Family-owned businesses are more common than you might think — it's estimated that family-owned businesses contribute more than half to the U.S. gross domestic product. 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 considerations if you're establishing a business with your relatives.
[Read more: How to Obtain a Federal Employer Identification Number for Your Business]
Types of family-owned business structures
One of the biggest challenges family businesses face is that different people have different ideas about what ownership looks like. Let's look at the five different types of ownership and the pros and cons of each model.
Owner-Operator
In this model, ownership control is limited to one individual or couple. A good example is the British monarchy, where the crown passes to the sovereign's firstborn. This is usually the simplest business structure, but there are some pitfalls to be aware of so you can avert problems both in the business and the family.
First, there needs to be a clear succession plan in place for maintaining this ownership model. Otherwise, the company could be left without a way to manage the day-to-day operations or make payroll if the owner dies unexpectedly. The family must also agree on the successor to avoid unnecessary fighting and problems.
One of the biggest challenges family businesses face is that different people have different ideas about what ownership looks like.
Partnership
A partnership model involves multiple family members who own and operate the business jointly. In this model, only leaders in the business can be owners and benefit financially from the company. This prevents family members who don't contribute to the company's profits from benefiting from others' hard work.
The responsibility for making business decisions is shared equally among the partners, reducing the burden on any one family member. But if disagreements arise, decision-making could come to a standstill.
Distributed
A distributed family-owned business passes down ownership to most or all descendants, whether they work in the company or not. It's the most common ownership model since most parents want their children to inherit equal portions of the company.
The benefit of a distributed structure is that the business's success isn't reliant on one or two individuals. However, it can lead to conflict, especially if the leadership roles aren't well defined. And family members who actively work in the business may resent having to receive input from those outside of the business.
Nested
This structure consists of family members owning some assets jointly and some assets separately. It's called "nested" because smaller family ownership groups sit inside larger ones.
The family continues running the core business and distributes dividends to different individuals who use the funds to create their own business portfolios. But for this structure to work, the family can’t lose sight of the core business model.
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. The business is run by professional managers, and the family has little involvement in the day-to-day operations. However, it's hard for family members to maintain control over the direction of the company when they aren't actively involved.
Creating a governance system
A governance system allows family members to weigh in on business decisions in a formal and structured way. It outlines the roles, rights, and responsibilities of all family members and regulates business discussions and disputes that arise before they impact the business.
Here are a few documents needed to create a governance system:
- Family constitution: This is a nonlegal document outlining how the family will interact with one another and company shareholders. It serves as a foundation for how the family can address and resolve conflicts as they arise.
- Shareholders agreement: A shareholders agreement outlines the rules for the ownership and transfer of company shares. For example, the document could give other shareholders the right of first refusal if one person wants to sell their company shares.
- Succession plan: A succession plan explains who takes over the business when the current owners step aside. It also includes a written plan that explains how the change will take place.
[Read more: 4 Written Legal Agreements Every Family Business Needs]
This story was originally written by Emily Heaslip.
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