Legal Strategies for Family-Owned Businesses to Thrive

Family-owned businesses are the backbone of the global economy, but running a family-owned business isn’t always easy, particularly on the legal side of things. Succession planning, corporate structure, governance, and family dynamics are just a few areas where small business owners often seek legal advice. Let’s break down some common legal challenges facing family-owned entities and tips for helping your business thrive.

The Significance of Family-Owned Businesses

A family-owned business is when two or more family members own, operate, and control a company. This type of business is a major contributor to the economy, accounting for about 90 percent of all businesses in America and generating 64 percent of the country’s gross domestic product. They range from small shops to multinational corporations, each with a unique culture and operational dynamics.

Common Legal Challenges in Family-Owned Businesses

Owning and operating a family business can be incredibly rewarding, but this pursuit also comes with distinct challenges. Balancing family relationships with business needs can be tough, and legal issues arise more often than you would like. Here are some of the legal struggles a family business is most likely to face:

Family dynamics: Navigating relationships while running a business as a family is perhaps the most difficult challenge. Setting up structures and processes for governance that separate family issues from business decisions helps minimize conflicts and ensures the business’s success.
Corporate structuring: Choosing the right corporate structure, such as LLC, S-Corp, or C-Corp, is a crucial business decision that impacts control, taxation, and liability. Your choice may affect your business’s ability to grow, attract investors, and manage resources. Therefore, it’s necessary to align this choice with your company’s long-term goals and family values.
Business strategy: Balancing innovative ideas from younger family members with the tried-and-true mindset of the older generation poses a challenge. This dynamic can lead to butting heads, yet it’s also a unique opportunity for growth if both perspectives leave room for the other to help drive the business forward.
Succession planning: Only 30 percent of businesses survive the transition from the first to the second generation of ownership, and only 12 percent survive from the second to the third generation. One reason for this is that 47 percent of family business owners anticipating retirement in the next five years have not yet established a successor.
Employment decisions: Hiring and managing family members as employees and coworkers requires a delicate balance between professionalism and compassion. If you don’t tread carefully, you could end up conveying favoritism and causing hard feelings.
Financial interests: Separating personal finances from business income is challenging but necessary to maintain financial integrity and prevent conflicts. Transparent accounting practices and clear rules about dividends and salaries are crucial.
Disputes: Arguments over compensation, safety protocols, time off, and other matters are common. These disputes must be managed according to labor laws while also considering the family context.

Proactive Legal Strategies for Family-Owned Businesses

Consider these legal strategies to help you overcome the challenges of owning a family business:

Draft shareholder agreements early: Establishing shareholder agreements at the outset of your business creates a firm foundation for ownership, governance, and resolving future disputes. These agreements can outline everything from decision-making processes to exit strategies. Involve younger family members in the drafting process and invite them to shareholder meetings so their voices are heard.
Create a succession plan: Deciding who will take over leadership and ownership roles is vital for a family-owned business to live on for multiple generations. A well-crafted succession plan addresses leadership transitions, reduces liability risk, and preserves the business’s values and legacy.
Create an estate plan: Thoughtful estate planning involves much more than a basic will. Strategies like trusts and limited partnerships are used to transfer the family business to the next generation while minimizing gift and estate tax burdens. Such planning avoids potentially fragmenting the company and maintains the founder’s vision.
Involve the next generation early: Giving the younger generation a say in how the business is run keeps their interest and commitment level high. Through mentorships, education, and gradual integration into business operations, younger family members can gain the necessary skills and knowledge to lead the business someday.
Establish fair employment policies: A professional and productive work environment calls for the fair treatment of all employees, family and non-family alike. Create policies for recruitment, compensation, and career advancement based on merit and performance to avoid accusations of nepotism.
Clearly define roles and responsibilities: It’s easy for a small family business to begin haphazardly, with unclear or overlapping job duties. Clarity in roles and responsibilities ensures each family member knows their place within the business. This clarity simplifies operating your business and making important decisions essential for long-term success.
Create and update prenuptial agreements: As a family business owner or employee who could one day inherit ownership, it’s crucial to have a prenuptial agreement to prevent the business from becoming entangled in personal marital issues. The agreement should specify that business assets are to remain within the family, along with any other provisions that extend protection in unforeseen circumstances.
Use conflict resolution techniques: Establishing a formal process for addressing conflicts helps manage and resolve disputes fairly and considers the best interests of both the business and the family. Techniques might include mediation by an external party, holding family councils, or setting up a way to air grievances confidentially.

About Kennyhertz Perry, LLC

Kennyhertz Perry, LLC is a business and litigation law firm representing clients in highly regulated industries. The firm was founded by two veteran Kansas City attorneys, John Kennyhertz and Braden Perry. To learn more about the firm, visit kennyhertzperry.com.

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