Best practice in family businesses: Aligning dividend policies and profit-sharing agreements for long-term success

Family businesses are the backbone of many economies, including the Philippines, where they account for a significant share of employment and economic output. However, as these businesses grow and transition through generations, tensions often arise around how profits should be shared between family shareholders and management.

To address these challenges, it is best practice for family businesses to clarify ownership structure in their Family Constitutions and dividend policies in their Shareholder’s Agreement. Separately, it is imminent to establish a Profit-sharing Agreement that is distinct to shareholders, tied to executive performance and divided among management. This approach offers clarity, fairness and sustainability.

While a Family Constitution typically outlines the overall family’s values, vision and principles regarding the business, including ownership principles and succession plans, a Shareholder’s Agreement, on the other hand, formalizes legal commitments regarding ownership rights, voting and profit distribution to all shareholders, including non-family members who are shareholders. Including a clear Dividend Policy in these documents ensures that all family members understand how and when profits will be distributed to shareholders. This promotes transparency and helps prevent future disputes.

A well-crafted Dividend Policy outlines the conditions under which dividends will be declared, the formula for determining the payout, and the frequency of distribution. It balances the family’s desire for cash flow with the business’s need for reinvestment and growth. By institutionalizing this in the Family Constitution or Shareholders’ Agreement, the family signals its commitment to financial discipline and long-term business health, while also ensuring that passive shareholders receive their fair share of returns without interfering in management decisions.

Meanwhile, family members and non-family executives who serve in management roles should be subject to a profit-sharing agreement that is separate from the dividend policy. This agreement should link profit-sharing to clear performance metrics such as profitability, efficiency, and strategic achievements. By doing so, compensation is tied to the actual contributions made to the business’s success, encouraging accountability, motivation, and professionalism among the management team.

Separating dividend policies from profit-sharing plans is a practical and equitable solution that minimizes confusion. It ensures that family members who are owners receive returns based on their capital investment (via dividends), while those who are managers earn rewards for their operational performance (via profit-sharing).

In many family businesses, these roles overlap — some family members serve both as shareholders and as executives. The distinction in policies helps next-generation leaders appreciate the difference between returns to capital and rewards for labor and skill.

This dual-policy approach also helps reduce potential friction between active and passive shareholders. Family members who are not involved in management are assured of fair financial returns without questioning executive compensation structures, while those in leadership are appropriately incentivized to drive business performance without undue pressure to pay excessive dividends that could harm the business’s future.

The ultimate goal is to sustain harmony within the family, ensure business continuity, and professionalize governance as the business transitions through generations.

Family businesses that adopt these best practices strengthen their ability to attract outside talent, build investor confidence, and create a legacy that balances family welfare with corporate success. As such, families are encouraged to work with governance advisors, legal experts, and trusted board members to design and formalize these policies early in the company’s life cycle.

In aligning long term sustainability with family businesses, best practice is to regularly review all three — Family Constitution, Shareholder’s Agreement and Profit-Sharing Policy — and revise as needed. After all, from the family’s perspective, family comes first.