Successfully Representing A Family-Owned Business
By Christina P. O’Neill
Attorneys who represent family businesses must be knowledgeable about corporate governance, but they also have to know the players involved — a soft skill that sometimes requires a hard-line approach.
“A good lawyer for a family business has to be sensitive to issues in the family,” says Robert McLaughlin Sr., managing and senior partner of Gilman, McLaughlin & Hanrahan, LLP. “It should be someone who is aware of family dynamics, and who can play a role as adviser in conflicting situations that develop.” A family-business adviser should not be a specialist, but a generalist, “which is a vanishing animal in the practice of law,” he says.
McLaughlin’s resume includes representing three independent directors in the aftermath of the Demoulas family’s years-long legal battles, as well as dozens of other lesser-known but no less contentious cases. Not surprisingly, the issues of insiders versus outsiders, control and compensation are at the top of the list of casus belli.
In addition to having the sensitivity to family issues, there has to be some cold, hard calculation — and on occasion, stepping back. “Lawyers make this mistake — they are introduced to [the business] by one of the partners,” McLaughlin says. “As possible conflicts develop, as a lawyer, you have to remember that your obligation is to the business. You can’t be on the side of the person who brought you in.” And ultimately, the family law lawyer has to know when to call a timeout and advise individuals in a dispute that they each need their own counsel.
How Not To Kick The Hornet’s Nest
John Talvacchia, a corporate attorney at the Boston office of Eckert, Seamans, Cherin & Mellott LLC, suggests telling individual family members that situations could arise in which it’s in their best interest to seek individual counsel. Preferably, as in many things, this should be done long before it’s needed.
While it’s possible to represent individual family members in matters that do not conflict with the legal needs of the business, the line can easily get blurred. “You are trusted,” Talvacchia says. “They’re going to confide in your personal issues as well as business issues.” And some of those personal issues have the potential to negatively impact the business. “You have to be vigilant because you can’t expect the client to be.”
Take this scenario: The founder of a family business dies and the wife takes over the business. The attorney representing the business had a long-term relationship with the founder. The business falls on hard times, and its bank wants the widow to sign a personal guaranty. It’s in the interest of the company that she signs, but not in her interest to do so. The widow signs, but the business fails, and the bank seeks repayment from her. The attorney for the business should have advised the widow that she should seek independent counsel.
Or, this one: A company decides to raise money by issuing stock. A family member wants to buy in. The lawyer for the business should recommend to this family member that they seek independent counsel.
He recommends drafting an engagement letter outlining who the client is and the nature of the engagement. The letter should include a description of the nature of the legal service for both the company and individuals, and should recognize the potential for a conflict. It should include wording about what steps the attorney or firm will take in the event that conflict arises.
Insiders, Outsiders And Exit Plans
A common problem in second-generation family businesses is conflict between siblings who want to stay involved in the business and those who don’t. “Often, the second generation takes the credit for the founder’s efforts, and outside siblings think they share equally,” McLaughlin says.
Situations that lead to legal discord are disputes about compensation and about levels of involvement in the business. In pass-through business, partners incur tax liabilities whether they get distributions or not. The inside family members may want to keep the distribution in the company to grow the business. “You get this inherent conflict where those on the outside want their distribution, at least enough to pay the tax, and hopefully receive some ROI,” he says.
Additionally, in the course of estate planning, shares in the company given to grandchildren may push them into tax brackets that are unexpectedly high, McLaughlin says. “The problem is, there isn’t a market for buying the grandchild’s stock.” He advises that it’s good to have a circuit breaker to let a family member who no longer wants to be part of the business to get out.
David Klebanoff of Gilman, McLaughlin & Hanrahan, LLP, observes the challenge of annually setting a value on company stock. In businesses where everyone gets along, they see no need to update the value of the stock. “A safety agreement should be that unless value has been set within the last 24 months, the old value is void,” he says. One preventive measure is to have the option to sell the stock at a discount off-book value.
Family businesses should build into their legal planning the possibility that future partners might be at loggerheads someday. Say that two partners started a business, but now the second generation doesn’t get along. Having a buyout clause avoids the need to dissolve the business to get out. McLaughlin warns, however, that valuing a business is not an exact science. A superstar performer, for example, should not have to pay a buyout premium to an underperformer who wants to exit.
Things get more complicated when family members divorce in businesses in which marital assets are the majority of the business, McLaughlin notes. A founder may not want a former in-law owning a big chunk of the business. Prenuptial agreements that exclude inherited family assets take the business out of consideration as a division of marital assets.
Fitting Client To Counsel
Family businesses can be divided into two types, says Richard Narva, founder and senior advisor at Narva & Co. In the family-managed model, the owner-managers seek to transfer role and operations responsibility from the first generation to the second. While some of these businesses can be large, they also tend to be “lifestyle” companies — “You work hard, you work long hours, you try to do well, and at the end of every year, you decapitalize the company to finance [the family’s] lifestyle,” he says. “It’s not often a strategic decision, it’s simply an intuitive judgment made by the major breadwinner in the business to improve the family lifestyle.”
Family-managed businesses rarely use legal help in a proactive way; they use it only when needed. These companies are not an attractive market to an institutional law firm, he says — they are served by very small firms.
The family-controlled enterprises vest control in a family shareholder group, which may or may not be involved in management, but which keep control through a number of mechanisms. A trust may hold the shares of individual members, and instead of decapitalizing every year, the family shareholder group attempts to grow the enterprise. This model more closely resembles any other nonfamily company, and is therefore a better fit with an institutional law firm, Narva says.
Getting Two Disciplines Into The Room
Before founding his company in 2009, Narva practiced corporate law with a specialty before succeeding his father as president of Morton Shoe Companies Inc. as the third-generation head of the company. He also has a long history of directorships in family-owned companies and has been advising family firms since 1986. He founded a predecessor firm with a partner in 1986, which lasted until 2005. He was then a partner in a boutique investment bank until founding his eponymous firm in 2009.
Family-controlled firms have ownership, tax and estate planning issues that investor-owned companies do not. And, Narva says, it’s almost never true that the lawyers doing the tax and estate planning and the lawyers doing corporate financing speak to each other — even if they work in the same law firm.
In fact, he says, when he visits a client, the attorney working on tax and insurance structures and the one advising on joint ventures have not been put into the same room together. “Two weeks before the closing of the deal, they talk. Sorry, it’s too late,” he says. Not too late for the rudimentary things, but when the issues of control, money or power mixed with family dynamics are added on, “you can’t close the deal.”
The type of lawyer who can avoid this situation is one with the skills to take on a leadership role — a skill that’s often learned outside of law school, Narva says. An attorney can advise a client on whether to take on the LLC model or the corporate model — “a first-year associate can do that,” he says. The real issue is integrating tax and estate advice for the shareholder control group with the growth goals of the company. “Integrating that requires involvement at the highest levels; lawyers are fearful of jeopardizing their relationships,” he says.
The lawyer who represents a family business has to focus on the forest, not the trees. His or her firm has to be large enough to offer specialties needed by the client, according to Narva, but not so big that the client’s representation will be pigeonholed, with one specialty not knowing what the other specialty is recommending. The family business lawyer has to be both sensitive enough to anticipate and recognize conflict, and objective enough to avoid conflict.
“Lawyers need to understand that in the same way that they’re not CPAs, they have to know when to call in an accountant,” Narva says. “They have to know when and [whom] to call to deal with complex family issues being acted out in the business.”