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BW Businessworld

Keeping It In The Family

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B.K. Modi, the chairman of Spice Group, his son Dilip and daughter Divya plan to stay together for the next 10 years and create a large global business entity. To realise this ambition, they formalised everything from business discussions within the family to business development within the companies. In February-March this year, the Modis drafted a family constitution with the help of London-based management consulting firm McKinsey and formed a family council.



Modi himself is a battle-scarred veteran of family conflicts. His father, Gujar Mal Modi, founded the Modi business empire, but had a falling out with his step-brother Kedar Nath Modi, who wanted his part of Modipon, Modi Industries and Modi Rubber. In 1989, the assets were split, with 60 per cent going to B.K. Modi and his brothers. Even after the split, things did not settle down. B.K. Modi and his brothers then had issues over the division of assets. Could a family constitution have saved the fall of the Modi empire? The answer is obvious.



Click here to view enlarged imageUndoubtedly, family constitutions are coming back into fashion — and in a big way. Advocates of family constitution point to other recent tussles and splits in high-profile business families as a good reason for such instruments: the Ambani brothers and the Bajaj family, to name two. "If the Ambani brothers were together, the size, shape and scale of their business would have been different," says an analyst. But there are also people who believe that the two Ambanis running separate empires are in fact better in value creation.



In another case, R.S. Lodha, a chartered accountant claimed a part of the Birla business empire, Birla Corporation — whose current chairman is his son Harsh Vardhan Lodha — which was willed to him by Priyamvada, wife of M.P. Birla (cousin of B.K. Birla, who is the grandfather Kumar Mangalam Birla).



Internationally, Japan's Mitsui family, which owns nearly a fifth of Japan's car market and nearly a sixth of its textile production, has a family constitution that dates back to before 1800. European business families — like the Mulliez family that owns Auchan, one of France's biggest retail chains — have family constitutions that go back decades.



Among others, the Dalmias, the GMR Group, the Burmans of Dabur, the Murugappa Group and the Agarwals of the Adhunik Group have formal family constitutions. The Singhanias-run JK Group has a more elaborate family parliament called the JK Organisation (JKO).



Family-run businesses contribute 60-70 per cent of GDP in most developed and developing countries. India is no exception. It's also true that most business families face challenges stemming from differences in attitude and aspirations of family members. A study by the Confederation of Indian Industry (CII) found that just 13 per cent of the family businesses survive till the third generation and only 4 per cent beyond the third generation; one-third disintegrate because of generational conflict.



SPICE GROUP Founder: B.K. Modi (wearing cap) Second generation: Dilip Modi, Divya Modis vary just as much. They also serve different purposes: in some, they may lay down succession rules; in another they may be about the family's governance of the various businesses. In yet another, they may be how the businesses will be divided if differences of opinion reach the point of no return. How do they work? Are they effective? Are they even needed?



The Nature Of The Beast

Some call family constitution the ‘mantra of long life', while others dub it a ‘bureaucratic limitation'. "Family constitution articulates how the family sees the future and the requirements for success as a family together," says John L. Ward, Clinical Professor of Family Enterprises at the Kellogg School of Management and a leading authority on family businesses.



Raja Sujith, partner at Majmudar & Co., a legal firm, calls it an agreement or arrangement in writing among family members for managing the family business jointly owned by them. The constitution helps avoid conflicts among family members and ensures proportionate returns to all, says Sunil R. Chandiramani, partner & national director-advisory services, at global consultancy Ernst & Young.



 


 


The 100-plus years-old Murugappa Group and the JKO had pre-emptive strategies to weather the differences. "We have a process of consultation and consensus," says A. Vellayan, executive chairman of the Murugappa Group. JKO has a family parliament, which has a constitution, says Hari Shankar Singhania, president of JKO and chairman of JK Tyre & Industries.



Does size of the family matter? "If more than three family members own the business, a family council and a constitution will help them avoid conflict of interests," says Harsh Goenka, chairman of RPG Enterprises. "Such a mechanism will lay out the future of each member in the business." In the RP Goenka group, a new holding structure has been put in place to determine the key investment companies that Harsh and his younger brother Sanjiv Goenka will own. The realignment has been done on the basis of the businesses each is managing. In Harsh's businesses, only his family and son are involved. Since his family is small, he is not thinking about a constitution now.



Not everyone agrees on its merits, either.









GMR GROUP Founder: G.M. Rao

Second generation: Kiran Grandhi

and GBS Raju (sons) and

Srinivas Bommidala (son-in-law)

"It is an impediment to progress," says Adi Godrej, chairman of the Godrej Group. "We formed a family council 10 years ago to discuss the issues facing promoter shareholders. Beyond the issues of the family, there we also briefed members on our businesses. We don't think constitution is necessary to run a family." That may be a minority view, but what do the workings of a constitution tell us?



The Constitution In Action

Kolkata-based Adhunik Group (revenues: Rs 3,000 crore), is run by the six sons of its founder Mahadeo Prasad Agarwal. The eldest, Jugal Kishore Agarwal, is 59 years old, while the youngest, Manoj Kumar Agarwal, is 41. After the father's demise, the family nominated the youngest as managing director of the group, contrary to the traditional practice of appointing the elder.



As there are multiple inheritors, the family formed a council and a constitution about seven years ago. The junior Agarwal says the family, which is in the iron and steel, power, cement and mining businesses, discuss all the issues relating to promoters in the council. "Beyond that, business development and strategic investments are also concerns of the family council. The council takes decisions within the framework of the constitution," he says.



The Agarwal family council makes amendments in the constitution every year according to the changing scenario. If any family member wishes to withdraw from the business for personal reasons, the constitution has mechanism for such a separation.







"We have come across this situation more in the Middle East, especially in Saudi Arabia, the UAE and Yemen, than in India," says Sona Rajesh, practice head of organisation effectiveness at Tata Strategic Management Group. "The families there are very large, and can't do business without a family council and constitution. Moreover, their businesses are spread across different countries in the region."



Different Folks, Different Strokes

Can the prospective results of a family constitution be achieved without one?  Niraj Bajaj of the Bajaj Group companies says there should be an equal lifestyle among family members to avoid differences. "In the Bajaj family, we had tough rules on expenditure and lifestyle about 15-20 years ago. Now it's a bit relaxed, but even now nobody can be a spendthrift." That should help preserve family wealth.



The Bajaj family has frequent meetings of its members. Whenever Rahul Bajaj, the head of the family, comes to Mumbai, the families get together and discuss business and family issues. "If we need to convey something to all the members, we will circulate notes among the members," says Bajaj Group's Niraj. Though they don't have a family constitution, the messages emanating from these meetings are considered as rules and regulations.



But this equality, which is in the unwritten rule book of the Bajaj family, can be ensured through a family constitution. C.R. Rajagopal, partner at Deloitte, Haskins & Sells, says the constitution ensures equal treatment for members in the businesses. In his opinion, a formalisation of these rules through a constitution will resolve conflict situations.

 

 



 


The Burmans of Dabur rotate the chairman and vice-chairman posts within the four branches of the family, and there will never be more than four family nominees on the 12-member board. For them, the family constitution is an expression of fair principles by which all members would participate in the family's business.



The Dalmias, promoters of Dalmia Cement, adopted a constitution in 2004 after the bitter experience of a family split when the second generation decided to run their own ventures. Jaidayal Dalmia was at the helm of family till 1993. After his death, his seven sons and two daughters parted ways. Jai Hari and Yadu Hari took over the reins of Dalmia Cement. Now, cousin brothers Puneet Dalmia and Gautam Dalmia — the third generation of the family — are in charge.



The trigger for forming a constitution was — in addition to generational transition — a more ambitious business vision, which required more formal structures and processes within the family, says Puneet Dalmia, managing director of Dalmia Cement.



DABUR Founder: S.K. Burman Current generation (5TH): Anand Burman (extreme right), son of A.C. Burman (sitting on the right); Mohit Burman (extreme left) and Gaurav Burman (sons of V.C. Burman — third from left); Amit Burman (third from right) son of G.C. Burman (second from right); Chetan Burman (son of Pradip Burman — fourth from left); Saket Burman (son of Sidharth Burman — second from left)The Dalmias have a family council consisting of Puneet, his father Yadu Hari, uncle Jai Hari and cousin Gautam. This council provides strategic direction to the group. The group also has a governing owners' council with the four Dalmias and two other advisors. "The governing owner's council is to guide the family for business welfare and family welfare and to support the family in preserving and enhancing our values and our reputation."



There are 10 decision categories and 25 decision types which are referred to the family: among them, board and management appointments, capital structure (leverage and dilution), dividend policy, succession and exit, business plan and capital expenditure, family welfare, and vision and values. The family constitution provides the fundamentals for resolving these issues.



The Dalmias' constitution may be unique to the family's circumstances, as is that of the Agarwals of the Adhunik Group. But the ambit of both family constitutions raises an important question: if the family constitution makes all strategic decisions, what role does the board of each of the group companies play in strategy?



The Question Of Legal Sanctity

G.M. Rao, chairman of GMR group, picked up the idea of his family's constitution from a CII meeting in 2000. He hired a leading consultant to draft it. The consulting team spoke to the family members and finalised the topics. Issues covered including succession planning, media and political policy and grooming the next level. Family governance is an essential component. "If any dispute occurs within the family, it should not migrate into the business," says Rao. "The constitution is a firewall."



But will the terms of the constitution hold up in court should it come to such a pass? In B.K. Modi's Spice group, his son Dilip and daughter Divya hold 25 per cent each in the holding company; the rest is with Modi himself. Modi says the partners can cash out their stake as per the constitution, which is legally binding. McKinsey & Co. drafted the constitution in consonance with the applicable laws in the country.


















TYPICAL CONTENTS IN A FAMILY CONSTITUTION


  • The process for hiring, assessing and remunerating family members

  • The rules for nominating, training, assessing and appointing successors

  • Processes for nominating and assessing individuals for appointment to the family company's board of directors and/or the family council

  • The composition and rules of conduct for a family council

  • Communication and disclosure policies between company and family

  • The process for resolving conflicts between members of the family

  • The rights and obligations of shareholders in the family company

  • Recommended retirement age for family directors and managers

  • Processes for buying out family shareholders in the business

  • Policies concerning external, non-family ownership and management.

  • Procedures for amendments to the constitution


 FAMILY COUNCIL: SUGGESTED ROLES
Family Issues


  • Draft and amend family constitution based on inputs from family members

  • Facilitate selection of family council in the long term

  • Manage sale of shares of the owners

  • Train and develop next generation

  • Plan family gatherings and help to create healthy family relationships




Business Issues



  • Elect family members for the Group board

  • Deal with macro business issues, ownership, return on equity, dividends, etc

  • Understand the rationale of family executives

  • Debate issues among themselves

  • Express agreed views through their appointed chairman







Majmudar & Co.'s Sujith agrees. "The constitution can be legally challenged by any members in the family, so it should be duly supported by the law of the land," he says. A family constitution has to be drafted in accordance with the charter documents of the companies involved in the family business and the applicable laws.



At present, there are no specific legal provisions for family constitutions in the Indian framework; it is up to family members to abide by it. "The family constitution is relevant in the present day because it gives direction, vision and guidance to the younger generations to run the business. However, the disputes arising out of the family constitution will be adjudged as per the laws of the country," says Sujith.



G.M. Rao is making the family constitution a legal document. Once all family members finish signing it — the equivalent of taking an oath of office — it will be a legal document.


 



 


The JK Group's parliament or JKO, is more than 100 years old, and was formalised in early-1950s, registered under the Trade Union Act. The constitution defines rules and regulations for the family members. The family members have to qualify for joining the JKO. Business integrity is the major parameter for qualification. "Our family is so large and everybody wishes to work together. How to keep a family together is as important as running a business," says 77-year-old Hari Shankar Singhania, president of JKO and chairman of JK Tyre & Industries. According to him, JKO is not a duplicate power centre, but it behaves like an advisory body for the group companies. His younger brother Raghupati Singhania, vice-chairman & managing director, says the Trade Union Act was the only major legal format available at that time to register the family body. "It is a loose legal power with vision and values. Its constitution elaborates on dos and don'ts," he says.



Timing Is Everything

The family constitution seems like a modern invention; but is there a good time to set it up? According to a report of global consultancy KPMG's Australia unit, the family constitution is most likely to be adopted or revised at the time of generational change within the business. "It can often be considered when the business is about to be passed on from the founder to his or her children," the report says.









ADHUNIK GROUP Founder: Late Mahadeo

Prasad Agarwal Sons: Jugal Kishore Agarwal,

Ghanshyam Das Agarwal, Nirmal Kumar Agarwal,

Mohan Lal Agarwal, Mahesh Kumar Agarwal,

Manoj Kumar Agarwal

G.M. Rao says it is best to bring in a family constitution during the time of its founder. More than just a succession plan, GMR's constitution is a model of governance, laying down a code of behaviour that applies to all family members — Rao's two sons (Kiran Grandhi and G.B.S. Raju) run key parts of the group along with his son-in-law (Srinivas Bommidala).



The constitution board of three members will decide GMR's next chairman, before two or three years before Rao's retirement. If there's no consensus, the deadlock trustee will take the final decision with his veto power. All the process has to be completed in 90 days.



Puneet says there is no right time to introduce a constitution: it can be done whenever the people are ready. The Munjal family of the Hero Honda Group is a possible candidate. Four months ago, the family's holdings (roughly $5 billion) in the 20 Hero Group companies have been realigned. The group said in a statement: "All promoter cross-holdings have been untangled and consolidated in the name of the relevant family."  The new arrangement has resulted in ownership transfer to the four family groups. It is believed that  five family members in the third generation currently working within the Munjal group of companies harbour large ambitions even post-settlement.



DALMIA GROUP Founder: Late Jai Dayal Dalmia Sons: Yadu Hari Dalmia (top, standing) and Jai Hari Dalmia Grandsons: Gautam Dalmia (right), son of Jai Hari, Puneet Dalmia, son of Yadu HariHowever, Rahul Munjal, managing director of Easybill and eldest among the new generation, recently said in an interview: "At some point the family will get larger, people's ambitions will change, by which time we plan to have out family constitution in place." He, however, declined to respond to BW's questions.



The Age Of Discontinuity

Business continuity and legacy are good principles, but enshrined in a constitution, they could also become shackles. As E&Y's Chandiramani points out, a constitution can hamper business opportunities. For instance, a constitution could ban putting its equity in high-risk sectors. The opportunity may be in the larger interests of the company's future, and it might be capable of taking on the risks, but the constitution could limit it. This is against the interest of company executives, employees and even shareholders.



Of course, family constitutions can be amended, and many lay out procedures for doing so. Family agreements reflect the emotions and perceptions of family members, says Rajagopal of Deloitte, which can change with the times and circumstances. That's when the constitution needs to be updated. But these changes could also be subject to legal challenges in court: the separation of ownership and management could become a blurred line.



Sujith lists a few other challenges. First, a family constitution drafted as per present business requirements may not fit into the future legal framework. Second, if family members get into a dispute, it will be adjudged according to the law of the land, not by the family constitution. Third, a number of different kinds of tax implications, especially in share transfers and demergers, will have to be carefully analysed and considered whilst drafting a family constitution. Finally, the constitution may not be sustainable when the group diversify into new businesses and venture into other countries.



Family constitutions may become the new trend, as more people become entrepreneurs and entrepreneurs become industrialists. As established businesses grow, accommodating the aspirations of an enlarged family may push many business families in this direction. But as a wag once put it, a family is a unit composed not only of children but of men, women, an occasional animal, and the common cold. How many constitutions can accommodate all that?



nevin(dot)john(at)abp(dot)in