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Timothy (Tim) is a director of his family business. His fellow directors are his brother and his brother’s wife. He and his brother won 40% of the shares each and the remaining 20% are held in a trust for the grandchildren of the founder, Tim’s deceased father. Tim is the managing director and his brother is non executive chairman. All board members are over sixty years old.
The company has grown and is profitable. It has a professional management team and Tim is aware that soon he will need to start planning for succession. Tim’s brother now wants his son (Tim’s nephew) to be employed as Marketing Director and put onto the board. The son/nephew has worked at the company previously and was difficult to manage, expected a high salary and did very little. He is 24 and has no marketing, business or governance qualifications.
The Chairman and his wife have both voted to employ their son and Tim has caused a major family row by speaking against the proposal. The proposal has been deferred until next board meeting in three months time. Tim is concerned that, as the company constitution states that all decisions on hiring and firing company members must be taken by the board, he will be outvoted and forced to accept. He is also concerned that his nephew may aspire to succeed him as MD and knows that the management team would not remain under those circumstances. Tim is relying on the dividends from the company to fund his retirement.
What should Tim do?
Tim's conundrum is typical of those experienced in second generation family companies where the founder's ownership has been distributed to the immediate family.
Before Tim takes any hasty action he has to realise that he has no more right to impose his will on the company than the other directors and shareholders according to their voting rights, and that his actions may result in wealth destruction in excess of what his nephew may do.
Tim's options are:
- Resign and sell his shareholding - May be difficult to achieve. His brother and sister in law may not have the money to buy him out. He could end up selling at a price below his shareholding's true value.
- Resign and take the existing management team to start up a competing business - This would effectively destroy the value of his investment in the family business, plus he would need the capital to start a new one.
- Apply to the court to have the company wound up on the grounds of either:
- the directors have acted in their own interests and not the interests of the members as a whole, or
- affairs of the company are being conducted in a manner that is contrary to the interests of the members as a whole, or
- it is a fair and equitable thing to do due to a deadlock or a breakdown in mutual trust between the directors.
Of these, the court would be reluctant to make an order for a) or b) on the basis of a single board decision alone. There is no potential for a deadlock with either the board or the shareholders even if the trustee abstained or was not entitled to vote as Tim's brother has the casting vote as chairman. If the relationship between Tim and his brother continued to deteriorate there could be grounds due to the breakdown of mutual trust. Winding up the company would destroy a lot of its value because it is worth more as a profitable going concern than as a bunch of assets.
- Accept the decision of the board and employ his nephew. As managing director, Tim would be able to set suitable performance criteria for his nephew as a senior executive and potentially groom him as a successor.
The appointment of the nephew to the board is also difficult to contest. Board appointments must be confirmed by the company shareholders in a general meeting. If Tim's nephew was the only one of the founder's grandchildren, the shares held in trust effectively belong to him and the trustee may elect the abstain from the vote. Assuming Tim's brother is chairman of the meeting, he would have the casting vote. Tim could contest the outcome of the vote on the grounds of a related party transaction or oppression but would be unlikely to succeed.
Tim's best approach would be to negotiate with his brother and sister-in-law to accept his nephew's employment by the company subject to appropriate performance criteria and deferring his appointment to the board until such time as he has proven his management skills. As an additional incentive for Tim's brother and sister-in-law to accept, Tim could offer to groom his nephew for the role as managing director as part of an agreed succession plan. This approach has the best chance of preserving the value of the company and the family relationships.
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