When Business Becomes a Pleasure: Legal Tools for Running Successful Friend and Family-Owned Enterprises
“Never mix business with pleasure”. This well-known tag-line embodies the proverbial cautionary tale of the pitfalls that await family members or close friends who chose to go into business together. Notwithstanding this warning, history regales us with tales of family-owned businesses which have been established time and time again. Some have thrived and resulted in dynasties and legacies while others have imploded, reinforcing the tale of caution. Although establishing a family or friend-owned business does present some opportunities, these types of ventures are associated with some considerable risks. Starting and running a business generally is not easy endeavour but it can be especially challenging when the business is owned by friends or family. In addition to the usual business-related issues that need to be addressed, the management and operation of a family business raises very specific legal and strategic challenges. These include control and ownership conflicts due to lack of formal governance structures, power imbalances and disagreements over the direction of the business, conflicts of interest particularly if family members or friends hold different roles in the business or have different financial interests, Lack of transparency, difficulties in attracting talent, balancing personal relationships and business interests and limited opportunities for exit to name a few. These issues are complex and are often marred with love and affection leading to problems and disputes.
While these challenges are inevitable, there are legal and strategic tools which, which with proper planning and management, can be utilised to protect the business and to preserve filial relationships. The secret to running a family business successfully using these tools lies in agreeing key issues in advance. All stakeholders involved should understand how the interests of the business and those who own the business relate and everyone should be clear on their role in making the business a success. There are several key steps that should be taken to guarantee the optimal operation of the family business and set the stage for a smooth transition from generation to generation and beyond friendship as the case might be.
Business Structuring and Corporate Governance
“By failing to prepare, you are preparing to fail.” Benjamin Franklin
Most family and friend-based businesses come into existence because of either the bond that exists between the family and friends or to gain certain benefits under the law. The form of the business is thus a function of what is expedient and interests in the business are created merely by circumstances. While a business may have started out as a casual arrangement between family members and friends, continuing to operate with no clear business structure and ownership options, threatens the continuity of the business, particularly when disagreements arise between business owners. It is therefore of utmost importance that formal business structures and clear governance practices are put in place as the business begins to mature.
Establishment of a formal business structure
Generally, most family and friend-owned businesses are conceived and born as a side hustle or as an instrument for facilitating survival. Even with dreams of growing them into bigger entities, business ownership may lack clarity on which ownership and management structure to choose. This dilemma is heightened in case of a family business as the rights and responsibilities of the parties involved are may be subject to extraneous family consideration such as the position in the family, as opposed to contribution and expertise.
No matter how complex these interactions, family businesses are still businesses. There must therefore to assure success subscribe to the structural forms that guarantee success. The Parties involved must with intentionality and professional advice determine the best legal form of the business based on its nature and the objectives for its existence. The form may also be dictated by regulatory requirement. Whichever form the business takes, whether business name, partnership and limited liability company, this form must be founded on the clear understanding of how it serves the viability of the business.
Additionally, it also makes sense for the family members and friends who are founding a business to expressly memorialize their understanding of the goals of the enterprise and expectations from each other. Any structure that is put in place must be well-deliberated and implemented and agreements such as Partnership Agreement, Founders Agreements, Shareholders Agreement and more should be put in place to govern the relationship between the parties involved and to assert their desires and vision. At a minimum these legal agreements must, inter alia, stipulate each family member’s contribution/investment, define the role of the family member/friend in the business, explain what happens to the business in the event of a disability or death of one or more family members, make provision for how interests can be transferred and how members can exists, contain valuation provisions to determine the value of the business in the event of a transfer, include Corporate governance provisions which set forth the manner in which the business will be managed and clearly outline how disagreements and disputes should be resolved.
Establishing Proper Corporate Governance Procedures
Even in the context of a family business it is imperative that Corporate Governance considerations are taken into account. Utilising a Board with independent directors, infuses objectivity and accountability into the business. Adopting corporate governances’ principles support businesses viability and ensures that value is preserved for all interested parties irrespective of the challenges that may be at play. This is even more imperative when you consider that family and friend-owned businesses may be particularly prone to conflicts of interest. To avoid conflicts of interest, it is important to establish clear policies and procedures for disclosing and managing these conflicts.
EMPLOYMENT POLICIES
While some businesses have employee policies which broadly define what the role, responsibilities, and liabilities of the employees are, there are times when family businesses avoid having contractual agreements signed by family members. As a consequence of this omission, if there’s ever an employment conflict involving family and friends, it becomes difficult to resolve that conflict objectively or indeed to mount an actionable claim.
It is imperative that even where family and friends are involved, there are properly drafted employment contracts in place which ensures an appropriate allocation of job responsibilities and equal treatment of the family members. This guarantees that there is a basic expectation setting for all the family members in terms of employment rights and responsibilities and that there are no contractual issues that could eventually lead to a fallout. In addition to the Employment Contract and a General employment policy, another useful tool the development of a Family Employment Policy to manage expectations as well as insulate the business from “family favours”.
PROFESSIONAL ADVISORY SERVICES
“We all need people who will give us feedback. That’s how we improve.” Bill Gates
When it comes to a family run business, a key factor for ensuring its smooth management and success, is the quality of independent advice and input that the business owners obtain from external professional advisors, such as accountants, lawyers or human resource practitioners to mention a few. In addition to obtaining advice directly from such business enablers, tremendous value is also placed on settling up a Board of Advisors, made up of outside business leaders and professional advisors who can help the business with difficult management decisions.
Professional advisors are also critical for ensuring compliance. Every business is required to be compliant with several laws, rules, and regulations and a lack of knowledge or adherence to these rules breeds significant legal, financial and operational risk. The risk of none compliance is heightened withing a framework of a family business, where particularly at inception there is laxity in terms of accountability. Having an independent party responsible for this, enables the business owners to focus on the long-term strategic goals of the business.
SUCCESSION PLANNING
When family or friends are involved in a business, personal and emotional issues can arise that can impact the decision-making process and threaten its long-term viability including rivalries, favouritism, or personality clashes. Additionally, family members or friends may have competing priorities when it comes to the business, the most common being where some prioritise growth and expansion, while others prioritize stability and maintaining the status quo. Unequal distribution of power and ownership, lack of clarity around roles and responsibilities: Without clear roles and responsibilities and generational differences, further compound the risks that may impact the continuity of a Business. Succession planning can help to mitigate these potential conflicts among family and friends and to ensure the business continues to operate effectively
Succession planning provides continuity by ensuring that there is no disruption and that the business continues to operate efficiently even after the current owner(s) retire or pass away. Planning for succession also ensures that there is a preservation of generational wealth and the maintenance of the culture and values on which the business thrives. It is also important to note that a well-executed succession plan can help retain key employees, who may be more likely to stay with the business if they see a clear path for their own career growth and development.
It is important that succession is well planned and well documented. Existing ownership and management structure should be assessed and the retention of control and financial reward balanced for posterity. This may entail utilising professional advisers to split ownership into separate businesses or set up trusts/ investment companies for commercial, tax and succession purposes. Founding owners must also consider the possibility that family members may not have what it takes to run a business or may not wish to and that successors may have a different management style. The succession plan may therefore want to make provision for a gradual handover to reduce impact and support long term success. Preparing a written document is instrumental in creating among the current owners, and establishing a roadmap for how the business will continue to exist.
ESTATE PLANNING
“You cannot escape the responsibility of tomorrow by evading it today” Abraham Lincoln
Confusion may sometimes arise between succession planning and estate planning. The succession plan relates to the Business while an estate plan is for the individual owners of the Business. The Estate Plan is therefore not something prepared by the Businesses professional advises bur those acting on behalf of the owner. This notwithstanding, depending on the nature of the business, it is sometimes difficult to separate the plan for the future of the business from the estate plans of the individual owners.
It is important that each individual owner thinks through their own estate planning. In this regard, it is essential that the estate plans of the individual owners together are aligned with the succession plan an allow for an appropriate transition of the business.
Coming together is a beginning; keeping together is progress;
working together is success. – Henry Ford
It is evident that the highlighted challenges that plague and threaten family businesses, can be addressed through legal means. The legal tools delineated not only enable the business to overcome the pitfalls of mixing business with pleasure, but also provide fertile ground upon which the business can grow and thrive. The paradox between the cautionary tale that warns us against mixing business and love and the thriving business that excel, can be reconciled. With proper planning and management, family run businesses can create wealth, deepen relationships and provide employment for future generations. If not approached strategically, the “filial enterprise” can break up families and lead to legal disputes.
Family and friend-owned businesses can be both rewarding and challenging. While the risks and challenges associated with these types of businesses are undeniable, there are legal and strategic tools available to address them and to promote their long-term success. By establishing clear business structures and corporate governance procedures supported by professionally crafted agreements and policies, putting in places proper employment safeguards, by utilising professional advisors as guides in the complex business landscape and planning for succession at an enterprise and personal level, family and friend-owned businesses can thrive for generations to come. Ultimately, the key to success lies in proactive planning, clear articulation of expectations and goals and a commitment to the long-term success of both the business and the relationships that underpin it.
Kabanda Leah Lopa is a Legal Practitioner at CC Gabriel and Co Legal Practitioners
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This article is for general information purposes and is not intended to be and should not be taken as legal advice.