There is a certain appeal to a family-owned business. The allure of building an empire which becomes the legacy that lives on long after you’re gone, is a powerful one. However, not every family-run business can be the next Walmart or Pick ‘n Pay, and with a bearish market piling on the pressure, the number of litigations and liquidations are on the rise.
Paragon Lending Solutions CEO, Gary Palmer, looks at how best to avoid family feuds which end up destroying relationships and devaluing the business asset.
You can’t choose family
We’ve noticed a considerable uptick in the number of business owners who have come to us looking for finance to help them buy out members of their family who are involved in the business. As profits continue to retreat, financial pressure is taking its toll on many family run businesses. Blood might be thicker than water, but when the knives come out around the boardroom table, blood flows just as easily.
Disputes between business partners are always distressing. They can put the business at risk as time and management focus is removed from operations and can cost money should they escalate into litigation. Disputes between family members in a business, however, can have even greater consequences and have been known to destroy relationships as well as revenue.
Perhaps one of the most famous family feuds was between the Gucci family. Lawsuits and countersuits between family members saw the Italian company in and out of court for more than half a century. The bitter fight for control of the high-end fashion company took its toll on the family and eventually resulted in almost 50 percent of the shares being sold to an investment banking firm in 1988. Today the company is owned by a French multinational. This is an excellent example of the adage that in business, there are no matters of principle, only matters of money.
Get it right at the start
A close associate of Paragon’s, Howard Rubenstein of Rubensteins Attorneys, always advises that the best way to avoid disputes is to have the hard conversations at the start of the business relationship.
He points out that some members of family may be working in the business while others are passive shareholders. This can result in a misalignment of expectations. He advises mechanisms need to be put in place right up front for the eventual sale of the business or, in the worst-case scenario, the liquidation. Deciding on who takes the risk and signs for overdrafts or puts up surety for growth funding can add complexities. He says family should remove as many options for disputes as possible, but warns that there is no boilerplate. Each business will have its own unique requirements, as will each family.
Generational divide
Companies that survive the first generation of family ownership often falter when young blood enters the boardroom. Succession planning should be part and parcel of building a solid family business.
Deciding how the estate will be split and managed can tear families apart. Paragon has a client who worked with one of his six children, building a sizeable property portfolio. On his passing each of the children had different needs and therefore different ideas of what should happen to the business. Of course the son who was working in the business thought he was owed more than just a sixth of the proceeds, adding to the friction and resulting in a protracted battle between the siblings, ultimately taking its toll on the business - but worse than that, has resulted in the brothers no longer talking to one another.
Inter-generational discussions must take place and decisions taken with estate planning and tax efficiency in mind, which will impact all involved. Dividends for passive shareholders and salaries for active directors need to be discussed as a means to manage expectations and reward involvement.
Regular check-ins avoid future pain
Like the economy, individual realities shift over time. Using the annual AGM to check in on expectations and needs can help. Ongoing discussions, even if you have been diligent and reached an agreement on day one, are important. Amendments to shareholder agreements can be made to reflect requirements and lower the chance of fresh disputes arising during the year.
Dealing with disputes effectively
No matter how diligently a company is run, shareholder disputes will arise from time to time. Making use of mediation can be a useful tool, especially if used early on. In fact, smart business people are using independent mediators to help draw up the contracts at the outset of a partnership. This includes interrogating expectations and ensuring there is alignment between what partners are thinking and what they are verbalising. Once these expectations are in the open, the lawyers and accountants can ensure that the contract reflects this, within the bounds of the Companies Act.
Another mechanism that is often used in family disputes is the Texas Shootout or shotgun clause.
This exit provision can be included in a shareholders’ agreement. This buy-sell agreement is generally triggered when a situation has seriously deteriorated and is often likened to a prenuptial agreement in a divorce with the aim of protecting the children (in this case the business).
The shareholder who evokes the clause will offer to buy the shares of the others at a specific price per share. The other shareholders must then either accept the offer and sell their shares to that shareholder, or buy the first shareholder’s shares at that same price. It can also work in reverse with the triggering shareholder offering to sell his shares at a specific price, forcing the others to either accept of sell their shares at the same price.
While this has its merits, it can be used against shareholders when they are not in position to raise the capital required to respond to the clause.
Mediation may be an appropriate method to resolve disputes within family run businesses. The parties will have an opportunity to air their grievances and an experienced mediator may be able to facilitate their resolution in an amicable manner. A clause requiring that disputes be referred to mediation prior to the institution of legal action is advisable.
No matter what method of settlement is used, it is always better to do everything possible to avoid disputes. Working with a range of professionals from the outset can drastically reduce the risk of families falling out with one another in business dealings. Family holidays should not be added to the list of collateral damage in a family fallout.