two women at work holding boxes
From signing prenuptial agreements to creating a succession plan, there are several steps that family members should take when entering into business together. — Getty Images/svetikd

If you own a family business, you know how important clear communication and professional boundaries can be. While family businesses often benefit from close relationships and strong teamwork, sometimes it’s tempting to skip the legal documents that form the foundation of most businesses.

In the long run, however, skipping the formality of legal documents may not be good for your business or your relationship with your family. Here is a rundown of the key documents and legal agreements every family business should have.

Family business agreement

Set the tone and structure of your company with a family business agreement. These documents, as varied as the people and companies they are designed to protect, often include some of the following elements:

  • Role definition. Not all family members are equally suited for all positions. Placing loved ones in the proper jobs can have a huge impact on the company’s performance and longevity. Law firm Clarke Willmott suggests using a family business agreement to define what roles family members will play and the tasks for which they are responsible. Also listed should be any steps family members are to be precluded from taking — hiring, for example, or loaning or borrowing funds.
  • Family code of conduct. You’re family. You’re all on the same page. You have the same motivation and the same goals. You share a set of family values. That’s all great news. Now put it down on paper. Memorialize your goals and the conduct expected of anyone whose actions could impact the reputation of your business.
  • Creation of both a family council and an advisory board. Both of these are recommended by the Conway Center for Family Business. The family council’s purpose is to provide updates to, and receive input from, all family members with a financial interest in the company, whether or not they are currently employed by it. In contrast, the advisory board should be comprised of non-family members, with the purpose of providing objective, outside advice. Issues for the advisory board range from assessment of family members’ skill sets to succession planning.

Buy-sell agreement

Whether it is included in a partnership agreement, part of an LLC operating agreement, or as a standalone document, any business with more than one owner needs a buy-sell agreement.

Also known as a shareholders’ agreement, this legal document controls the transfer of shareholder equity. It describes how the company should be operated and outlines shareholders' rights and obligations. Perhaps most importantly, a buy-sell agreement should include a complete list of trigger events—those which result in the transfer of ownership of company shares. The list should include but not be limited to death, retirement, divorce or the desire of a shareholder to separate from the family business.

According to William Weigand of Davis Wright Tremaine, LLP, a good buy-sell agreement will be customized for your business and regularly updated. It should include an appraisal of the current value of the business — one specifically suited to your type of firm — and a plan to periodically reassess that value.

[Read: 5 Things to Know When Selling Your Small Business]

Prenuptial agreement

Sometimes, the health and future of the business must take precedence over the potential hurt feelings of a soon-to-be family member. If the idea of asking your intended spouse to sign a prenuptial agreement is distasteful, imagine telling your family you lost part of their business in a divorce or that your ex is their new partner.

A well-written prenup can head off these types of nightmare scenarios. It will not only establish the value of the company at the time of the marriage, it will set out the method of valuation to be used in the future if the unexpected—but hardly uncommon—should happen. If it is anticipated that the spouse will have a role in running the business, that role should be spelled out in the prenup, along with the compensation to be paid.

Effective prenups are executed in writing, before witnesses. While it may seem excessive at the time, having separate legal advisors will preclude claims of poor or no representation later.

Don’t let a lack of family turmoil blind you to regulations and expectations of the wider business world. Run your family business the way any successful, similarly sized business is operated.

Succession plan

The need for succession plans has become so common that there are entire TV series devoted to this legal document. A succession plan outlines who will assume a leadership role in the company when someone steps down, retires, or passes away. It ensures the business can continue to run smoothly without interruption.

It can be uncomfortable to discuss your family business’s succession plan, often because it requires acknowledging that one generation won’t be around forever. But this transition is inevitable, and thinking about these issues well ahead of time can help ensure the company’s value stays intact.

A succession plan not only covers things like who assumes leadership roles, but also ownership transitions, time frames, the role of the older generation during and after the transition, and other legal considerations. For instance, will your the family CEO be asked to step down from the board of directors when he or she retires from the company? How much income will that person be eligible to draw from the family business? Codifying these issues in a written document makes for less confusion when the time comes.

Corporate governance checklist

Successful family enterprises have developed rules, communicated those rules to both family and non-family employees, and established procedures for dealing with non-compliance. But those family rules are not the only ones your business needs to follow. Don’t let a lack of family turmoil blind you to regulations and expectations of the wider business world. Run your family business the way any successful, similarly sized business is operated.

A good checklist should be prepared with the help of legal counsel and include items like holding board and shareholder meetings and keeping proper minutes. Armed with an up-to-date corporate governance checklist, you can assure yourself as well as your vendors, customers, and employees that your business is being run legally and ethically.

[Read: A Guide to Creating a Board of Directors]

Working with family—people you love and trust—can provide a welcome sanctuary in complicated times. Putting some basic agreements in place can help preserve that sanctuary for future generations.

CO— aims to bring you inspiration from leading respected experts. However, before making any business decision, you should consult a professional who can advise you based on your individual situation.

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Published June 27, 2022