Family is family, but legal structure is key

An agreement locked with a handshake is an honorable way to seal a deal, especially when you are family. But when it involves business, a legal document will hold up in court – a handshake will not.
One of the biggest mistakes family-owned businesses make, experts say, is not putting agreements on paper and not seeking legal help to protect their assets. Because while family is family, disputes can arise when you mix family relationships with business.
Sibling rivalry, new generations taking over the business, divorce, illness and other situations can lead to conflict.
“When that relationship sours, the problems begin,” said Paul Campellone, an attorney and shareholder with Adler Pollock & Sheehan. “People then have different versions of what happened” before that proverbial handshake.
One of the basic choices that family-owned businesses have to make is how they will be organized: as a sole proprietorship or partnership, a limited liability company, an S corporation or, for a larger enterprise, a C corporation.
The choice has tax implications – S corporations’ profits are not subject to the self-employment tax, for example, as LLC profits are – and legal implications in terms of how family members’ personal and business assets will be protected in the event of a lawsuit.
Financing structures are also important. Experts say in family-owned businesses there is often miscommunication between members of the family on financing and whether money put into the business is an investment or a loan.
“I run across situations where people think they have ownership in a business because they provided money to help start the business,” Campellone said.
And it’s important to define the roles of different family members in the business, both in terms of ownership and in management.
Catherine Parente, a partner in Carlin, Charron & Rosen LLP’s litigation support and business valuation services group, has advised family-owned businesses for more three decades. She said she has seen some really ugly disputes that could have been avoided with an attorney or accountant.
“Having been involved in partner shareholder agreements, litigation and matrimonial disputes, all hell can break loose,” she said. “I’m talking about nasty situations that were made on a trust basis without any legal agreements.”
Businesses should prepare in advance, for example, for the event that a sibling marries, Parente said. Should that husband or wife be allowed to work in the business? Regardless of the answer, put it on paper, she said, and have it looked at by an attorney.
Bob Bischoff, president of Rhode Runner Inc., which has athletic shoe and apparel stores in Providence and Smithfield, said he is a firm believer of building a house on a solid foundation.
That is why he and his wife, Colleen, formed the company as an S corporation and brought in attorneys and accountants to do everything by the book, he said.
“Through the corporation we had to set up officers in the company,” Bischoff said. “I own 51 percent and am majority owner.” At the same time, he said, he and his wife understand that whether the company succeeds or fails, they are both responsible for it.
When not all family members are involved in the business – a common situation as second- and third-generation owners come into the picture – conflicts can also arise about how to handle the revenue from the business.
“The father will give shares of the business to various members of the family, and there is a tendency for those in the business to reinvest the profits and those not involved in the business to want the dividends,” said William O’Hara, founder of Bryant University’s Institute for Family Enterprise.
A way to avoid a dispute on shares of the business, O’Hara said, is to have the first-generation owner develop a detailed succession plan.

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