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To Grow Family Business, It Must Be Managed Properly To Grow Family Business, It Must Be Managed Properly

To Grow Family Business, It Must Be Managed Properly

First appeared in the Business Ledger 

Family businesses can bring out the best in people as they work together to build a lasting legacy, both economic and emotional, for the ones they love.

That same dynamic also can present unique challenges that often derail the goals of the business and the family. A number of legal strategies and structures can be used to plan for these challenges and to build a foundation for continuing success.

A key to setting up a legal structure for the family business is understanding the difference between ownership and management. In order to generate the economic benefits to be shared by the owners, the business must be properly managed. Some family members may have ownership interests but are not interested in or suited for management. Family members who bear responsibility for managing the business may not possess sufficient ownership rights to insure they are adequately rewarded for their efforts.

Proper planning can help manage this potential tension. The basic legal documents of any business, including articles of incorporation or organization, by-laws, operating agreements, and shareholder or buy-sell agreements can be drafted with these issues in mind. The allocation of authority among officers, the election of directors and officers, and their compensation can be considered in advance and built into the legal documents.

The documents often contain conditions or restrictions on the payment of dividends and distributions to owners, the transfer of ownership interests among family members or to third parties, and competition by family members who own or participate in management of the business.

Families inevitably face the death, disability, retirement or divorce of family members who serve important roles in the business. The ability of the business or other owners to acquire the ownership interests of a family member after one of these life events in a way that gives adequate compensation to the seller without crippling the business can be addressed in a number of ways.

Life insurance on key members, a defined mechanism for determining the value of the ownership interest, and a clear procedure for exercising rights to purchase the ownership interest can make it easier for the family to manage the effect of the event on the business and reduce emotional stress.

It is often necessary for a family business to share economic benefits with family members who are not active in the business.

The equity ownership of a business can be structured in multiple classes with differing voting rights and even no voting rights, to provide an ownership interest to family members without a role in daily operations.

Inactive members are concerned about being entirely locked out of management may insist on protective provisions that require super majority approval for major actions like selling the company or borrowing or expending large sums. Inactive family members can be given an ownership interest in real estate or equipment or can have consulting agreements with the business, so that they receive economic benefits in the form of rent or fees, without having any management authority in the operation business.

The ownership and management structure needs to be tailored to the particular facts of each family business and should be carefully designed with the help of advisors. Experienced lawyers can help provide ideas and options as well as draft the appropriate documents.

Accountants can help with valuation issues and tax concerns. There are many family businesses associations and councils specifically oriented toward helping families, and business consultants with experience in the field are also valuable. The business can establish an advisory board or bring in outside directors with business experience to provide an objective perspective to the family owners and managers.

Many families include in the legal documents for the business a requirement for an annual family meeting, which can serve as a celebration of accomplishments, a forum for communication of issues and decisions, and a planning session for the future. A family would not build a home without a plan, and building a multi-generational business also demands thoughtful planning.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader must consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.

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