In this article, Aditya Shrivastava, Manager Content Marketing at iPeaders talks about the 3 family business legal challenges and what can one do to ensure that their business does not meet a bad fate. Read out this crisp article to know is your family business safe?
On 2nd November 2015, President Pranab Mukherjee applauded family businesses for playing a key role in India’s economic growth, as reported by The Hindu. This was an attempt to appreciate the fact that India’s family businesses have substantially contributed to India’s economic output and employment generation. In his speech, Mr. Mukherjee stressed on how family businesses contribute 60 to 70 percent to the GDP and 40 to 50 percent of the employment.
An article by Business Line reported that “India has the third highest number of family-owned business in the world.” With 108 publicly listed family businesses, India lands on the 5th position in the Asia Pacific in terms of market capitalization. Globally, the number goes further below with India at the 22nd position. In addition to this, if one looks globally, India’s family businesses have matured over a period with nearly 60 percent of family businesses in their third generation.
These numbers indicate that family businesses are widespread and extremely important for the Indian economy, however, given that our motherland’s trajectory is growth-oriented, there is a need to address the elephant in the room and take steps to ensure that it is taken care of.
As per a report by Credit Suisse Research Institute (CSRI), India most prominently perceives succession planning, followed by a greater competition, and talent retention as the biggest challenge. However, what family businesses fail to understand is that they can turn into a nightmare if not taken care of.
What if I told you that succession could be planned beforehand if it is well documented? What if there was a way to retain talent? In my last article, I had written about how you can grow your family business to reach the next level. Most of the issues that family businesses in India perceive as a threat can be easily taken care of through legal means. In fact, legal help can not only help you overcome such issues but also help you grow further.
If you remember the case of Mafatlal and Mafatlal, you would agree that it set a precedent of what could go wrong in a family business. This is why there is a need to ensure that the rights of shareholders in a family business are required to be set in writing.
What could possibly happen if you were about to restructure your organization and a family member who represents a distinct class of equity shareholders calls the scheme unfair and protests in the AGM? The consequences of such omissions can be fatal. No amount of reading on the internet can possibly list out what could be the potential challenges unless it’s a comprehensive course on business laws. You need to ensure that your business is free from risks and ready for any future challenges.
Most legal issues that emerge in a family business are out of informal family relationships. The complex nature of such decisions taken out of love and affection are often problematic and lead to disputes.
Here are top 3 legal issues that you can take care of, if you are running a family business:
1. Business Structure
Most family businesses are in existence because of either the bond that exists between the family or to gain certain benefits under the law. For example, a HUF Deed is generally created with a view to getting tax exemption. Once created, it is fairly difficult to opt out.
It is undeniable that certain family businesses generally start out of a side business and once it sees success, they are formally conceptualized into bigger entities. It gives all the more reason for them to ensure that there is a proper structure in place. The issue is greater than this. Any business, at its inception, is often in a dilemma about which ownership structure to choose. The situation worsens in case of a family business as the rights and responsibilities are decided on one’s position in the family and not the contribution.
How can one bring in a structure at a place which is being run through hierarchy?
Any structure that is put in place must be well-deliberated and implemented. There could be an effective shareholder or partnership agreement in place.
Here are some of the points that ought to be put into the contract:
- Each family member’s contribution/investment
- Well-defined role of the family member in the business
- Stake in the family estate
- Credible succession
2. Employment Policies
While most of the companies have employee policies which broadly define what the role, responsibilities, and liabilities of the employees are, however, there are times when family businesses avoid having contractual agreements signed by the family members.
In future, if there’s ever a conflict, there is no actionable claim one can file against the other because there exists no contract to prove it. It is one of the major mistakes that these businesses generally make. There is nothing wrong in ensuring that there exist agreements between the family members to ensure proper functioning of the business.
A contract shall also mean equal treatment of the family members and divided job responsibilities. Further, it will ensure that there is a basic expectation setting for all the family members and no-one has any contractual issues that could eventually lead to a fallout.
3. Licenses and Permits
Are you running a family business without a tax professional, CA or a lawyer? Do you have any member in your family who is qualified to do so?
Every business, big or small, is required to be compliant with several laws, rules, and regulations which ensure that there is no legal intervention in the future. They are the most important aspect of any business. However, lack of such knowledge in a family business often turns troublesome.
For instance, If you have watched the movie Guru, you would know that the protagonist had figured out a loophole in the system of exporting and in no time he reached the pinnacle of success. However, once the journalist figured out the mischief, the protagonists business was affected majorly. Would you want to be in the protagonist’s shoes?
Let’s take another example. A friend whose father was running a chain of business was applying for various tenders. Unfortunately, he was not able to secure even one of them. Every time they applied for the tender, it leaked. They could not do anything about it. This is when my friend decided to understand the dynamics of business laws to gain a better understanding. After taking a course, he realized that he could perhaps draft a contract with the vendors and ensure that the business expanded hassle-free. Today, his family business is one of the biggest in the state of Rajasthan.
How would you want your family business to progress? The answer lies with you.
Preparing beforehand for any challenge or issue that may occur possibly in the future is smart business planning.
A famous professor by the name Rodney E. Evans once said, “Family business is a fertile ground for conflicts. If you can avoid it, there is nothing better, if you cannot, there is nothing worse.”
I will leave you with that thought.