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4 Worst Legal Mistakes a Family Business Can Make

Too many family businesses don't even know these simple issues are problems--until they find themselves in legal hell.

Running a family business is the most natural thing in the world--and the most unnatural. Handle it well, and it can make you rich, capitalize on bonds no ordinary colleagues could share, and keep your family employed for generations. Handle it badly, and it can instead keep lawyers like me employed for generations.

If you've committed any of the following oversights, take care of them as soon as you can make a date with your lawyer. And if you're considering launching a company with the family, don't even think about cutting corners and making these potentially fatal mistakes:

1. You mix your family finances with the business's

A lot of family businesses start as a side job or a hobby that eventually turns into a money maker.  When you start to outgrow that stage, you need to look into housing it in a formal legal entity like a limited liability company or a corporation.  This is especially important if a number of family members might be liable, as would be the case if, say, they signed for loans or chipped in cash or otherwise could be considered partners. Without this protection, you all could end up bankrupt if something goes wrong. That's not the kind of family sharing you want.

For most small family businesses, an LLC is a great choice.  It gives personal liability protection like a corporation, without formalities like a Board of Directors or meeting minutes.  An LLC is taxed as a pass-through entity, so business profits flow through to the owner(s) and the LLC pays no separate tax on profits. Also, having a legal entity allows for easier transition planning.

If you don't form a legal entity like an LLC, or if you want to do business under a catchier name, you need to file for DBA or a "doing business as" status.  This is simply a way of stating that your business name is not the same as that of the legal entity controlling it. In many states, not having a DBA will make it hard to open a business checking account and may even keep you from being able to sue a vendor or customer who wronged you.

2. You muddle along with no employment agreements

You may not want to discuss with Dad what will happen if he calls in sick too many times or how with Grandma how much money she has to pay you. But everyone in a family business has to make their expectations clear early on--about employment, operations, even dissolution. And you have to put the agreements in writing. It may seem awkward to talk about it now, but it will be ten times more awkward after something goes wrong.  And something will.

3. You never bother to get the license

For many  types of businesses, even many home-based companies, you have to obtain local, state or federal licenses.  Zoning permits or variances may also apply, particularly if you allow customers to visit your office or home. It's usually pretty easy to find out the requirements--one visit to your  city hall or county office can get you all the information (and forms) you need. Business licenses are often inexpensive, but if you're operating without one, the fines can be pretty costly. But the fines are not the real problem: The blow you'll suffer in lost reputation and foregone business by being shut down is simply not worth the risk.

4. You have no succession plan.

The last thing you want to think about in a family business is what will happen to the company if you are hurt or pass away.  In that regard you're not alone: In a survey conducted by LegalZoom, 75% of small business owners said they do not have a succession plan in place.

It's no fun to think about, but you should consider who will run the business, either temporarily or permanently, if you can't run it.  In a licensed business, like medicine or law, you may want to identify a professional who might be interested in purchasing your business. Spend time with this person and get him or her acclimated to what you do and how you do it--introduce them to vendors, suppliers, payroll, payment issues, website access and a host of other contacts and tools they will need to take over.  Let others know you've designated an heir and  mention it in your will.

Remember that if you do not have a formal legal business entity like an LLC, your business technically passes with you.  With the right structures in place you can leave your ownership (or fractions of it) to your loved ones in your will, and they can keep running the business in the same name without interruption. After all, that was the point of having a family business in the first place, wasn't it? To keep it in the family.

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Last updated: Apr 9, 2012

CHAS RAMPENTHAL | Columnist | General Counsel, LegalZoom

Chas Rampenthal is general counsel and vice president of product development at LegalZoom. He's also a former talk radio host (KTLK AM 1150 at Clear Channel) and an entrepreneur himself, as the founder of LegalEndeavor.

The opinions expressed here by Inc.com columnists are their own, not those of Inc.com.



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