How to avoid costly misunderstandings in family run businesses

In particular, the following sorts of questions often don’t get considered properly until a problem arises…and they can be very difficult to resolve after the event…..

• What happens if one of the co-owners dies? Where will his/her shares go? Should the company be sold?
• Would the surviving co-owner(s) be able to buy out their interest and, if so, how will that be funded?
• Can the Company itself perhaps buy back its shares?
• What would the price be? Market value or a pre-agreed price? What if there is no consensus on price?
• Does life insurance need to be taken out both to provide for the company and to ensure that the business can continue to function (ie, key man insurance) and perhaps separately to enable the surviving co-owner(s) to buy out the interest of the deceased? Does there need to be a cross-option agreement in place to deal with this?
• What happens when an owner-manager is ill and cannot continue to work (and does there need to be private health insurance or critical illness insurance in place)?
• When should the business be sold and who decides?
• What happens when one of the owner-managers wants to retire? Does the continuing owner buy him out and again, at what price?
• What rules should there be about bringing family members into the business? And what about transferring shares to other people or into trust?
• What happens if there is a fundamental disagreement on something which causes deadlock?
• Should there be a dividend policy? In what circumstances should a dividend be paid?
• What if further investment is required? Who provides it?
• At what point should a management team be brought in? And how would they be remunerated and incentivised? Are share options a good idea?
   

It is crucial to the success and continuity of the business that there is a common understanding on these issues. Without this there will be all sorts of risks of misunderstandings and confusion over how to deal with these issues should they arise in practice, and with the potential fall-outs. They can also be a serious distraction from running the business itself and making it a success.

That common understanding needs to be set out somewhere and this is often done through the Articles of Association combined with a Shareholders’ Agreement, if a company, or through a Partnership Agreement, if that structure is used. The business and the individuals concerned can then put in place any financial planning needed to ensure that the understanding can be implemented.

Some families have their own constitution setting out the family’s purpose and intentions for their business which can help ensure everyone is on the same page, and thereby minimise the risk of disputes arising.

As ever, a bit of careful planning up front can avoid a lot of problems in the future.