You and your family members came into the family business because you wanted to control your own destiny, invest in your own growth and go to work with the people you enjoy most.

And then, there’s the side goal of wanting to make millions and help your family become (or remain) wildly successful. The benefits of being a member of a family business may include power, money and position, but when asked, others mention additional reasons—independence, freedom, self-direction and a sense of accomplishment as the more intangible reasons to be part of a family business.

Family businesses, which by broad definition are businesses owned or controlled by family members, today include more than 80 percent of U.S. businesses. Some predict that family-owned business soon could represent 50 percent of all nongovernmental workers. They will generate nearly half of the gross national product.

Privately-owned (most of which are family-owned) businesses also account for more than 90 percent of all construction firms, retail service or distribution firms, wholesale companies and manufacturing firms.

In most cities, the family business owner is the backbone of many established institutions. Their influence over the community is real, but all-too-often undervalued. Not surprisingly, the socioeconomic stability of our nation would hit a catastrophic low if family businesses were to disappear.

So on the one hand, the luxury of power, money, independence, self-direction and community responsibility lures many people into the business, but those same qualities can also keep the day-to-day operations and board meetings emotionally charged.

Without adequate planning, the dream can be more like a nightmare. If the business parade is led entirely by Dad—the president and CEO—and something happens to Dad, then that well-thought-out parade can come to an end. An unexpected death or unexpected “irreconcilable difference” can lead to disaster for the business. Two brothers in business may decide they’d rather be brothers than business partners. The solution? Agree to the creation of a family agreement, sometimes now referred to as a family charter.

What are family charter agreements?

They are documents that set out the arrangements between family members regarding future handling of business matters. They include the purpose and goals of the business, employment agreements, termination agreements and stock purchase agreements. Some agreements may go as far as to govern voting decisions, company operations and the method of valuing the company.

Why have them?

Family charter agreements with reasonable and well-documented clauses commit family members to certain understandings about business matters at the start of a business relationship, when the odds of achieving unanimity are at their highest. These clauses can be used as a safeguard against problems, and they also enforce certain actions should future shareholder disagreements develop. For instance, the agreements should let owners contemplating a sale of stock know the impact and outcome before the stock is sold.

If your family charter agreement is for a fixed duration, and if it avoids vague clauses without legitimate business purpose, then the family charter should be enforceable at both state and federal levels. That is a matter for the attorneys drafting the document. Often, an arbitration clause is provided to avoid court proceedings. And, if Uncle Milton and Granddad decide that sister Gracie is “in” and want to eliminate cousins Bob and Ellen from the business, the agreement can be modified at any time. The catch? The charter agreement can call for the consent of all interested parties.

What makes up a solid family charter agreement?

Purpose, Vision, Values // Clear statements of the purpose of the business, its goals and its core values are extremely helpful in getting every family member on the same page from the outset.

Buy-Sell Provisions // Buy-sell provisions are agreements between shareholders, or shareholders and corporation, regarding restrictions on and situations requiring a transfer of stock. Events leading to the sale of stock can include death, disability, termination of employment or a shareholder’s desire to move on. There are two main types of buy-sell agreements:

• A cross-purchase agreement is a contract between shareholders where each remaining shareholder has the first right to purchase a proportionate share of the exiting shareholder’s stock, based on present ownership percentages.
• A redemption agreement is a contract between the corporation and each of the shareholders specifying the conditions under which the corporation’s stock will be redeemed. It includes a computation of the stock’s redemption price. This type of agreement may preserve the proportionate ownership among surviving active shareholders by retiring the exiting shareholder’s stock as treasury stock.

Why are stock transfer restrictions necessary? In many family (or closely held) businesses, shareholders actively participate in management. If the stock is freely transferable, a shareholder can sell his stock to anyone, which could lead to a stranger (a.k.a. unwanted person) taking part in running the company. In addition, many small businesses are formed as S corporations, which have strict eligibility requirements. If ownership is not sufficiently restricted to keep out nonqualified shareholders, the company’s S election will be terminated, resulting in serious tax ramifications for all involved.

Buy-sell provisions also benefit the exiting shareholder. By creating a market for the stock, a shareholder can leave without accepting a new shareholder into the corporation. A special allocation election can also be put in place so that the departing shareholder’s portion of income or loss is not affected by events subsequent to the stock’s disposition.

If a shareholder dies, a buy-sell provision can allow the spouse or other heirs to sell the shareholder’s stock to the remaining owners. This preserves ownership of the corporation; it also creates a “market” for the stock, values the company for estate purposes and provides income to the survivors of the deceased. Life insurance policies on each of the shareholders could provide funding for buying out the deceased shareholder’s stock. In order to be valid, any restrictions on stock transferability must be clearly documented on the face of the shares.

Operational (Pooling) Agreements

In operational agreements, shareholders obligate themselves to vote in a certain way on specified matters. The agreement can effectively strengthen (or weaken) the stockholder’s control over corporate matters by limiting who may serve as an officer or director. This ultimately controls who is involved in management and decision-making. It may also include guidelines for the timing and amount of dividend payments, and specify shareholder and employee compensation. For example, because S corporation income or loss flows through to the shareholders, each is responsible for making estimated tax payments on the company’s income. The shareholder agreement can provide a formula for cash distributions based on earnings to be made quarterly to cover these estimated payments.

The Roles of Each Family Member

Defining the role of each family member with appropriate modifications from time to time can avoid a boatload of problems. Make sure you define the role, the title and sometimes even the compensation, benefits and work environment provided. Also, if known, the long-range objectives for each family member are also helpful to have recorded in the document.

When you start a new business, it’s difficult to imagine problems arising from the people who give you comfort and pleasure. It’s likely that, as you gather the educational, financial and civic leadership for your company, you’ll have demands placed on your time and enthusiasm. This is the time to be skillful. Don’t risk putting your business into harm’s way by neglecting a shareholder’s agreement. Get input from all shareholders up front and draft a detailed agreement. That way, in the event of an unfortunate circumstance, conflict, or inequity, you’ll have a strong document to guide you out of the conflict.