Family constitutions: Why it is important for family-run businesses and what it should offer

The family constitution – meant to record and formalise devolution of familial wealth, vision, values and ethos – is becoming a compulsion. 

Dec 01, 2017, 06.18 PM IST 
By Kala Vijayraghavan ,
Lijee Philip

Increasing complexity in business and a growing propensity for disputes has birthed the concept of a family constitution, but the challenge, experts say, is to stay the course and execute it well. Recently, a consultant who had set up a family constitution heard from one of the younger members of the clan. It was a complaint on the way a particular vertical was being handled. Surprised, the consultant checked with other family members, only to find that there had been no business and family plans review meetings for a long time, defying basic norms of the charter. “The journey is difficult and some fall off track,” says Vijay Dhingra of Deloitte Haskins & Sells. “Many such families tell us that it is difficult to coordinate and agree to meet on a particular day. The constitution then gathers dust.” But the amalgamation of profession and relations in a family-run business is not a smooth road. The family constitution — meant to record and formalise devolution of familial wealth, vision, values and ethos over successive generations — fast becomes a compulsion. In larger businesses, a detailed family charter lays down ground rules to ensure and delineate long-term ownership. It keeps the family together but also provides a mechanism for separation — explaining how the business will be valued and shared with the family member seeking exit.

At GMR, founder and group chairman GM Rao (60) began work on a well laid-out succession plan, a code of conduct and rules for every family member’s entry to the business. With Rao’s two sons and son-in-law in the business, it was necessary to build a strong foundation. Harsh Mariwala’s Marico has the options of a ‘drop-dead successor’ or developing internal talent in its family constitution. A Business Necessity With policies and regulations in India evolving in line with global best practices, families are increasingly focusing on how to adapt business plans and ownership structures to this new environment of greater compliance and transparency — catalysing the trend of a family constitution. Experts say families today are conscious of, say, putting away some assets in bankruptcy remote vehicles or creating structures to legitimately address any potential introduction of inheritance tax. Varun, son of Vikram Thapar of Thapar Group, entrepreneur and director of KCT Coal Sales, says, “History has taught us that the absence of a framework that defines the parameters of participation in a family business and a clear succession plan are likely to have a negative impact on relationships between family members.” “The current generation of Indian business families has learnt from their western counterparts on how to foster shared respect and affection between working and non-working family members by implementing strong family governance structures that bring clarity of purpose and intent. These sentiments are essential for the business to run smoothly,” he says. Regulators and equity-infusing investors expect succession to be properly defined to ensure conflicts in business families are urgently addressed. Having a constitution ensures that business and family objectives are well laid out, which, in turn, brings value to the shareholders. However, its success hinges on how strictly the family head ensures rules and guidelines are followed. Grudging The Rules Rajesh Narain Gupta, managing partner at advocates SNG & Partners, says family members can be uncooperative about meetings and reviews. “Implementation of the family constitution is often a challenge. Not only are there legal hurdles, but the cost element is high, especially in case of assets transfer. Say, a family promoter trying to transfer his real estate to the trust would need to pay stamp duty.” The constitution also leads to creation of revocable and irrevocable trust structures and testamentary wills of family members. In several cases, promoters want to transfer shares of listed companies to the trust, which needs clearance from the capital markets regulator. With the majority of Indian businesses being family-owned, private equity (PE) investors are also more comfortable with families that have set up the constitution. Poonam Mirchandani, head of trust & fiduciary services for private clients, Barclays India, says the goodwill and market standing of a family-owned business now depends not only on governance at the corporate level but also on repute. Hence, solutions that help maintain an efficient balance between the two have become critical. Recently, a family constitution made it legally enforceable for a midsized PE investor wanting to the exit a family business, clearly stating considerations for shares and how it is payable over the next five years.

Gap In Delivery The charter, feels Barclays’ Mirchandani, still lacks an effective implementation and execution mechanism in India. “While a shareholder’s agreement does help achieve delivery of certain aspects of the family constitution, it fails to provide an end-toend solution.” Now, medium-sized family business owners have begun setting up trusts to bridge this gap in seamless integration with family constitutions. Though not all members will agree with the guidelines, conflicts, at least, can be avoided with regulation, says SNG’s Gupta. Peter Leach, partner, Deloitte, has worked with several successful family businesses. In his book, ‘Family Enterprises,’ he says the constitution should be regarded as a living document, with a provision to be reviewed every four to five years. There should also be mechanisms for family members to record any concerns before an impending review. Wealth creation on the back of vibrant capital markets is seeing families struggle with inter-generational wealth and power transfer. The mentality of entitlement by accident of birth has not yet given way to a competence-driven framework.

One of the ideas we experimented with was a democratic process of election of the next leader,” says Shailesh Haribhakti, chairman, Haribhakti & Co, who is a leading chartered accountant and director on the boards of Bluestar, ACC, Torrent Pharma, Ambuja Cements, Future Lifestyle Fashion and L&T Finance Holdings. However, succession based on f lair and competence in family-managed businesses is difficult — also because of societal pressures of marriage ties and expensive international education. “It has therefore become important to provide for lumpy, anticipated expenditure through trusts for specific benefits to specific youngsters. Even insurance products are available to achieve this end,” quips Haribhakti. Many mid-sized families are beginning to hedge against reimposition of wealth and inheritance taxes. Others are planning for serious, organised giving — often through sociallyconscious investing. These activities can be successfully positioned among variable endowed family members, says Haribhakti. Near-term, ownership with strong governance can be expected to separate from management under intensifying competition and the threat of disruption. Experts feel rewards too will be so structured that sustainability and an integrated view become main drivers of action.