Setting up a family business: key considerations and must-have documents

Although starting a family business (or planning to involve family members in your existing business) will be an exciting venture for everyone involved, the process and future running of the business will come with unique challenges. Careful planning and clear agreements to ensure long-term success and harmony amongst the family are required.

Here are our key considerations and the essential documents you will need if you are setting up a family business.

1. Should all family members be part of the business?

While involving family members can strengthen the business, it's important to consider:

• Skills and qualifications: Ensure that each family member has the necessary skills and experience to contribute effectively. Consider the risks if they don’t.
• Interest and commitment: Only involve those who are genuinely interested and committed to the business.
• Potential conflicts: Be mindful of potential conflict between family members and have mechanisms in place to resolve them (see below).
• The impact of divorce: Although there are tax-saving opportunities for the family by employing a spouse or partner or providing them a shareholding upon which dividends can be declared, do consider what would happen if that relationship was to break down. Could there be a considerable impact on other staff members? Could the smooth running of the business be affected? Think carefully – do spouses and partners need to be involved? If they do, then ensure the following documents are in place, are fit for purpose, and are kept up to date.   

2. Shareholders agreements

A shareholders’ agreement is crucial for outlining the rights and responsibilities of each shareholder. This document should cover:

• Ownership stakes: Clearly define who owns what percentage of the business.
• Roles and responsibilities: Specify the duties and expectations for each family member involved. Employment contracts are also key.  
• Decision-making processes: Establish how decisions will be made and who has the authority to make them.
• Voting rights: It is important to consider the following:
  • Should some shares carry more voting powers than others.
  • Determine what constitutes a majority for different types of decisions. Avoid stalemate situations at all costs.
  • Define the voting rights of each shareholder to ensure fair and democratic decision-making. 
• Pre-emption rights: protect existing shareholders by giving them the first opportunity to buy existing shares before they are offered to outsiders. A clear and effective pre-emption rights clause will be key in:
  • persuading a Family Court against ordering a transfer of shares to a soon-to-be ex-partner or third party; and
  • maintaining family control over the business and prevent dilution of ownership. 
• Valuation mechanisms: Understanding how the business’s value will be determined will help prevent conflicts and misunderstandings. It may also assist in framing how any valuation on divorce is conducted in favour of the business rather than the outgoing shareholder. 
• Dispute resolution: Early and effective dispute resolution is key in both businesses and families. Having an agreed and swift referral to mediation or other non-court dispute resolution process will put you and the business on the front foot with the aim of achieving swift and bespoke outcomes. 
• Exit procedures: Have clear procedures in place when a shareholder is exiting to ensure all parties are aware of the process and what is expected of them. This will include the transfer of shares and responsibilities, and/or compensation and settlements. 

3. Articles of Association

The articles of association are the rules governing the company's operations and define the company's purpose. The articles should include:

• Company objectives: Clearly state the business goals and mission. Are all family members ‘on board’, have the same ambitions and working towards the same outcomes?
• Management structure: Outline the hierarchy and management roles within the company to ensure everyone is clear on their responsibilities. Again, employment contracts are key. 
• Meeting protocols: Set guidelines for how and when meetings will be conducted. If a family member will be hard to pin down, consider who has to be at these meetings and how many attendees will be needed for the meeting to be quorate. 
• Pre-emption and voting rights: They can be included in the articles as well as shareholders agreements to provide an extra layer of protection and clarity. 

4. Pre/Post-Nuptial Agreements (PNAs)

In combination with a shareholders’ agreement and the articles of association, PNAs will protect the business from potential disputes arising from family members' personal relationships. These agreements can:

• Remove much of the discretionary nature of the court’s decision-making: The courts’ powers are wide-ranging (including the power to sell a business and transfer shareholdings) and judges have a great deal of discretion as to how they apply those powers. A PNA providing for a pre-determined and agreed approach to the business is likely to be followed by the courts. 
• Ensure the future of the business: PNAs can ensure businesses remain intact in the event of a divorce by shareholdings being transferred to / retained by the business owner and/or other lineal family members, and persuade the courts away from making orders which require business assets being sold or being used as security to raise capital. In principle, there is nothing wrong with ringfencing all business assets from sharing on divorce if the ‘needs’ (which can also be prescribed in the PNA) of the parties are met.  
• Clarify asset ownership: PNAs can define what assets are owned by an individual and should be retained by them, what are joint assets and could be shared, and if necessary clarify what are personal or business assets if there is likely to be a dispute or confusion over their ownership.  It will be easier to provide for a bespoke approach to the sharing or retention of different classes of assets if properly documented.  
• Clarify asset values: A PNA should record the value of a business at the date of marriage. If the court, stopping short of a sale or share transfer, was minded to take into account the value of the business in the financial split on divorce, the valuation at marriage will provide a clear baseline from which non-matrimonial asset arguments can be launched. 
• Propose a valuation methodology: Similar to the shareholders agreement, a proposed approach to valuing the business and who should undertake the valuation (e.g. company accountant?) will inject more certainty into this exercise and a quicker route through to the parties having the information they require to implement the terms of the PNA. 
• Provide for the resignation from roles and not bring employment claims: An agreement to not attend the workplace and not remain involved in the running of the business may be beneficial if others will be affected by any ongoing acrimony. 

Conclusion

Setting up a family business requires careful planning and clear agreements to ensure success, harmony amongst family members, and strong foundations to weather any storm. With the UK’s divorce rate above 40%, minimising the impact of relationship breakdown must be factored into the planning of every family business from inception and/or as part of bringing through the next generation.

If you have any questions or wish to explore how Mills & Reeve LLP can provide holistic planning for you and your business, please contact Andrew Moore.