The American Dream means something different to everyone and we all pursue it in very different ways. Yet, the one common goal that is often expressed is that we all want to share our success in the American Dream with the ones we love – our family. While family owned businesses are often started with the best of intentions, after all we expect to be working with like-minded people with whom we enjoy spending time with; the real-world does not always cooperate. Starting a business from scratch is difficult, and doing so with family adds an extra layer of complexity that should be considered as you plan for your future, and the future of your business. Before taking the leap to starting a business with your kin, make sure you consider the following scenarios from the outset.
Family Business Documentation
Often times a business is started with a simple conversation over a kitchen table, or a mere hand shake, based upon the parties’ prior relationship that is built on trust. This happens even more when that trust is built on family ties. While such a handshake agreement might have been sufficient in years past, the inevitable “he said, she said” disagreement is sure to arise. The first step you should take at the outset of forming your business, regardless of whether your partners, shareholders or members are family, is to retain a corporate attorney (also known as a business attorney) to formally draft all creation and formation documents.
You may ask yourself, “But why is this necessary when I trust my family members wholeheartedly?” Great question. The answer is that now is the time to make sure expectations are managed before issues and disagreements arise… inevitably they will as the business changes over time.. Failure to handle critical issues from the outset when forming your company can cost you money in legal fees in the long run, but more importantly, it can also cause issues between family members that could have otherwise been avoided.
Determine ownership percentages amongst each of the owners at the beginning of your business formation. This information will be provided in the organizational documents (as mentioned above) which a business attorney can help you draft. Keep in mind that generally it is not a viable solution to have a 50/50 split between two owners because this can create an automatic deadlock if a dispute occurs. Be prepared to talk this through with your family members. In the family setting, the prospect of anything other than a 50/50 split can cause turmoil between siblings or other relatives. Having these important conversations ahead of time will help you navigate the ownership structure cautiously while balancing concerns about deadlocks and curbing potential jealously when one family member owns a greater percentage than another.
Funding your Family Business
Starting a business requires capital. Depending upon the nature of the business, capital needs can vary. Companies can raise capital in many ways such as by an investment from respective owners (ie. shareholders, partners, and members), issuing shares via an IPO, or acquiring loans from either an owner or bank. Most companies initially will not seek to raise capital through an IPO; instead they will opt to either raise the necessary capital through a loan or private investment. When it comes to family owned businesses, if possible, it is often better to seek options to raise the necessary capital outside the family dynamic for two main reasons.
First, should the business fail, instead of risking family members fighting amongst themselves to recoup the investment or loan, the family members can instead present an united front against the third party seeking to collect money. Second, North Carolina law allows owners who contributed more than their ownership percentage to pursue a contribution claim against their fellow owners. As you might imagine, if an owner contributed 100% of the seed money to start the company but received only 25% ownership, a contribution claim might be raised which could result in some undesirable and very interesting family feasts over the holidays.
Now the family business that was once viewed as a dream has now become a nightmare, litigation between family members, even for a contribution claim, can quickly become bitter and tumultuous when emotions may be running high. While not all companies can be completely funded through a loan from a bank, using a neutral party’s resources rather than a family member furnishing the necessary capital can at least minimize the potential for litigation amongst family members.
Forming an Exit Strategy for your Family Business
A business lawyer can help you plan an exit strategy for your family business. Hopefully, after the years of sweat and sacrifice your American Dream has come to fruition and it is time to enjoy the fruits of your labor. Ideally, you have had an exit strategy in place for years, but if you not before you head out to celebrate with your family on that dream vacation with the funds from the sale of your business, you should make sure you’ve planned ahead accordingly.
When creating your exit strategy, unless your organization documents indicate otherwise, you may want to retain a business valuation expert to discern the true maximum value of your business and a business attorney that can handle the transactional documents to protect your interest and rights. A business can be bought and sold in multiple ways, but if one family member is planning to buy/sell their part of the business to another family member, special considerations may come into play.
For example, if one family member wants to purchase another’s interest rather than complete acquisition from an outside buyer, it is crucial that the owners have an attorney prepare a Buy Sell Agreement outlining the terms and requirements to purchase the interest. If this wasn’t done in your original business formation documents, you can have a business lawyer create one.
Conclusion
Whether you are embarking on the adventure of buying and selling your family business, or forming a new one from scratch, a business attorney can help you lay the groundwork for success. Remember the classic credo, “blood is thicker than water” and plan ahead to put proper documentation in place to help minimize the risk, and maximize the reward, of doing business with a family member.
If you have questions, contact Sodoma Law today at 704.442.000 or email us at attorney@sodoamlaw.com
