• The History of a Family Business
  • September 23, 2010 | Author: Robert H. Louis
  • Law Firm: Saul Ewing LLP - Philadelphia Office
  • This fact pattern , which I wrote for a seminar, sets forth the many challenges and opportunities presented by family businesses:

    The History of a Family Business

    In 1965, Jeffrey Spalding decided he had worked for others long enough-about 12 years. Feeling that the US economy was in good shape and would continue to prosper, he developed a plan to go into the home improvement products business. His idea was to open a store in his community in the suburbs of Philadelphia, stock it with tools, building products and related items and see if he could survive. He felt sure he could fairly well working for others, but doubted that he could attain an ownership or high level management where he was, a family-owned business where he was not part of the family, and to which various family members were being added at executive levels, despite having little or no experience. Besides, he didn’t think his current employer, an older man who had been in business for many years, had the energy to expand a business that Jeffrey thought he had. Clearly, he thought, this is the time to see if I can achieve something on my own.

    But to carry out those plans, Jeffrey needed capital, And he didn’t have nearly enough on his own. He might mortgage, or re-mortgage his home, but even that wouldn’t provide enough of a cushion to cover the startup period for the business. He spoke to several members of his family, and his wife’s brother agreed to contribute some capital and go into business with him.

    Questions to ask: How will the business be set up? Will all of the money contributed be capital contributions, or will some of it, from either or both parties, be set up as debt? How will the ownership be divided up between the two owners? Is any ownership attributed to the fact that Jeffrey thought of the business idea and was the founder? Or is it just a matter who puts cash in the business? At least initially, both Jeffrey and his brother-in-law will work full-time in the business. They will share the decision-making for the business, and understand that they will only take steps on which they have both agreed.

    The business begins. Either the two owners can work together smoothly and share similar ideas or goals, or they clash, either initially or after some period of time. A number of issues, legal, psychological and business, are suggested if they can’t get along, but assume that they do get along for about 20 years. The business has done reasonably well, and they now have four stores in various Pennsylvania and New Jersey suburbs of Philadelphia. At this point, Jeffrey’s son David has more or less finished college and Jeffrey would like him to join the business. His brother-in-law also has children, but they have gone astray and become lawyers, so there is little chance they will want to enter the business. The brother-in-law would like to do something else with his life, and the prosperity of the business has allowed him to think about other possibilities. He asks Jeffrey if he would like to buy him out.

    Jeffrey might say that he doesn’t want to do so, because he doesn’t have the resources to do so. He might suggest that the brother-in-law withdraw from working in the business and receive some payment each year of a portion of the profits of the business. What kinds of problems would that create, and how could they be dealt with? The brother-in-law might suggest that the business borrow money to buy him out. This would create a burden on the business and cramp its ability to continue to grow.

    The parties agree that Jeffrey will buy his brother-in-law’s stock over time, with a cash down payment and periodic payments for ten years. The brother-in-law is taking a chance that Jeffrey can continue to do well in the business, at least for the ten year payment period. What kinds of issues are presented by this arrangement?

    For the ten year period of the note payment, the business does extraordinarily well. Is this because there is now one boss, or would that have happened anyway? Just about the time when the note is paid off, one of Jeffrey’s nephews, a son of his brother-in-law, comes to him and says that the practice of law wasn’t as much fun as he thought it would be, and that he would like to join the business. The nephew has no other experience than being a lawyer, so Jeffrey considers him unskilled labor. Jeffrey considers whether he should bring the nephew into the business, partly because his father helped to start the business.

    In the event, Jeffrey decides that he will not bring the nephew into the business, thinking that it’s now his family’s business. Perhaps he’ll hear from his brother-in-law, suggesting that he owes his nephew a chance to take part in the business. Jeffrey won’t agree to this. Is there any way of dealing with this problem that will minimize the damage to the family?

    The business continues to prosper for a number of years. David’s younger brother announces his interest in working for the business. So does their sister, but Jeffrey tells her she cannot work in the business. Perhaps he has some ideas about women in the work force from a different era; perhaps he can’t see her in a management situation in the business; perhaps he’s concerned that she’ll get married and he’ll have a son-in-law who wants to come into the business. In any case, he says no. His wife objects. She says the daughter is just as smart and dedicated as her two brothers. It may be that Jeffrey will relent and allow her to join the business. What possible jobs might and/or should he give her? Follow this thread for some number of years. What if she is, in fact, the best of the three in managing the business? Shouldn’t she then become the heir?

    The second son is a different problem. He’s not very motivated. He tends to come in at 9:30, three hours after his brother and sister have arrived. He is sometimes difficult to deal with and condescending to non-family employees. This annoys Jeffrey, but it really annoys his siblings. But Jeffrey and his wife are not anxious to turn him out, fearing that he can’t make a living on his own. What should they do? In the end, he has an idea for a business of his own. His parents give him a sizeable sum of money to help start this business, which is unrelated to the family business. After a few years, the second son is doing very well, better in fact than the family business. Or, which is more likely, his business has failed, and he wants to come back into the family business. But this time, Jeffrey says no. Instead, he buys him another business. The siblings notice that a large part of the family assets have been devoted to helping the second son find his way. The new business also fails, and Jeffrey has a genuine dilemma: whatever he does, some children will be unhappy.

    Suppose there is a fourth child, who has no interest in the business, but instead chooses an unrelated career as a teacher. Does she have any claim on the wealth created for the family by the business? If the business constitutes most of the family’s wealth, and it is to pass to only some of the children, should there be some sort of “evening up” and, if so, how? Or should Jeffrey listen to the two children who are in the business, who believe that much of its value comes from their efforts?

    Perhaps that’s true, but much of the value also came from non-family employees. They are reasonably sure they won’t become owners of the business, or should they make an effort to become owners and, if they do, how should Jeffrey react? Are there any acceptable substitutes for actual ownership of the business?

    After more years have passed, Jeffrey thinks about retiring from the business. Some business owners refuse to step aside, no matter what their age, which causes a different set of problems. Does this happen because they have put too much of their lives into the business, and have nowhere else to go? Or do they believe that no child could possibly do as well as they did? Or are they afraid of leaving the business, their source of retirement income, in the hands of others? Are there solutions to any of these concerns? Consider, for example, a separate retirement plan to fund Jeffrey’s comfortable retirement.

    But Jeffrey decides he wants to retire, to go on that African safari he’s always dreamed of. Is this the first time he thinks about giving the ownership of the business to some of his children? If so, it might be too late to do careful, tax-efficient planning on how to transfer the business. He should have thought about the possibility of transferring the business at least ten years earlier. Let’s assume that he did think of it. This opens up a long discussion of methods of transferring business interests by various tax-saving methods.

    Suppose the children don’t want to continue the business. What should be done with it? Sale to employees is one possibility, or sale to some employees. Of course, it’s also possible to sell to outsiders. After that, the proceeds can be divided among the owners, mostly Jeffrey. It is also possible that outsiders approached Jeffrey years earlier, with an offer to purchase, that was too good to pass up. This would certainly raise issues of family dynamics.

    Or suppose the children do want to continue the business. Now, there is a third generation, some of whom want to join the business and, as before some don’t and, also as before, some just aren’t cut out for it. The multiplicity of family members, some of whom are cousins, seems to create an exponential increase in the problems described above, which is why few family businesses make it to the third generation. Can the older generation impose its will on the family and “make them” get along? Can they help to create structures or agreements that provide a template on how to run a family business that will continue provide a basis for family wealth, financial and otherwise?