Ties That Bind

Contracts That Work

Contracts are not for every family member, of course. "When a young adult comes into the family business, it's a trial for everyone," says Dr. Ralph M. Daniel, a business psychologist and principal of California Family Business Institute LLC in Santa Barbara. "You never know where the 21-year-old will be in three months, and you don't want to saddle the company or the young adult with a contract." But the majority of the time, it makes good sense.

From the family member's point of view:

  • The contract provides peace of mind. Take the example of a company that wants to lure back a family member who has left the family business. If he or she has to leave a rewarding, well-paying job, a one- or two-year employment contract would recognize his or her need for some security.

The same holds true when older family members begin phasing out of the business. Knowing they will have real responsibility and will be financially secure in their semi-retirement eases the angst associated with leaving the company.

  • It helps clarify management opportunities. "I'm working with a company where the three daughters want employment contracts," says Daniel. "They're afraid that if they stay without them, the company--traditionally managed by the male relatives--will continue to deny them opportunities for growth. Negotiating the written agreement forces the family to address this question."
  • It provides an incentive to be productive. The contract, by its very existence, says the family business doesn't have to hire people just because they're related, that the family member employee is special and that the terms of this agreement are custom-crafted to reflect that.
  • It offers definition. When David Schulman was asked by his grandfather, Jerome Schulman, to come into his Chicago manufacturing business, David took a chance and joined the company. Early in his employment, however, he feared he'd made a big mistake: The warehouse lessee to whom he had leased the empty building next to their manufacturing facility didn't want to renew his lease. Since family members--16 in all--owned the huge building, they were going to get stuck with the empty building and an annual $100,000 tax bill unless they did something.

So David went to work. In 1994, he and his grandfather formed Grand Warehouse Corp., a public warehousing corporation, and David was put in charge of operating it. In six months, the 24-year-old had the space filled again. The problem was, David wanted complete authority over what to do with the profits, and some family shareholders were unhappy with that arrangement. "We drew up an employment contract that guarantees me a salary, stock incentives, a car and managing control of the company," David says. The definition of these perks was just what he needed to stay.

From the company's point of view:

  • It minimizes the potential for conflict. This is especially true when more than one family member is involved in the business or when business ownership lies with two or more families or the family and some investors, says Wolfson.
  • It's a sign to nonfamily employees that family members are expected to perform. "If a family member doesn't live up to the terms of the contract," says Daniel, "it's easier to terminate the person."
  • It protects the business. When family businesses have confidential information, such as secret manufacturing processes or recipes that have been handed down for generations, they usually add a noncompete provision to the contract. "If limited in the time period and geographical areas it spans and in the industries it covers," says Wolfson, "[the provision] will generally be enforcable in court."

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This article was originally published in the April 1998 print edition of Entrepreneur with the headline: Ties That Bind.

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