4 Musts Before Starting a Family Business

family business legal
Here's four often overlooked legal issues you should think about before starting a family business

 

Starting a business can be an exciting and optimistic period in an entrepreneur’s life. However, what most business owners do not realize is the decisions made at the beginning of a business’ life often have the largest impact down the road such as if/when having to face litigation. Therefore, it is important to place a strong emphasis at the business planning stage.  Here are some important considerations that one should think about when starting a family business.

1) Family Financing

Most often, start-ups seek family members as the first investors for a business. Because of the familial relationship, a family member who invests normally does not ask to see financial projections or require the investment be contractually sound. Now, while this may seem like a wonderful scenario for both sides (family member helping out and someone receiving funding with little question), the investment can be harmful for both parties in the long-term if planning is not considered.

In the case of the family investor, he/she may be receiving less than they bargained for. In the case of the entrepreneur, he/she may feel imposed by the family member because of the family member’s investment by the family getting involved in the business in a way the entrepreneur did not anticipate or, worse, the possibility future litigation by the family member if they feel as though the business and/or arrangement is not going the way the family had hoped.

Furthermore, there could tax consequences if not handled correctly. For instance, an investment by a family member is to be structured as a loan but subsequently categorized as an equity investment by the IRS due to the familial relationship. The equity investment determination thereby disallows the use of large deductions such as the interest expense deduction. The determination could also affect the rights of family as a creditor in case the business fails to perform.

2) Employing Family Members

            Finding the right employees is essential to the success of any business. Of course, hiring family members can make it a tricky predicament. Family members have a tendency to believe they can act as they see fit.  Employing persons that think they are outside the rules, or exempt from the ordinary responsibilities of an employee is a detriment to any business.

Every business owner that hires family members needs to make sure there is a set list of job responsibilities, and a defined hierarchical structure, ideally in a contract.  The fact a governing document is in existence furthers the position that there is a separation between work and family. By giving the family member the boundaries of the relationship, it is less likely that the family member will thwart the development of the business.

 

 

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About the author

Senen Garcia

Senen Garcia operates SG Law Group LLP a thriving law practice in multiple states assisting clients with their corporate, real estate, estate planning, and property insurance claim needs.  Additionally, Mr. Garcia has accounting practice assisting small businesses with tax and accounting needs.  Along with his work with SCORE, Mr. Garcia has also provided assistance with the local Small Claims Clinic that provides assistance to individuals filing small claims cases. Mr. Garcia has spoken on a variety of topics such as:  How to start a business, Communication within your organization, Importance of Capital Accounts, What’s in Business Name Anyway?, and Stock Purchase Agreements vs. Asset Purchase Agreements.

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