Statistics show that fully 10% of all Americans eventually have their own small business. Because investment capital is generally the biggest issue in starting a business, many new businesses also start up through “family” investments. When asked to “invest,” many family members fail to understand exactly what they are getting, for what they give.

Family businesses often have special advantages that encourage investing: years of trust, great business connections, good reputations, and a family network to help bring in sales. When it comes to investing in a family member’s business, however there are even more reasons to talk with a lawyer. Without legal advice, the losses of a business investment may actually spill into personal bank accounts. Even profits the investor should get might not be recovered, if the family member is dishonest or incompetent.

The type, and also the business form, of a family business “investment” is crucial. Depending on the physical location of the investment or business, you will have choices between making a personal loan, a secured loan, or entering partnership agreements (the most common type of investment), LLCs, or other types of corporate ownership. By structuring the business investment properly, a lawyer can help take flash points out of potential disagreements. Some corporate investments can be seen as “closely held” companies, without the special protections corporations have. Who, for example, has the final say in using the investment? What happens when it comes time to calculate a change in the business (such as growing the business)? If an investment is set up badly, a lawsuit may wipe out not only the business assets (if any), but also possibly an investor’s personal assets.

You will want to be clear about your rights to recover the investment: do you own part of the business’s cash assets, or inventory, and you should be able to require an accounting of the business at any time? You will also want to talk with a lawyer about your priority with other creditors, in terms of making a claim for your investment, if (for examples) the business goes into bankruptcy, or the titled owner of the business should die or get divorced.

State and federal laws on taxation will also vary, depending on how the investment is used, and how business liabilities and debts are structured. Talking with a lawyer can help avoid enormous liabilities in your personal taxes if the business succeeds or fails.

Not all problems, from taxes to profits, can be planned for in a family business. Some families acquire new members through marriages, divorces, and births. These new faces can change the friendliness of an investment. These dynamics also make it important to have good legal advice available to get out of the investment. By the same token, there is also the possibility a family relationship might improve by a working relationship. The point is that the same advice, which applies well to non-family business investments, applies even more strongly when dealing with family members. Some family members may enter into a business arrangement, in the belief they “can work it all out later.” One way to avoid many of the complications of how to say “No” when investing is by meeting with a qualified lawyer, before investing in any tie that may bind.

- Claire Kalia

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