Many family business owners view their lawyer as a necessary evil. It’s almost as though we carry some deadly disease; call your lawyer only when the life of your business depends on it! But just as physicians have learned to control smallpox with small doses of vac
cine, administered over time, the owners of a family business can also use regular doses of lawyers and other advisers to minimize the risks of the many problems that can put your business at risk.
The annual legal audit of the business is similar to the annual financial audit performed by your accountant; however, the legal audit reviews the business’s existing practices, procedures and documents to anticipate and correct any legal problems before they fester and become major threats to the business. Your lawyer should go over the basic corporate documents in detail: the articles of incorporation, the bylaws, the minutes of shareholder and directors meetings, any buy-sell agreement, Subchapter S election, any incentive stock-option plan and
the stock record book.
The legal audit also includes an examination of the company’s contracts with suppliers and customers, loan documents, employment contracts with key managers, non-compete covenants, equipment and real estate leases, and all your documents relating to employment matters and qualified retirement plans.
Finally, the lawyer should look at your ongoing practices and procedures, including hiring and firing practices, insurance coverage, environmental issues, disability insurance, Worker’s Compensation and unemployment compensation to verify that all legal protections are in place.
The goal of this annual legal audit is to identify potential problems when the remedies can be employed quickly and economically. If this audit is not conducted and the problem is brought to your attention by an unhappy ex-employee, supplier, customer or taxing authority, the remedy is almost never quick or economic.
The annual fiscal-year-end review takes place about 30 days prior to the end of the company’s fiscal year, when you have 11 months of data available. This is the opportunity for your lawyer, accountant, financial and insurance advisers to consult with the family business owner on a number of issues.
What is the company’s projected year
end taxable income? What steps can be taken now to minimize the tax liability? Can income be deferred to next year (or will that merely add to next year’s tax problems), or can deductions be accelerated to this year? Should qualified retirement plans or medical reimbursement plans be implemented? Can lease payments for real estate or equipment owned separately by the family be increased? How can the business earnings be leveled out, so as to avoid the peaks and valleys that may trouble a potential buyer in the future?
What is the personal-income-tax status of the business owners? If this is a C corporation, should income be left in the business or distributed as a dividend? Even in the case of an S corporation, there is a delicate balancing act between the future cash needs of the business and the owners’ need to pay income taxes and receive sufficient after-tax income to maintain their lifestyles.
What plans do the owners have to exit the business? Will the business be retained in the family or will it be sold? What steps should be taken now to posi
tion the business for new management?
What plans are in place to grow the business in the next fiscal year? If those plans succeed and the value of the business increases, what strategies exist to shift that future appreciation to the next generation now? What capital accumulation or banking needs should be considered to provide for expansion of the business? Or, if contraction of the business is anticipated, your advisers can assist in the difficult decisions the owners need to make.
If your business does not annually conduct both a legal audit and a fiscal-yearend review, I recommend that you call your attorney now. Ask your attorney to schedule these meetings and to include your other advisers as necessary. Why are you working so hard every day when the business you love may be at risk-a risk that can be minimized with these careful steps?
Manterfield, a partner in the law firm Krieg DeVault LLP, assists family businesses with succession planning. The information in this column is not intended to be legal advice.