Starting a business requires careful planning and strategic preparation, but hard work alone isn’t always enough. Sometimes you need to lean on a system of support. Whether it’s borrowing capital from mom and dad or partnering up with a sibling, entrepreneurs and seasoned professionals alike often turn to those they trust when launching a new venture – and who better to trust than family, right?
Unfortunately, as many can attest, going into business with a family member, or even a close friend, can end badly for even the most strongly bonded tribes. As attorneys who handle disputes between business owners, partners, and shareholders throughout Texas, our team of small business lawyers is all too aware of common conflicts and pitfalls that can put families’ personal and professional ties at risk.
Common Legal Issues When Starting a Family Business
Because starting a business with family creates personal, professional, and financial risks, it’s important to understand what potential problems commonly arise, whether you have the tolerance to take those risks on, and what you can do to minimize and avoid disputes and litigation as much as possible.
A few of the most common problems family members face when considering or starting a business include:
- Underestimating financial risks
- Insufficient documentation
- Failing to understand legal duties
- Minimizing the risks of personal issues
- Thinking disputes will be easy to resolve
Let's dive deeper into each issue:
1. Underestimating Financial Risks in a Family-Owned Business
Starting a new business can be an exhilarating experience, and one that creates strong feels of hope and future prosperity. Unfortunately, many business owners and their family members fail to fully appreciate the risks associated with starting a business. Those risks aren’t glamorous: about 50% of businesses fail within the first 5 years, and roughly 66% within the first 10 years. While savvy and sensible people may be deterred by those risks in other contexts, they don’t always give them the same consideration when they involve a family member. That may speak to the faith family members have in one another, as well as the hopefulness and desire to help. However, it doesn’t change the real financial risks, and the repercussions of those risks should the business become another statistic.
2. Don't Expect Trust & Family Bonds to Take the Place of Formal Agreements
You trust your brother and sister, and you know your son or daughter will pay you back, so there’s no need for all the formalities... right? That’s an all-too-common way of thinking for family business partners, and it can make for a ticking time bomb. Trust is simply not a substitute for clear, carefully crafted, and enforceable agreements. Formal, written agreements not only ensure a consistent vision for the business itself, but also to protect the rights and interests of the partners or shareholders involved. Protect your family relationships by drafting and executing partnership agreements, operating agreements, and other critical contracts or documentation. Many families in business relationships regret not taking this step. Consider it an investment in peaceful Thanksgivings and family celebrations well into the future.
3. Beyond a Family Duty: You Have a Fiduciary Duty as a Partner in a Family Business
Family members who get involved in a loved one’s startup all too often fail to understand the legal duties they must uphold as a partner or shareholder in the business. In Texas, our laws function under the assumption that partners who enter into a new business do so at arm’s length, meaning they’re aware of their need to protect their own interests. It doesn’t really work that way with family members, though, as there is a legal assumption that family members (and in some cases close friends) are part of a relationship of confidence and trust.
In these types of informal fiduciary relationships, Texas law imposes stringent duties of loyalty and good faith. This means family member business partners have obligations to make full disclosure, place the interests of their partners above their own, and have the right to set aside unfair transactions between fiduciaries if they aren’t fair – for which the burden of proof will often fall upon the defendant.
4. Minimize the Risks of Personal Issues
Personal conflicts crop up in the hierarchies of even the most powerful corporations, and they can put a lot on the line. They also become magnified and even more intrusive in businesses helmed or supported by family members. From long-standing resentments to disloyalty and jealousy, family baggage can become one of the biggest points of conflict, and a source of dysfunction that radiates throughout a business. Put a formal operating agreement in place that clearly addresses member responsibilities and defines a process for dispute resolution to minimize misunderstandings.
5. Mom Can't Settle Every Dispute
Business owner disputes are difficult no matter what the relationship between business owners. Family members have additional personal dynamics that add to the stress of a business relationship. Though some family partners enter into a business relationship thinking they’ll be able to smooth things over should an issue arise – just as they did as children when mom was around to referee – the reality is that partnership disputes can exacerbate and intensify emotional reactions, and potentially harm not only professional relationships, but family bonds as well.
To save headache and heartache down the road, it’s best to have mechanisms in place before these problems arises. These legal protections can be tailored to your unique situation with the help of a lawyer, and may include partnership or shareholder agreements, buy-sell agreements, and other important contracts and governing documents established early in the formation of the business (although it's never too late).
What Happens to Your Family Business During a Texas Divorce?
In Texas and many other states, assets and liabilities acquired during a marriage are presumed to be community property owned equally by both spouses. In divorce, this community property is subject to equitable distribution – which means split in some manner that is equitable, not necessarily 50/50.
Learn how to protect your family-owned business from a divorce.
Texas Family-Owned Business Lawyers: Focused on Your Future
Hendershot Cowart P.C. attorneys are industry leaders in business law and litigation. We know the complexities of legal matters involving families when it comes to business ventures and complex litigation. By leveraging our multi-disciplinary approach and 130+ years of collective experience, we provide the counsel and representation clients need to address a range of issues while prioritizing their rights and interests. That includes proactive and responsive assistance for matters such as:
- Business formation and entity selection
- Drafting partnership and shareholder agreements
- Buy-sell agreements and contract drafting
- Intellectual property protection
- Contractual disputes
- Business owner disputes
- Shareholder oppression
- Fraud and misrepresentation
Speak with a Houston small business lawyer by calling (713) 909-7323 or contact us online. Hendershot Cowart P.C. serves clients in a range of industries throughout Texas.