5 Dangers of Starting a Business with Family Members

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Most people launching a new business will help from family. New businesses borrow start-up capital from Dad. Sis would be a great partner. Let's do this. It's the American dream.

Makes perfect sense, right? Your family is already inclined to help you. You trust them. They trust you. If your business is successful (and you know it will be), then you are doing them a favor. Who would you rather share the good fortune with than your own family? Generally, starting a business with family members is a bad idea.

Take a look at Why Friends And Family Are Your Worst Business Enemies. Mark Kohler, an attorney and CPA, writes an insightful piece in Entrepreneur Magazine’s blog. I completely agree.

My shareholder oppression practice deals with disputes among business partners every day. Many of those partnerships-gone-bad involve families who are now at each others’ throats. The human emotional carnage involved in those lawsuits is often heartbreaking.

Problems with Starting a Business with Family Members

Here are the problems:

  1. Families fail to appreciate the risk of starting a business. 50% will fail within five years. Two-thirds within ten. Family members have faith in each other. Family members want the best for their own. Family members are blind to the financial risks. They would never invest their money in such a venture for a stranger. What will Thanksgiving dinner be like if you lose Dad's retirement money?
  2. Family-business partners tend to be lax in documentation. This is almost always a recipe for disaster, as memories fade about what the original deal was. Trust is no substitute for a well-crafted partnership or shareholder agreement. Things change. Family members always regret starting a new business without proper documentation.
  3. Family-business partners do not realize the duties imposed by the law. Texas law assumes that business partners enter into a new venture at arm’s length. With eyes open and the motive to protect their own self-interests. Generally, there usually are no special duties when parties form a partnership. The parties are held to their agreements. After the partnership is formed, the parties owe fiduciary duties to each other. These duties are much more limited in a small corporation or limited liability company or limited partnership. Such duties are non-existent in a borrower-lender relationship. But, the law treats family relationships differently. The law typically assumes close family members (and sometimes close friends) are in a relationship of trust and confidence. In those relationships, the law imposes strict fiduciary duties of good faith and loyalty. Family business partners must make full disclosure and place the interests of the other before their own. Transactions between fiduciaries may be set aside if they are not entirely fair. And the burden of proof is often on the defendant. Business owners cannot assume that the courts will defer to their business judgment when things go bad in that situation.
  4. Family baggage plagues family businesses. Jealousy and resentment from childhood clouds business judgment. Family members see disagreements as disloyalty. Spouses are more loyal to each other than to in-laws. Step families often have resentments and anger. Disfunctional relationships in the family are magnified in the business context.
  5. Business disputes are always difficult to resolve. All partnership disputes involve lots of emotion, feeling of betrayal and ingratitude. Among family members, this is true in spades. I have had settlement discussions derailed over who should have gotten mother’s china.

The family business is an American institution, but business needs to be business. The wisest policy is to keep business and family separate.