Great partnerships are based on aligned interests, and accepted rules for managing conflict. The by-laws, or operating agreement, of an entity codifies how the most important decisions get made and who gets to make them. The best relationships are where the by-laws are put away and not needed to resolve ownership conflicts in the future.
The root cause of conflict among business owners is typically a failure to anticipate problems and negotiate resolution mechanisms before the trouble starts. Often, one party doesn’t want to “send the wrong signal” at the start of the relationship. The excitement of a new venture, or bringing on a capital partner, often pushes aside the need to negotiate these types of details.
Getting it right at the beginning is the best way to manage relationships between partners. But needs change over time, whether driven by market conditions, new opportunities, ownership changes or chance. That is why it is important to review your by-laws or operating agreements every three to five years to make sure they are current with your situation. These documents should be reviewed well in advance of a capital event.
Unless you own 100% of the business yourself, you need to play chess, not checkers. If you do own 100% of the equity, then you need to decide what happens when you are not able to be decisive.
Your goal is to have current documents that anticipate future challenges; don’t wait until you have a problem (e.g., death, disability, termination or liquidity event) to decide the rules.
The most common need is to have a buyback clause, or put/call arrangement, in the founding documents. After all, you agreed to be in business with your partner, but not your partner’s spouse.
In a family business, ownership succession is typically the biggest risk in the business. That is why it is one of the greatest risks to the continuity of the business.
Boards are responsible for strategy, oversight, capital structure, management continuity and risk management. The board should not necessarily be involved in ownership succession, since that is the realm of the owners, not the board. But effective boards become responsible to assure that someone competent is in charge of ownership succession. An experienced director once told me that effective boards operate with the motto of “sensors on, noses in and hands off.”
So, if you are an outside director in this situation, what should you do if you see that the ownership group is not addressing its own continuity?
As with most matters in the boardroom, it depends. But here are the questions to ask yourself once you become concerned:
As a director, you are bound by the duties of care and loyalty. This situation is a test of both. You may want to consult the firm’s counsel, or perhaps an outside counsel, to make sure you fully understand the legal ramifications of the situation.
In other words, who is on which side? A person’s affiliation with a particular faction will influence their decisions and behaviors. In delicate situations like a business ownership conflict, when people play for “all the marbles,” it tends to bring out undesirable behaviors that need to be managed to achieve a resolution.
This is often construed as “who can I trust to work on the issues?” If you have been in the boardroom for a few years, you should already have a good read on people’s EQ, as well as their IQ, and how those forces will influence the situation.
With successive generations, there tends to be decreasing interest, or competence, to manage a family business. It is perfectly normal to have non-family members running a family-owned business, but someone still needs to represent ownership. If the fiduciary board has little guidance from the family, this becomes a true test of fiduciary duty. In that case, there is even more reason to get an unbiased third-party opinion of how to deal with conflict.
Staff, customers and suppliers may not be involved in what’s going on, but they are keenly interested in what is going on, since it likely impacts their livelihood. Think about it: the ownership problem may determine whether or not they have a paycheck, and all they can do is sit on the sidelines and hope someone tells them about the situation. As a director, you want these people to stay focused on their business mission and not look for another source of income.
Good common sense suggests that you want to keep business owner conflicts out of the court—and out of the press. Those forums will only make the situation more complicated and less pleasant. Not everyone has aligned interests on this point.
Typically, the outside professionals become the catalyst for change when there is no decision-maker. Their goal is to protect their clients, which initiates action. The independent director needs to understand their motivations and possible conflicts of interest, and from there discuss a sensible course of action with their colleagues.
©All Rights Reserved. August, 2021. DailyDACTM, LLC d/b/a/ Financial PoiseTM
Bruce Werner is the Managing Director of Kona Advisors LLC and served as an outside director on private company boards for the last three decades. Kona Advisors LLC provides advisory services to the owners, investors and CEOs of private and family-owned businesses. With deep experience in governance, succession planning, finance, strategy and management issues, Kona…
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