The family business has proven to be a distinct enterprise with unique concerns and issues. In the widest sense, a family business is an enterprise where family members have influence over strategy and major policies; maintain the intention of keeping the business in the family, own significant portions of stock, and sit on the board.
Other criteria for a family business include that the founder, or the descendants of the founder, still run the company on a daily basis, and where multiple generations participate in daily operations, and have significant management responsibilities.
In the United States, business attorneys understand that these startups can have great potentials because they tend to involve a tight – knit group with shared core values, goals and work ethic, each personally invested in seeing the company thrive.
However, one of the first and most crucial steps to launching a successful family business in the United States is choosing the right business structure. The importance of this step can’t be negotiated because it to a great extent defines who you are and how you operate.
When making this very important decision, family members involved in a new business will have to analyze certain criteria in making a determination, including personal exposure to legal liability, tax implications, and flexibility, costs of formation and ongoing administration and future needs. An experienced small business lawyer can help you navigate the process effectively.
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Why Structure a Family Business?
Also note that many family – owned businesses grapple at some point with contrasting business strategies, diverging ownership criteria and contentious personal dynamics. Work environments tend to be emotionally – charged, creating challenges in everything from daily management to very important decisions.
But by establishing the right business structure for your family, you explicitly define each party’s roles and help to neutralize potential future conflicts. Remember that choosing the right structure may also give you certain competitive advantages. When everyone is on the same page about the mission, strategy and individual responsibility, it sets the stage for smoother operations, higher production and bigger profits.
4 Steps to Structure a Family Business
It is estimated that more than half of all companies in the U.S. are family businesses. Just as there are many variations on what it means to be a family, there are many ways to structure a family business. Here are a few things to think about if you are starting a business.
1. Choose Your Ownership Options
Most family businesses in the United States are structured in five models of ownership.
- Owner/operator: In this model, ownership control is limited to one person or couple. A good example is the hereditary monarchy, where the crown passes to the sovereign’s firstborn. There needs to be a clear succession plan in place for maintaining this ownership model.
- Partnership: Here, only leaders in the business can be owners and benefit financially from the company. This model prevents family members who do not contribute to the company’s profits from benefiting from others’ hard work.
- Distributed: This is the most common ownership model. Distributed family – owned businesses pass ownership down to most or all descendants, whether or not they work in the company.
- Nested: This model consists of parts of the family agreeing to own some assets jointly and some assets separately. It is called “nested” because smaller family ownership groups sit inside larger ones. For instance, the Jones family could own the company, but only certain family members own the rights to the company’s IP.
- Public: In this model, a portion of the shares are publicly traded or the business acts as a public company while remaining privately held by the family.
However, have it in mind there is no one ownership model that is right for every family business, but these decisions are important to make at the beginning of the venture.
2. Find the Right Entity
Ownership is just one piece of the business structure. Have it in mind that you will also need to set up a formal legal entity. Here are some further details regarding your business structure options:
Founding a corporation involves creating an independent legal entity that exists apart from those who own, control and manage it. If the shareholders or owners die, the corporation doesn’t dissolve because it is considered an entirely separate entity. Corporations have the ability to transact business, pay taxes and enter into contracts, while allowing owners to limit their personal liability. There are two basic types: An S – Corporation and a C – Corporation.
Limited Liability Company (LLC). An LLC is one of the least complicated business structures, allowing for flexibility, pass – through tax perks and limited personal liability for business debts/ protection of personal assets.
There are also no residency requirements, so owners do not have to be U.S. citizens or permanent residents. On the flip side, LLCs can have limited growth potential, and existing business converting to an LLC might incur some additional taxes.
This business structure can be created when two or more individuals co – own a business and share the company losses and profits. Each partner/ co – owner makes a contribution. There are two different partnership structures in the United States.
General partnerships involve an equal division of responsibilities and rights among partners and each is responsible for the partnership’s debts and obligations. Limited partnerships, meanwhile, have both general and limited partners, allowing each partner to set or limit personal liability.
- Sole Proprietorship. This is more or less the easiest and most common structure for brand new businesses. Nonetheless, it may not work for all family businesses because it involves ownership and operation by a single individual, with zero separation between the business and owner. Still, sole proprietors can hire employees or independent contractors, so it may still work for some families, as long as it is understood one person is primarily running the show.
3. Establish Good Governance
In the United States, many family-owned businesses set up a system of governance where family members can weigh in on business decisions in a formal and structured way. Note that these governance systems can be as informal as a family assembly or family council, or as official as a board of directors or shareholder Council.
Nonetheless, for a Family Business to succeed, it must have good and solid governance. The purpose of a governance system is to provide clarity on the roles, rights and responsibilities of all family members, as well as to regulate any business discussions and disputes that may arise before they impact the business. Your governance system will likely be decided based on the ownership model you choose.
4. Seek Advice on Taxes
Always remember there are certain ways hiring and working with your family members may impact your taxes, especially if you are working with immediate family. According to experts, the taxes you withhold and report tend to be different depending on the role they play, how your business is organized, and your relationship with them.
For instance, hiring your husband or wife will alter your tax responsibilities; hiring your second cousin will not. Therefore, as you work through your ownership model and business structure, keep your tax burden in mind. Taxes may impact who in your family assumes certain roles. Speak to a lawyer or a CPA as you structure your family business to learn more.
Business Structures are tangible “things” that aid Professionalization and Best Practice by providing more clarity, substance, formality, authority and discipline to business operations. Formalize your business idea with the right ownership structure, business entity and tax considerations to protect the longevity of your company.