It’s a trust issue

Bundaberg Brewed Drinks’ CEO John McLean MAICD is a strong believer in the value of non-family directors. The third-generation family business has three independent directors on its board and plans to hire another who can advise on international expansion.

The fast-growing Queensland company has had independent directors since it formed a fully functioning board in 1997. Unlike many family businesses, it did not start with a board that consisted only of family members.

“We saw real value in having a mix of family members and independent (non-family) directors on the board from day one,” says McLean. “External directors who are not part of the family bring different perspectives and skills and help stop family businesses from becoming too insular in their thinking. Good directors pay for their fees many times over.”

The company’s governance approach is working. Annual sales exceed $130 million after several years of consecutive double-digit growth and its beverages are sold in 40 countries.

McLean’s view on the benefits of non-family directors is at odds with trends in family business governance. More family companies are forming boards, but fewer of them have independent directors – a potentially concerning governance trend.

The latest Family Business Survey, by KPMG and Family Business Australia, found 52 per cent of family businesses surveyed had adopted a board, up from 39 per cent in 2011.

However, almost three-quarters of non-executive directors (NEDs) on these boards were family members, compared with just over half in 2011. Family companies, it seems, are increasingly appointing family members instead of independent directors to their boards.

The survey gave several reasons for this change. A family member could transition from a management role to a board position to remain involved in the business. Also, family members might have more interest in governance, or family businesses could be struggling to find suitable non-family NEDs.

Bill Noye, the national lead partner of family business services for KPMG Australia, says the survey has positive long-term implications for board independence in family companies.

“More family businesses are forming boards and their inclination is to start with family members, before appointing non-family directors. As family businesses recognise the benefits of governance and independent directors, we will start to see a higher proportion of non-family members on boards.”

Extrapolating governance trends from a single survey, of course, can be misleading. The Family Business Survey, based on 204 responses from a range of small, medium and large companies, might not fully represent the governance intentions of larger, more sophisticated family enterprises. But anecdotal evidence supports the challenges that family companies face when appointing independent directors.

We saw value in having family members and independent directors on the board.

A director of a second-generation family company, under the condition of anonymity, told the survey: “I feel there is a reluctance to appoint non-family NEDs as they feel like outsiders won’t understand the way they operate, or are more likely to trust family members over outsiders. They tend to be concerned with sharing confidential information with outsiders who may seek to meddle with the family way of doing things.”

The CEO of a fourth-generation manufacturing company said: “Trust is paramount. We find it difficult to find suitably qualified outside directors who we feel we can trust. Having a referral through a known source certainly helps. Once we get to know them better and there is a position on the board available, only then we will consider appointing them.”

Family Business Australia CEO Robin Buckham says governance initiatives in the sector have not yet extended to a higher proportion of non-family directors on boards. “Lots of family businesses are looking to bring in external advice, but often the starting point is the accountant or another trusted adviser. Some family enterprises do not understand the role of a non-family NED or are afraid to give up power to an outsider or set up a structure where they could be outvoted on a particular issue. It’s not easy bringing a non-family director into what can be a complex family structure with lots of internal politics.”

Buckham expects more family businesses to form boards and recruit non-family NEDs over the coming decade. “A vast number of family business owners are baby boomers who are getting ready to retire. They are becoming more risk averse and conservative as they get older and are looking to establish a structure, such as a board, to guide the business when they step back from it. Also, more family businesses are expanding into new markets and recognise that external directors can bring skills they may not have.”

Buckham says third- and fourth-generation members have a greater appreciation of the benefits of independent governance. “The younger family members, by and large, are better educated than their parents and are doing MBAs and other courses. They understand that you can structure boards to provide advice and good governance, without giving control away or letting an outsider tell the family what to do.”

Stronger interest in independent governance is needed for family businesses to realise their potential. The Family Business Survey found high-performing family businesses typically have a formal board of directors with at least one non-family NED. They also adopt mechanisms, such as family constitutions and councils, which help set and manage expectations across the business and family.

Bundaberg Brewed Drinks has independent advisers on its family council to provide perspective. Its company board has three family members and three independents, with scope to increase the size to 10 if needed. Over the past 18 years, the board has had five independent directors.

Bundaberg Brewed Drinks also has its accounts externally audited. McLean says: “We try to run the business as close to being a publicly listed company as possible. Having audited accounts, a fully functioning board and independent directors adds to confidence. Our key stakeholders know the business is capable of sustainable, strong growth.”

McLean says independent directors help challenge management thinking. “Having experienced, non-family NEDs who can assist the CEO, provide a second opinion, and bring different ideas is incredibly valuable. The last thing any family business should have on its board is a ‘cousin consortium’ that agrees with everything that is said.”

Non-family NEDs can also mentor other directors with less board experience or help younger family members who show an interest in governance. “Introducing independent directors has been a very positive learning experience for our family directors,” says McLean.

Values the driving force

Angus Kennard, a non-executive director of Kennards Hire, talks about the challenges of appointing non-family members to family company boards.

Company Director: Why do some family companies resist appointing non-family members as independent directors?

Angus Kennard: With many family companies there can be a trust issue in sharing confidential information. Also, independent directors are meant to ask the questions that family and others cannot. I suspect that creates conflict with founders who want to do it their way and might be less open to new ideas.

CD: What has been Kennard’s experience with independent directors?

AK: Our board appointed NEDs in the early 1990s to help with independence. They can say what needs to be said. If you only recruit from your family pool, not only do you not get diversity or the skills you need at that time, but you might be waiting a whole generation [for change].

CD: How do you get the balance right: having an independent director who can challenge management if needed, while understanding the family’s values?

AK: NEDs must have emotional intelligence and understand there are many soft elements that need to be navigated. For Kennards, values are the driving force in alignment. We need balance and diversity across gender, skills, and age; and between executives and non-executives and family. If one element dominates, the right result is less probable. NEDs are there to represent the best interest of the business, which includes family. Sometimes it is hard to separate the two. The family must be open to [independent governance] and accept that NEDs are there to deliver value, which can be confronting at times.

CD: When should a family company add independent directors?

AK: They should think about it now if they don’t have any. Many NEDs are not doing it for the money, but to make a difference. It doesn’t have to cost a lot. You just need to be open minded to the benefits.