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The Family-Owned Business

There are three major pitfalls to avoid when operating a family-run business.

Michael J. Conway, JD, and Stephen J. Baumgartner, MSc(Econ)

Graziadio Business Report,  2007, Vol. 10, Issue 2
This article is copyrighted and has been reprinted with permission from Pepperdine University

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Pitfall #2: Ignoring Fiduciary Responsibilities in the Event of a Dispute

Whether family business owners are general partners in a partnership, officers or directors in a corporation, or managing members in an LLC, each of these entity structures carries a fiduciary obligation for the owners to act in the best interests of the business and to treat other owners fairly in their business dealings. This fiduciary duty applies regardless of the type of dispute involved, the egregiousness of the other side's behavior, and whether or not the parties are family members. Fiduciary duties also apply from the inception of the business until its dissolution.

When family business owners become involved in a dispute, they frequently believe that they are justified in taking advantage of the other owners based on some actual or perceived slight that may have occurred. Although the law recognizes the equitable doctrine of "unclean hands" in resolving such disputes, it does not look favorably upon those who take advantage of others. Ignoring fiduciary responsibilities is risky business for family business owners/partners. They could be subjected to significant punitive damage claims from the other family member partners or from the non-partner spouse who can claim under community property statutes.

Instead of responding in kind to the bad behavior of their partners or of their spouse's partners, family business owners or non-partner spouses are better off to immediately seek relief from the courts rather than taking justice into their own hands. Such relief may include a temporary restraining order and a preliminary injunction against the offending party or business, imposing a receiver to manage the affairs of the business pending dissolution, and/or a substantial damages award against the offending party.

Pitfall # 3: Failing to Plan for the Future

Even the most conscientious family business owners often overlook succession planning. There are many reasons why, but it often boils down to the same reasons why people fail to create a will. All family business owners should put as much time and attention into their business succession planning as they do (or should do) for their personal estate planning. Without a plan, the entire business could collapse if and when the business owners can no longer effectively work together to manage the business.

Family business owners should consider these issues when creating a business succession plan:

1.      How will a divorce involving one of the owners impact the business?

2.      If an owner dies, how will his or her interests be distributed?

3.      What happens when an owner wants out of the business at some point in the future?

4.      What options or mechanisms will allow the purchase of a deceased member's interest without bankrupting the entire business in the process?

5.      How will the fair market value of an owner's interest be calculated in the event of a buy-out?

Thinking through the best solutions for each of these issues will help protect the business and ensure that the needs and concerns of the owners are reflected in all legal documents. Family member owners will need to have the best tools available to effectively manage and grow their business.

Even in the most efficiently run businesses, nerves can fray among co-owners and partners. When family issues and personalities enter the picture, things can only get more challenging. Having the proper documentation in place can help ease the stress for any enterprise, especially for those that are family-owned and operated.

Resources are plentiful for the family-owned business and include:

·         Programs offered through various university resources

·         U.S. Small Business Administration

·         Family Business Institute

Consult your attorney for specific information regarding the type of legal documentation that is best suited for your business.

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Michael J. Conway, JD, is the General Counsel for the Baja Fresh Mexican Grill chain of restaurants in Thousand Oaks, California, where he focuses on general business matters including contract disputes, employment issues, arbitration/mediation, and litigation of commercial, insurance, and real estate matters. He is the immediate past president of the Loyola Law School Board of Governors and is active in The Alliance for Children's Rights where he provides pro bono legal services to adopting parents through the organization's legal assistance program. He was selected by Law & Politics and Southern California Super Lawyers magazine as a "Rising Star" in both 2005 and 2006. mconway@bajafresh.com

Stephen J. Baumgartner, MSc(Econ), teaches strategy at the Graziadio School of Business and Management and consults at the Encino, California, law firm of Greenberg & Bass, LLP (www.greenbass.com). As a strategic planning and financial analysis specialist, he has extensive expertise in litigation support, forensic analysis, financial modeling, debt restructuring, reorganization plan preparation, new venture start-ups, and project management. Baumgartner has more than 20 years of experience in finance, information systems, manufacturing, real estate, and management in firms including Xerox and Rand. stephen.baumgartner@pepperdine.edu

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This article first appeared in Graziadio Business Report,  2007, Vol. 10, Issue 2

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