When dealing with family members, in general an element of trust is always prevalent but how far can we take this trust? Business related contracts, in the main, dealing with ownership are sometimes considered by family businesses to be non-essential. The rationale is that “because we’re family, we don’t need a lot of complicated legal documents.” This is a great concept, except when it does not work.
Contracts are critical only when there are disagreements. If the owners of a particular family business can guarantee they will never have a disagreement, then well-prepared legal documents may not be necessary. This, obviously, is not a realistic assumption. In the event of a dispute, it is essential to have a detailed written understanding worked out in advance that will minimize the number of important issues left open for argument.
As part of their planning, family business owners should consider including the following types of provisions in their ownership agreements:
- Buy-sell: Triggering event buy-sell agreements provide that an owner’s interest may be bought upon his or her death, disability, termination of employment, or divorce. They can also provide additional ownership to family members or non-family executives who are essential to the business.
- Capital calls: If a family business requires a capital call to raise additional cash liquidity, the owners may already be under financial pressure. Having the details of capital calls spelled out in advance in the ownership documents can provide predictability and certainty about the way the process works, reducing one additional source of stress if the business is strapped for cash.
- Voting trusts:Voting trusts may grant certain family members (or non-family managers) the power to vote the ownership interests of other family members. Although ownership of a family business may tend to become more dispersed with each generation after the founders, voting trusts make it possible to keep governance and voting rights concentrated in fewer hands if that is preferred.
- Deadlock resolution: If the family business owners believe it is critical to avoid deadlocks over major issues, such provisions can provide a mechanism for ending the deadlock. These kinds of buy-sell provisions typically state that, if a deadlock occurs, one owner (or group of owners) may offer to buy out the interests of the other owners. Those other owners must either accept the offer to be bought out or, if not, they must in turn buy out the initiating owners on the same proportionate pricing and terms.
- Supermajority voting: Under these kinds of provisions, certain key decisions must be approved by more than a simple majority vote of the ownership. This limits the ability of majority owners to force minority owners to accept major decisions.
- Key man insurance: Insurance proceeds may fund buy-sell obligations that are effective upon an owner’s death or disability. Such insurance can provide a source of liquidity to repurchase a deceased or disabled owner’s interest without having to sell or leverage company assets or raise additional equity.
- Alternative dispute resolution (ADR):ADR mechanisms, such as mediation and arbitration, make it less likely that a family disagreement will end up in a public litigation situation. With litigation, it can be extremely difficult to maintain personal relationships among the litigants. Use of mediation and arbitration is no guarantee that family members will be able to resolve a business disagreement without permanent relationship damage, but ADR may help reduce such damage.
At the Family Business Office we can offer you assistance in dealing with family business succession planning issues through incentives supporting advisory and mediation services. Contact us today on [email protected].
(All factual and statistical information presented in this blog has been obtained from an extract of an article from the familybusinessmagazine.com) Follow us on our Facebook page and Family Business Office website at www.familybusiness.org.mt