To succeed, the family business must be treated like a business.

I can remember how excited my two brothers and I were at the release of Sergio Leone’s Man-With-No-Name western trilogy, starring Clint Eastwood as the infamous, quick-draw bounty hunter. The third film in the series, entitled The Good, the Bad and the Ugly, inspired an ongoing family debate that still lingers today; namely, which of the three brothers in our family is “good,” which is “bad,” and which is “ugly.”

For me, the notion of the family business conjures up many other good, bad and ugly memories. The family business is the lifeblood of many American households, including my own. I can still remember 15 years ago when I began developing my first business plan. Since then, I have counseled hundreds of other family businesses and witnessed firsthand how families can begin with a simple inspiration and build it into a successful enterprise. It has been an honor leading these families through their initial legal roadblocks, then releasing them into the entrepreneurial world as they set about their destiny. This, of course, is the “good.”

Unfortunately, there can also be a “bad” side to the family business. Not all families are meant to be in business together. Just as I have seen the joys of a successful family venture, I have also witnessed the agony that results when the adventure takes an unforeseen turn and rips the family apart. Some of the most bitter, prolonged and expensive lawsuits I have ever encountered involved family members feuding over their business. This is the “ugly,” and it should be avoided at all cost.

What is a Family Business?
At the outset, we should attempt to define the family business, since there seems to be no universally accepted definition. Wikipedia defines family business as “a business in which one or more members of one or more families have a significant ownership interest and significant commitment toward the business’ overall well-being.” This seems overly broad, as is noted in the comments after this definition. Read literally, virtually every small business could qualify under this definition.

Black’s Law Dictionary, the legal bible for lawyers, surprisingly does not define “family business” at all. Nevertheless, we should narrow the Wikipedia definition and define the family business as “one in which one or more people from the same family collectively own a controlling interest in the business.” This better equates to the layperson’s understanding of the phrase.

Is a Family Business Right for You?
I have a list of five questions I like to ask all family members jointly before their initial consultation and formation of their family business:

  1. Have you ever previously worked together on any projects that failed due to your inability to work efficiently with each other?
  2. Do you believe you will work fewer hours as co-owners of a family business than you would if you were employees of a similar company?
  3. Have you failed to discuss specifically what each family member will be contributing to the business?
  4. Have you refused to discuss in detail how each family member will be compensated by the business?
  5. Have you neglected to discuss which family member will make a final decision in the event all family members are in disagreement over an issue?

If any of these questions are answered “yes,” we then proceed with the very serious discussion of whether the family members have sufficiently analyzed if they should be in business together.

How Do We Begin the Family Business?
The best advice a lawyer can give family members who want to start a business together is simple, but in fact, rarely followed: treat the business like a business. The family should decide from the outset who will own specific percentages of the business, and who makes final decisions in the event of a disagreement. It is equally important to determine how the business will be financed. Everyone should understand from the beginning how they will be compensated. There should be a clear understanding how profits and losses will be distributed among the family members and how additional capital will be raised if it becomes necessary. Everyone should agree what happens to a family member’s interest in the business upon death or insolvency. Last, but perhaps most important, it must be agreed upon how a family member can leave the business if he or she elects to do so.

These are fundamental principles conveyed by attorneys to clients every day during the formation of their businesses. Nevertheless, it is amazing how often families reject this advice under the premise that “We know and love each other,” or “If the business fails, we will have much bigger problems at home, so we don’t need to worry about corporate documents.”

How Do We Operate the Business?
If the great economic recession has taught us anything, it is that all businesses must be managed through financially sound principles with a rational mission and plan. No exceptions. I have lost count of the number of businesses I have seen fail over the past few years merely because they did not adequately manage their cash flow and comprehend the status of their financial statements and debt structures. Pro forma balance sheets, budgets, cash flow analyses and project management techniques have become mainstays for the successful formation and operation of new businesses. Downplaying these essential elements because “it all comes out of the same pocket” is a recipe for failure. Utilize the family’s strengths and outsource the weaknesses. If some family members are experienced with management, finance and marketing, then let them put their skills to work. Assess the remaining needs of the business, and find the appropriate outside vendors for assistance.

How Do We End the Business?
What happens if somebody wants out? This is when we must avoid the “ugly,” because if someone wants out, it usually means they are unhappy. When members of a family business start asking this question, it is often too late for congeniality, and the lawyers have already been called into the war room. Blood may be thicker than water, but I have seen many unfortunate scenarios where it is not thicker than money.

Once lawyers get involved in the breakup of a family business, it almost inevitably ends in a relationship disaster for the family. Someone (if not everyone) ends up broke, emotionally scarred, or both. Bridges can be irreparably burned, and family who once gathered for holiday meals may go decades without speaking.

There are only two ways to avoid the “ugly” results of a family business breakup, short of a resolution in court. The first is to thoroughly discuss and determine the answers to these difficult issues up front and decide how they will be resolved before the business is ever formed. If this hasn’t happened, and the family feud has begun, the only remaining non-legal option is for one side to surrender in hopes of preserving the family relationships. This is, of course, much easier said than done.

My brothers and I used to ask our parents to resolve our dilemma over the “good, bad and ugly.” I recall they told us that all three brothers would be “bad” until we moved out of the house and gave them grandchildren, at which time we would become “good.” Since that has happened, they have avoided labeling any of us as “ugly.” The goal for the family business is also to avoid the “ugly.” Many successful businesses have managed to accomplish this through detailed initial preparation and by operating the venture as a business. iBi