Independent directors and family businesses

A family business is a business in which one or more members of one or more families have a significant ownership interest and significant commitments toward the business' overall well-being. There is an intention to transfer the business to the descendants.

In these types of businesses, the shareholders belong to the same family and participate substantially in the management, direction, and operation of the company. Family-controlled businesses have their strengths as well as weaknesses.

Generational gap

The younger members may be forced to accept the decision of the elders even if it is outdated. Senior members may be averse to new ideas and fresh strategic positioning in the changed backdrop, social and economic perspective.

In order to avoid such conflict of interests and perceptions and to ensure that the task is accomplished in good faith which is in the interest of all stakeholders, good governance mechanisms are essential. One such way is is the appointment of independent directors – preferably an independent professional manager.

If the business is listed in the stock exchange and a major chunk of shares are held by the family members, independent directors are present in the board as per Clause 49. If the family managed business is not listed in the stock exchange and does not involve public money; there is no legal requirement to have independent directors on their boards. But these businesses have stakeholders such as fund providers from India and abroad, customers, suppliers, employees and society at large whose interest must be kept in mind while running the business.

As the family business gets more complex, it becomes necessary to rely on the board to play an active role in more important matters such as setting the company's strategy and reviewing its management performance. The family business board has to become more organised, well focused, and open to outside independent directors. Independent directors can participate in the decision- making and thus the company will have an opinion of a third person. Their inclusion in the board will give it a shape of well governed company and thus the business can attract foreign fund and additional debt if required. Independent directors can be someone who can give right advice to the family, help them change of generational transformation and adapt to such changes. Their role is to ensure that the family expectations and the needs of the business are balanced in a manner that will sustain the business and meet the family's long-term financial interests.

Four major findings of the research paper titled, “Independent board directors: How to improve their contribution to the family business, ” authored by Gallo, Miguel A. of IESE Business School, Barcelona, Spain showed that the main reasons for having independent directors are to improve the structure of corporate governance and to resolve succession problems. The main reasons for seeking the resignation of independent board directors are lack of the necessary personal qualities, lack of the right relationship with other directors, and calls for their resignation from significant shareholders. The main reasons why they fail to give the best of themselves are that the owners are not genuinely committed to having a professional and effective board of directors and the fact that important decisions are made by the family without taking their opinions into account.

Adjudication

In a closely held company if a minority group of shareholders feels that it is not being treated fairly, legal recourse available is to approach the Company Law Board (CLB) under Section 397 and 399 of the Companies Act. Normally the CLB follows the route of asking the minority shareholders to sell their holding to the majority at a price to be decided by an independent expert on valuation, drawn from a panel. Litigation in any situationis costly and time-consuming. The same objective can be achieved by intervention of an impartial independent director through informal adjudication process.

Today's family business may, in future become a global corporation or a part of it. At some point , the question of valuation of a family business as a going concern arises. There have been a plethora of empirical research papers that show that the better the corporate governance, the higher is the valuation. If presence of independent director can promote governance practices, it can prove to be a boon for the family business.

(The authors are Professors at IMT Ghaziabad.)

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