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Leaving Your Business to Your Kids: Perils and Pitfalls

Many entrepreneurs dream of passing down the business they successfully developed to future generations.  But sometimes that dream becomes a nightmare.  Consider these real-life examples.

Four grandchildren of a company’s founder inherited equal ownership shares upon their father’s death.  Two of them ran the business, as President and Vice President.  The other two served with their siblings on the board of directors, but didn’t work for the company.  Disputes erupted between the two officer family members, leading the President to enlist the support of his other siblings on the board to terminate the Vice President’s employment.  The fired sibling then filed a lawsuit against the company and his siblings.

Two men founded and ran a successful business as 50-50 shareholders.  Each of them left his share of the company to his son.  When the two founders were in charge, they had their differences but found ways to resolve them and successfully operate the business.  The two sons were unable to coexist with like success.  They clashed repeatedly.  The son serving as President took the position that his office entitled him to unilaterally make most major decisions.  The other son asserted that various decisions were the responsibility of the board of directors, but the board was deadlocked.  The disputes wound up in court.

 Resolving Disputes

 So, what do you do when you find yourself in such a predicament?  The default dispute resolution mechanism is for someone to file a lawsuit.  While sometimes there may be no other option, litigation should be the dispute resolution means of last resort.  Litigation tends to be expensive, time consuming and, in family situations, fraught with emotion.

Another, often better, option is mediation, which essentially consists of structured settlement negotiations, guided and facilitated by a trained mediator.  A good mediator can do much to enhance the prospects of a mutually agreeable dispute resolution.  For one thing, a mediator can enhance effective communication by serving as a go-between.  Also, a mediator can bring a valuable independent perspective to the situation.

Sometimes, the most effective means of resolving a dispute is a hybrid approach.  For instance, in the first scenario described above, the parties went to mediation and hammered out an agreed resolution, involving the company buying out the Vice President’s interest.  But, the parties could not agree upon the value of that interest.  So, they entered into a buyout agreement, providing that the value of the interest would be determined through a court proceeding, with the parties agreeing to accept the trial judge’s valuation and forego any appeal.

Applicable law may provide a specific remedy for a particular type of business dispute.  For instance, regarding the second scenario described above, the laws of many states provide that where a corporation’s directors or shareholders are deadlocked, leaving the business unable to function properly, a court may appoint an additional director to the board, who can act as a tie-breaker.

There are many approaches that can be taken to resolving family disputes arising in the context of next generation business ownership.  A good lawyer experienced in the area can be of great help in navigating through the available options.  Litigation, mediation and other approaches are not ends unto themselves, but rather means to an end, and the means chosen should be the one that best fits the circumstances.

Preventing Disputes

Of course, the best approach is to prevent disputes from arising in the first place.  A good lawyer experienced in business succession and estate planning can be invaluable in that regard.

Many different approaches are possible, and should be tailored to the situation.  For instance, if some children are going to be involved in running a family business, while others will not be, and there are substantial family assets outside of the business, it may be advisable to leave the business to those children who will work for the company, with different assets going to other children.  Also, if multiple children are expected to be next generation owners of a family business, with some of them actively working in the business and others being passive owners, attention should be paid to how and when the passive owners can expect to derive benefit from their interests.  Finally, a 50-50 ownership structure is fraught with peril, as it can lead to deadlocks, and may not be ideal for many situations.

In short, when family disputes relating to ownership of a business erupt, sometimes it takes a pound of cure to resolve them.  But, preventing them from arising is even better.  As Benjamin Franklin said, an ounce of prevention is worth a pound of cure.

The article originally appeared in the July 2013 addition of St. Louis Small Business Monthly.