It happens all the time. You and your spouse are chatting over pizza one night and an app idea pops into your head. Or your sister pitches you to invest in some real estate with her. Maybe a friend asks if you want to partner on a cool new business she’s been wanting to start up. Or maybe your parents offer up a position for you in their business when you finish college. Whatever the situation, it is all too common that these businesses get going informally, and this can create major problems if the business grows, or worse, if the business goes south. Going into business with family or friends is always risky, but when done right, it can be quite rewarding. Consider these as your starting point when starting a family business:
Write it Down.
You might hear that a back-of-the-napkin agreement is better than nothing. It’s all well and good when you’re laughing over drinks about what you’ll do with your first million, but who wants to find out the hard way that you don’t actually agree when the time really comes? Formalized agreements should be the norm, particularly the following:
- Founding Documents: Whether you’re starting a corporation, LLC, partnership, or non-profit, formalize the organization properly from the get-go. This sets clear parameters for business operations, helps get the company set up properly for tax purposes, and provides the foundation for an organized business if and when the time comes for financing, acquisition, IPO, etc.
- Employment Agreements: “I’ll be the CEO and you’ll be the CFO” is a great starting point, but there should be employment agreements in place outlining roles and responsibilities. This is important to ensure the company is properly paying taxes for employees versus independent contractors and protects the company in the event someone is terminated and there is a disagreement about whether it was appropriate.
- Corporate Governance: Have a written record of meetings so there is a history of business discussions. This could be relatively informal, but at a minimum, there should be a once per year board meeting, and a once per year shareholders meeting, if applicable.
- Vendor Agreements: Have an app idea and want your graphic designer brother to put together the graphics for your app? Whether he’s doing it as a favor, getting paid a fee, or getting in on future earnings for the work, have a written agreement in place. It sucks to go to court over a dispute. It’s super awkward to stand in front of a judge with your brother to fight over whether his digital panda design was worth the $100,000 he’s suing you for after your app went viral.
Have a Disaster Plan.
Your founding documents should always have a “disaster” section, known as a buy-sell agreement, that articulates what happens to the business if an owner dies, gets divorced, or goes bankrupt. This is important in any business, family or not, where a bitter ex-spouse or an aggressive bankruptcy creditor can tie up a business and its assets in litigation for years. These disaster clauses can look different depending on the scenario, but there should be some sort of buyout option where the company and/or the other owners can buy back one owner’s share of the business in the event of death, divorce, or bankruptcy.
Don’t Mix Personal and Business Finances.
Ideally, before you spend a dime on the business, you’d have its own bank account set up and funded. But that’s not always the case. As early as possible, get this in place. Mixing personal and business finances is one of the easiest ways to end up personally responsible for business liabilities. Not only can you end up losing your home, personal assets, and nest egg if the business goes south or ends up in litigation, but without proper financial formalities in place, you can end up with unnecessary tax complications. Don’t skimp on the CPA or tax attorney at the outset. Save time and money down the road by getting set up properly up front.
Go For It.
A lot of people might tell you that doing business with family or friends is a bad idea. And in some cases, it might be. But if a good opportunity presents itself, don’t pass it up because of the “what ifs.” Instead, plan for them.
Already in business with family or friends and skipped some (or all) of these steps? It’s not too late. You can always memorialize agreements and get the finances and operations of a business in order after the fact. But don’t wait until there’s a problem. It will be more costly and entirely more complicated, and having relationships with friends or family at stake just muddies the waters.
Obligatory Disclaimer: Did you like what you just read? I’m glad! But please know this post is for information purposes only and is not considered legal advice, nor does this create an attorney-client relationship. Head over to my legal blog to check out other relevant information and contact me through there if you want to discuss your legal needs.