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Avoiding Business Disputes When the Founder’s Children Take Over: A Practical Guide for Business Owners

For many business owners, the most attractive and aspirational succession plan is to pass the family business on to their children. However, passing a business down to different generations can be a challenge. While approximately 40% of U.S. family-owned businesses transition into a second-generation business, only 13% are passed down successfully to a third generation, and just 3% survive to a fourth or beyond.

Those stats, which have given rise to a term called the “three-generation rule,” are grim. But with careful planning and proactive measures, a family-run business can be a strong, successful business for generations to come.

In this article, we’ll help you understand why disputes between family members in a business occur, identify common areas of disagreement, and offer solutions to help avoid and, if necessary, resolve disputes that do arise.

Why Disputes Arise During and After a Transition to the Next Generation

Disputes often arise when the founder’s children take over a business due to various factors, such as:

  • Differing visions and goals: Each sibling may have different ideas about the direction the company should take, leading to disagreements and disputes.
  • Competing interests: Siblings may feel they have unequal stakes in the business, leading to power struggles and resentment.
  • Lack of clear roles and responsibilities: Without a clear delineation of duties, siblings may step on each other’s toes, creating friction. For example, disagreements over who should take on key leadership positions can create tension.
  • Financial disputes: Disagreements over compensation, profit distribution, and investment can cause friction among family members.

Proactively Avoid Disputes Through Effective Operating Agreement Provisions

The starting point for limiting the negative impact of disputes between family members in a business is to anticipate the common reasons, such as those set forth above, why they might happen. The next step is to work with legal counsel to create a well-designed operating agreement that helps prevent disputes in the first place, and include mechanisms for resolving disputes that do arise.

One way to proactively avoid disputes among the children of a founder is by clearly defining roles and responsibilities in the operating agreement. This can help to establish a clear division of duties for each sibling, minimizing confusion and potential conflict. For example, one sibling may be responsible for overseeing daily operations, while another focuses on marketing and another on financial management. By assigning specific tasks and decision-making authority, you can help to reduce the likelihood of disagreements and power struggles.

In addition to defining roles and responsibilities, it’s essential to establish and document a transparent and structured decision-making process in an operating agreement. This can involve creating a voting system, where each family member has an equal say in major decisions, or appointing an advisory board to provide impartial guidance. By setting up a clear decision-making process, you can ensure that all family members feel heard and are invested in the company’s future. 

An operating agreement should also anticipate and address successorship issues once a family member joins a business. In certain instances, a family member may join but decide not to stay, and a successor provision can set forth the process for removing the family member, compensating them for their interest, and adding a new business partner, as appropriate, and any approval rights of remaining partners.

Finally, an operating agreement can and should address how disputes between parties will be handled. Dispute resolution clauses should include the applicable governing law that the parties will apply to any disputes, and the steps required for beginning and enforcing the dispute resolution process, including processes for engaging in negotiation, mediation, arbitration, and/or litigation. 

Resolving Disputes That Do Arise

Despite taking proactive measures, disputes may still arise. In my experience providing legal counsel to small to medium-sized businesses, including many family businesses, open communication is key to resolving these conflicts. By fostering an environment of trust, understanding, and openness, many disagreements can be resolved before they become full-blown disputes.

If disputes persist or escalate, consider using mediation as a conflict resolution strategy. Mediation involves enlisting a neutral third party to help facilitate discussions and guide family members towards a mutually agreeable resolution. This approach can be particularly helpful in emotionally charged situations where it is difficult for family members to see eye to eye.

Finally, lean on experienced professionals to provide guidance and help navigate difficult situations. An experienced advisor, such as a business lawyer, can offer valuable insights and strategies for addressing and resolving disputes, drawing on their expertise in family business dynamics. 

If you have questions or require assistance with these or any other legal issues that impact small to medium-sized businesses in Michigan, please contact Zana Tomich.

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