One of the most important aspects of any business continuity planning is to have pre-agreed rules on to how to deal with predictable issues, particularly control and ownership of the business, before they come up.
A shareholder’s arrangement can deal with the issues around appointment of directors and their delegated authorities (control), as well as dividend policies and ability to buy or sell shares (ownership). One of the common causes of conflict in a family business stems from how best to recognise and reward family members for their efforts. All too often families seek to aggregate remuneration and keep it equal, particularly in the second generation.
The reality is that individuals are equal as family members but may not be equal in terms of position in the company. In order to promote transparency and fair process, best practice suggests that we separate these roles as well as the remuneration. For example, many families agree to the following model:
- Managers – Market value remuneration and, where appropriate, bonuses for exceeding goals
- Directors – A set amount per meeting and effort
- Shareholders – An annual dividend based on ownership interests
By doing it this way family members are clear on what they are being remunerated for.
In relation to dividends, this can be a delicate subject and we need to consider the following:
- Commercially – What can the business afford? And how much do we need to reinvest back into the business?
- Family – The next generation wants certainty of amount and level of financial independence. The incumbent generation does not want to create expectations or create incentives for a ‘grander lifestyle’
A suggested solution is to have a pre-agreed dividend policy. For example, a set percentage of profit after tax which can be budgeted for and is always subject to director’s approval, as he or she has ultimate responsibility for the businesses’ financial viability.
Perhaps set this dividend as a low rate to start with. And remember, you should not mix salaries and dividends – salaries are to reward management and dividends reward ownership. Family can participate, and be recognised and rewarded as managers and/or owners – providing the roles and remuneration are separate.
Dividends are only of value if they are paid out to create liquidity for shareholders/owners.
Pre-agreed rules around ownership, shareholders agreements also need to include:
- Who can we sell shares to?
- How do we value our shares?
- What are the payment terms?
Some families pre-agree that shares are to remain in the bloodline and shares can only be sold to existing shareholders and/or back to the company. Most families opt for pre-agreed formulas to value shares in order to provide some certainty – these formulas can help avoid costly disputes. In addition, families often pre-agree to revisit this valuation formula every 2 or 3 years.
Once again, the area of remuneration and liquidity can cause conflict, always separate the roles and pre-agree the rules.
Dominic Pelligana is a KPMG Private Enterprise partner and leads KPMG’s Family Business Services.