Laying the Foundation for Success: Structuring the Board of Directors in a Family-Owned BusinessMy husband and I are about two weeks shy of completing construction on our new home, so outside of work, construction is our life. In construction, the concept of compounding defects means a defect in the foundation compounds as you build up, impacting everything from the framing to the drywall. This concept applies to family-owned businesses as well. Failure to build a corporate governance structure makes a family-owned business susceptible to conflicts of interest, family infighting, and other inefficiencies, impacting everything from the CEO to the future growth of the company.

The board sets the overall strategy and policies of the company, so your corporate governance foundation starts with structuring the board of directors.  As the overall governing body, the board elects the officers of the company and provides oversight of management without getting into the day-to-day management of the business. In a family-owned business, the board may take family politics into consideration, but fiduciary duties dictate that the board must act in the best interest of the company, not any individual shareholder. These concepts give the family the ability to rely on the board to challenge management, set long-term goals, and engage in conflict management when necessary.

Given the role of the board, the family-owned business must determine the best structure for its board.  Requirements for the board are typically set forth in the company’s governing documents (e.g., bylaws or operating agreement). Here are a few questions to consider when structuring your board:

  1. How are directors elected to the board?
    Shareholders or members elect the directors to the board. The company’s governing documents may require that a nominating committee nominate qualified individuals before they may be voted on by shareholders. The governing documents may also set forth certain qualifications for directors.
  2. How many directors should be on the board?
    Applicable law may require a minimum number of directors, but otherwise, the company has the ability to set a range for the required number of directors. Typically, an odd number of directors is preferred to prevent a deadlock.
  3. Should the directors have staggered terms?
    The board may be divided into different classes of directors with staggered terms. Utilizing staggered terms promotes continuity on the board, but makes it more difficult to replace an entire board if the shareholders are dissatisfied with the current corporate strategy.
  4. Should the board include non-family members?
    This can be a difficult decision for family-owned businesses, and the answer may depend on the current stage of the business. For example, a family-owned business in the first generation may prefer a closely held structure of a limited number of family member directors. On the other hand, a family business on the third or fourth generation may be better served by including non-family members who can bring a fresh strategic perspective or a new experience base to the board.

Just like a strong foundation ensures that a building will weather the test of time, putting a strong corporate governance structure in place sets the family-owned business up for success as it grows and experiences generational shifts.