within the business is maintained.