Family-owned businesses are often tough to govern. Shareholder control, compensation structures and succession plans all can be cause for legal disputes between family members. Without proper documentation to help address and resolve these issues, a family-owned business may be put at risk in terms of operational, managerial and financial perspective.
The following are tips on how to deal with common disputes that arise in family-owned businesses.
1) Failure to formally document a business agreement
Failure to formally document a business agreement can be really costly for a family-owned business. Many business owners wrongfully consider that business relationships between family members can be easily managed without a written agreement on the basis of mutual trust. Sometimes they do not even consider an agreement in order to avoid insulting a family member.
Well-documented business agreements ensure that all parties involved understand their rights and can meet their obligations to the business and to each other. Typically, business agreements include provisions that address management and control issues, distribution to shareholders, transfer of shares due to divorce or death, succession plans, and/or dissolution of business if the business partners decide to split.
By structuring a business agreement, the relationships between family members are clearly defined and everyone knows what to do and what to avoid for the benefit of the business entity. In fact, careful documentation can protect a family-owned business from tormented relationships while putting it in the lead in its industry.
On the other hand, without a formal business agreement, the business – as well as the business owners and partners, is controlled by the Corporations Code with all sorts of consequences. For instance, in case of litigation, the family members are very likely to argue on oral agreements that, most of the time, are wrongfully recalled to the best interest of each family member. Lack of a written agreement can severely jeopardize family relationships, causing more frustration and arguments and putting the business entity at risk.
2) Neglecting financial responsibilities
Regardless of the type of business structure – partnership, corporation or limited liability company (LLC) – all family members have specific financial obligations. Often when a legal dispute arises, financial obligations are neglected or deliberately ignored because each family member tries to act toward their best personal interest, rather than the best interest of the business.
When a legal dispute arises as a result of neglecting or ignoring financial responsibilities, the law may impose serious punitive damage claims on the family member partners who are responsible for risky business. However, the law recognizes the clean hands doctrine that actually allows a business partner to ask the court for equitable relief on a claim of wrongdoing or unfair conduct, provided that his/her innocence can be proved. Equitable relief may include a temporary restraining order and/or substantial damages award against the offending partner or the business.
3) Mixing personal with business
Mixing business and personal life often proves a fatal mistake. Often, family members mix their personal matters with business issues, thus compromising business relationships and operations. Although business relationships should be based on mutual trust and be formed by interpersonal skills, it is not wise to mix business with personal matters because then relationships are damaged, leading to poor decision-making.
4) Failing succession planning
Succession planning is extremely important in any type of business. Especially in family-owned businesses, it is critical to lay out a succession plan in order to protect the business from going bankrupt or collapse if the business owners cannot effectively work together and decide to split.
The most important issues that need to be considered in a business succession plan include divorce, death and a partner walking out from the business voluntarily. For instance, the succession plan should predict how a divorce of one of the owners could impact the business or how the interests of one of the owners will be distributed in case of a sudden death so that the business doesn’t go bankrupt. Effective succession plans take into account the market sentiment in order to protect the business and ensure that the needs of all family members are reflected on a fair market value.
In conclusion, lack of a formal structure is the most frequent cause of legal disputes in family-owned businesses. Failure to document everything often leads to legal disputes, litigation and/or the dissolution of the business.