Family business partners operate under completely different internal rules than the typical partnership. What the law says about partnerships doesn’t matter to partners in a family business. Rather than operate under the legal rights and responsibilities of a business partnership, family business partnerships usually operate under the same dynamics as the family. If Dad started the business, his say will always be law despite his granting of stakes to adult children. Meaning that Dad might own 20% of a business but his vote remains the only one that counts. Valuations get a little weird too. Founders often see the business as worth more than it really is.

Problems in Family Business Partnerships

Baggage. That’s the biggest problem. There is a lot of baggage that comes with entering a partnership with family members. When people go into business with a friend or acquaintance, they rely on mutual trust, albeit blindly, and the law, albeit naively. That difference is huge. While people never think about suing, they assume that they have legal protection if they need it.

When tension arises in a typical partnership, folks look for resolution knowing they have some legal protection. That changes in a family business. If Dad buys a new piece of machinery without consulting his 2 sons who are also partners in the business, what can they do? Sue? Not likely. Dad will always see the company he started as “his.” The stakes held by his sons will always be lesser despite their combined 2/3 ‘power’. Rarely will there be a formal Partnership Agreement. Dad will do what Dad wants to do.

What happens when a daughter goes into the business with her father and later decides that having a business is not for her. Does Dad repurchase her interest or does he merely say goodbye? It’s pretty easy to get agreement on valuation in a typical partnership. It’s impossible in a family partnership. The first thing Dad will say is, “she didn’t put any money in. Why should I buy her out?”  The daughter will tell me that, “I worked hard for 5 years, but he will never let me make any decisions. I should get something for my interest in the business.”

Joining a business with a family member can be stressful later because the documents that are typically drawn to govern how the partnership will work are seldom created in a family business. What generally happens is that senior family member in the business has the control—like it or not.

Valuating a stake in a family business is very difficult because it comes down to what the “senior” partner wants to pay. He may choose to help by overpaying what a share is worth or he may choose to pay nothing because he “granted” the stake for nothing in the first place. In other words, valuation comes down to what the senior (ranking family member) decides he wants to use.  Would you join a business with a friend on the basis that he will determine the value of your stake should you decide to leave the partnership? Of course not. But, people jump into family businesses every day on that basis.

What do wealthy families do? They prepare the proper documents! It not only protects everyone’s interest, it also protects the business! And it teaches the younger members about the right way to conduct business.

Fixing Problems Is Tougher in a Family Business

When there is a problem between partners in a family business, all the normal rules that help inform a solution are absent. You might think that resolving tension in a family partnership is easier than working out a solution between two non-related feuding business partners. No. I’ve worked with business partners who were ready to tear each other apart but once they understood how things work (legally) they could make the necessary compromises to reach an agreement. 

In a normal partnership, people are motivated by money. If I can show how a particular decision can make money, the partners will generally reach agreement. In a family business, the founder often clings to the old ways and the kids often push for extravagant new ways. As tension rises, Dad will dig in to the past and the kids will push to the extreme of modernization. Does a brick business with 5 employees need to go with full online automation of all processes? No, but hand-written invoices that get entered into a 3 foot wide paper ledger isn’t the way to run a business today. The friction causes wider separation.

Let’s take the case of the father-daughter trucking business. Dad started the business 30 years ago. His daughter stepped in about 10 years ago to help out with the books and planning logistics. She discovered a real knack for business. Dad, being the proud parent, tells his daughter that she is now a full partner in the business. She knew she would eventually inherit the business but now, as a partner, she wants to make more money and has a good plan to do so.

She sees that short hauls make more money per mile than long hauls.  She wants to sell off 2 of their 5 big rigs and buy 4 small box trucks. They can grab more customers and save money on operating expenses. Dad says that they have always been a long haul trucking company and always will be. She threatens to quit. Dad buys another big truck to show that he is still in charge.

Quiz for you. What percentage of the business does the daughter own? Was the father justified in the purchase of another big truck? Does the daughter have recourse? If she walks away from the business, is she owed anything? How much?

I get the call. When I met with them, the daughter started by saying that she is “done” with this business. The father says it’s his business to do with as he pleases including taking back her share which was never documented in the first place. When I talk about him buying her out, he says that she can have the whole thing. She says she wants  $800,000 that she could have made over the last 10 years if he would have let her run things her way.  Dad says he’ll give her $400,000 because he no longer cares what she does. He doesn’t have $400,000. She then says that when she leaves, the business will fail. She wants out and is angry that her stake is essentially worthless.

I don’t want to bore you with too many details of this example but I think you see the problem. Members throw around numbers that have nothing to do with reality. The separation is not rooted in business as much as in family dynamics. The daughter wants to run the business and Dad wants to keep control. Instead of working together, they push things in crazy directions that make resolution impossible. There are no governing documents.  There is no realistic appraisal of the value of the business. There isn’t agreement on how much of the business the daughter owns. Messy.

This situation won’t end up in court. Unless the dispute is over millions of dollars, cases like this rarely lead to litigation. Chances are that the business will suffer or fail. People will get into a mode of taking what they can before it fails. Somebody often buys a car. When partners battle, there is often a new car at the center of the argument!

I recently worked on another case like this. The parties were very far apart. Neither were acting rationally. Neither would accept a solution regardless of how stacked in their favor. It came down to history together, spite, and pride. Dad wouldn’t loosen his grip on the reins and the son refused to give Dad any support at the business what-so-ever. Both told me things about the other that were hurtful and untrue. There were no documents defining the partnership. I came up with a great solution for them whereby Dad could keep his business in tact and the son would get the capital he wanted to move on to something else.

“When partners battle, there is often a new car at the center of the argument!”

Closing Arguments

I learn something every time I get involved with a family business dispute. I’ve learned that getting involved in this type of dispute is painful for me.

I like people who start businesses. I care about them. I wanted the best for that terrible father-son battle. But, I’ve learned that the normal rules of engagement do not apply. The parties to the dispute do not act rationally once the tension hits the threshhold. Nothing can be accomplished if the parties are acting in spite and know that ultimately they will never be sued. You see, in a normal partnership having your partner sue you is always a possibility.

People go into a family business with their eyes closed. Asking for a Partnership Agreement would be like asking Mom for a contract when you started getting an allowance. It’s hard to act as adults with all that history speaking in your inner mind. Unless you are willing to risk major stress later, you must separate family from proper business processes. 

2 Pieces of Advice

1. Don’t enter a family business without an Operating Agreement and a Partnership Agreement. The Partnership Agreement should state the percentage of ownership for ALL parties and the rights of all parties to make decisions. The Partnership Agreement must have solid, enforceable Buy/Sell provisions covering death, disability, non-performance, and voluntary departure. DO NOT BECOME A PARTNER IN A FAMILY BUSINESS WITHOUT THESE DOCUMENTS. If you’re already in a family business partnership and there are no governing documents, get them done!

2. If you’re in a family business and there is some tension, no matter how small, get help before things get too hot to handle. I cannot stress this enough. There is no shame in getting help to straighten out the partnership before it blows up. We can develop agreements and build an outline for your Partnership Agreement. We can implement processes to resolve problems as they come up. Why bother if these agreements won’t ever get to court? When things are in writing and signed, even the most stubborn tend to keep their word. If a member of a family business will not sign agreements, there is a serious and malignant problem already developing.

A family business can be a beautiful thing. It can also tear a family apart. Doing things right ups your chances of success.

If you are in a messy family business, contact me.

Chris Reich