Key Takeaways

  • A family corporation is a business owned and operated by family members, offering liability protection and estate planning benefits.
  • Family corporations can use strategies like share restrictions and family trusts to maintain control within the family.
  • Governance structures, including succession planning and conflict resolution policies, are crucial for long-term stability.
  • Choosing between entity types (C Corp, S Corp, LLC) impacts taxation, control, and operations.
  • Family corporations provide opportunities for wealth preservation, tax advantages, and intergenerational ownership transitions.

A family corporation definition will tell you it is a business owned exclusively or primarily by family members. In a family corporation, the shareholders are relatives and the stock is largely held by one family. Families choose to establish this type of corporation to vest the business with limited liability or shield their assets from creditors.

How to Establish a Family Corporation

To set up a family corporation, you must file several documents with the state you plan to incorporate in and transfer your assets to the corporation.

Here's a step-by-step outline of the appropriate steps:

  1. Select a name for your family corporation.

    Note: You must include a suffix in your name to indicate your limited liability status.

  2. Visit the secretary of state's website to search their name database.

    Note: You will not be able to use a business name that's already registered in your state.

  3. Appoint directors and various other officers.

    Note: Most states will require you to appoint at least a secretary and a president. Beyond that, most states also require a certain number of directors. In California, for example, family corporations must appoint at least three directors. Be sure to select these appointees wisely. They will be the ones responsible for distributing dividends to your shareholders.

  4. Select a registered agent who will receive official correspondence on behalf of the corporation.

    Note: That person does not have to be an officer of the corporation, but he must reside in the state of incorporation.

  5. Complete the articles of incorporation.

    Note: You may want to hire an online legal document preparation service to help you with this. The articles of incorporation require basic information i.e., name, address, registered agent, names of officers, and the number of authorized shares.

  6. Create corporate bylaws.

    Note: In essence, corporate bylaws are the constitution for your company. They'll outline matters of corporate governance that aren't necessarily mandated by state law.

Benefits of a Family Corporation

A family corporation offers several advantages that go beyond liability protection. These include:

  • Wealth Preservation: Shares can be kept within the family to ensure that ownership and control stay centralized, helping preserve wealth across generations.
  • Estate Planning Efficiency: Family corporations can be integrated into estate plans to facilitate the smooth transfer of assets, minimizing probate and potential disputes.
  • Tax Planning Opportunities: Strategic use of family corporations may allow for income shifting among family members in lower tax brackets and leveraging gifting strategies to reduce estate taxes.
  • Unified Family Vision: By formalizing ownership and governance, family corporations foster collaboration and clarity in business goals and values.

Important Points for Consideration

When drafting corporate bylaws, it's important to carefully research state law. State law restricts a lot of your content. For example, in some states, directors may not be allowed to dissolve the corporation. Shareholder consent may be required.

Also, you want to name family members as shareholders. Specify how many shares each family member will be entitled to. Do not allow any member to transfer their share to an outside party without unanimous consent from the rest of the shareholders.

In these early stages, address important matters relating to corporate governance. These duties include:

  • Every officer's duty
  • Decisions that will be made by directors
  • Decisions that will be made by shareholders
  • What will constitute a quorum for a meeting
  • How shareholders will transfer shares

Make sure every shareholder signs the bylaws. These do not need to be filed with the state, but they're essential to your business.

At this point, you'll want to open a bank account in the name of your family corporation and deposit funds. As soon as the funds are in the account, they become the property of the corporation property and are not transferable to any shareholders without consent from the board. Those funds cannot be co-mingled with any of the shareholders' personal funds.

Create share certificates for every shareholder. These certificates will display the shareholder's name and indicate how many shares he owns. Indicate any restrictions on the certificate. For example, the shares aren't transferable to any outside parties without the unanimous consent of the shareholders.

Maintaining Family Control

Maintaining control in a family corporation requires proactive measures, such as:

  • Share Transfer Restrictions: Include clauses in the bylaws preventing stock sales to outsiders without unanimous family approval.
  • Family Trust Ownership: A family trust can hold shares on behalf of members, simplifying management and protecting against external claims.
  • Voting Agreements: Establish agreements that ensure family members vote as a bloc on key decisions.
  • Board Seat Allocations: Specify in the bylaws that a majority of board seats must be held by family members.

These tools reduce the risk of losing family control through unintended share transfers or disputes.

Nominating Family Members to the Board

Use your discretion to see if you want to mandate that the business remains in the family. Some companies ask family members to run the business while others simply ask them to serve on the board.

If your corporation ever goes public, it will be up to the board of directors to govern the decision-making. They'll also need to establish bylaws that mandate family members remain on the board in order to retain family control.

Control can also be maintained by limiting the number of shares that become available to nonfamily members. For example, the entire family or even a single family member could retain at least 52% of the shares in order to remain in control of the business and veto motions at the board of director meetings.

Succession Planning and Governance Challenges

Succession planning is one of the most critical aspects of a family corporation. Without a clear plan, leadership transitions can trigger conflicts or instability. Consider the following:

  • Create a Formal Succession Plan: Identify potential leaders early and provide them with mentorship and training opportunities.
  • Establish Conflict Resolution Mechanisms: Adopt dispute resolution procedures, such as mediation clauses, to manage disagreements.
  • Balance Family and Business Roles: Define clear job descriptions and performance expectations for family members involved in daily operations to prevent nepotism or resentment.
  • Prepare for Generational Changes: Each generation may have different visions; periodic family meetings can align expectations and update governance structures.

Effective governance is key to preserving both family unity and business success over time.

Frequently Asked Questions

  1. What is the main purpose of a family corporation?
    A family corporation is designed to keep business ownership and control within the family, offering liability protection, estate planning advantages, and tax benefits.
  2. How does a family corporation differ from a family LLC?
    While both aim to keep assets in the family, a family LLC offers more flexibility in management and pass-through taxation, whereas a family corporation may have stricter governance structures and double taxation (unless elected as an S Corp).
  3. Can non-family members own shares in a family corporation?
    Yes, but many family corporations use share restrictions or trusts to limit ownership transfer to non-family members.
  4. What are common challenges in family corporations?
    Succession planning, balancing family and business roles, avoiding conflicts of interest, and maintaining control across generations are common challenges.
  5. Do family corporations get tax benefits?
    They may qualify for tax advantages through income shifting, estate tax planning, and structured gifting, though it depends on the entity type and jurisdiction.

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