Newland's Business Notes

Don't Assume Your Children Will "Get Along"

Volume 2 Issue 4-- July/August 1998

Many family businesses evolve. What starts as a sole proprietorship becomes a partnership when the children become involved. The parents may begin to file partnership tax returns reflecting themselves and the children as partners.

When Mom or Dad, however, is asked about planning for the future, maybe preparing a will or trust along with a partnership agreement to protect the family assets, a typical response may be "This here is the way my Daddy did it, and I ain't going to no lawyer to waste my money on no partnership agreement or will."

As is often the case, so long as Mom or Dad is in control and alive, the business prospers; but, what happens when Mom or Dad dies? Typically, the only written evidence of the existence of the partnership is the Federal and State tax returns and, maybe, some partnership book entries.

That is what happened in one actual case when Dad died. Let's call the partnership, Dear Ole Dad & Associates. Brothers Bob and Ray survived Dad and continued in business as 50%-50% partners, with no written partnership agreement. At one point, Ray simply declared, "It's over."

Since there was nothing in writing about the life of the partnership or terminating it, the partnership was terminable at will, a legal term meaning the partnership could be terminated at any time one of the two brothers chose. Clearly, the potential for major disruption was present whenever Bob and Ray could not agree on any matter.

What could possibly cause two brothers to disagree? Just about anything! The list can be endless -- from lifestyle, cash needs, the marriage of one or both brothers. The reality is often like a soap opera. Many family businesses encounter cash flow problems when two or more of the children marry and have families of their own. Some businesses can only support one nuclear family, not the second or third generations of that family.

Since they can be terminated at any time, for no reason, partnerships such as Dear Ole Dad & Associates are the antithesis of planning. If Ray says "It's over," Bob may say "Wait a minute; can't we agree on some of these matters and have an orderly dissolution of the partnership?" Sometimes siblings may agree on how to terminate a family partnership, but far too often when siblings disagree, the fighting is intensely bitter. This is what happened to Ray and Bob.

One of the brothers petitioned a local court to force a sale of the partnership's assets and division of the proceeds between the brothers. You don't have to be a Rocket Scientist to guess that such a sale would not produce the best sales price.

If the fighting siblings do not have the wherewithal to bid on the assets of their own business, they can effectively be forced out of business. In the actual case, one of the brothers had already left the family business and had little incentive to see it continue.

Don't assume this planning problem is isolated to partnerships. While oral partnerships are easier to terminate in Virginia (and most states) than corporations or limited liability companies, the same types of problems can arise with corporations or limited liability companies.

As fair as it may seem to give equal control to all siblings, such an approach is not always the best answer. Why? Equality of control among a group of siblings can lead to deadlock, particularly if there are an even number of siblings. Giving a child, family friend, or outsider a tie-breaking mechanism is many times a better solution than deadlock or gridlock.

Instead of assuming that everyone will always agree, it is far better to expect that family member-owners of a business will disagree when the unifying older generation-founder passes on. While not all siblings fight with each other after a parent dies, the incidence of such friction is alarmingly high.

Don't leave your family and business in the shadowy valley of an oral agreement like Dear Ole Dad & Associates. Basic business documents, like partnership agreements and buy-sell or stock redemption agreements, should be reduced to writing.

Copyright 1998
Published by the law firm of Newland & Associates, PLC
9835 Business Way
Manassas, VA 20110
Call us at (703) 330-0000 for a full range of business law and tax-related services.

While designed to be accurate, this publication is not intended to constitute the rendering of legal, accounting, or other professional services or to serve as a substitute for such services.

Redistribution or other commercial use of the material contained in Newland's Business Notes is expressly prohibited without the written permission of Newland & Associates, PLC.