|FORTUNE Small Business:|
Should I split the family business?
We advise a small Texas plumbing firm on the pros and cons of dividing into three LLCs.
(FORTUNE Small Business) -- Dear FSB: My father, brother and I own a plumbing business that is under my father's DBA. We have since expanded. Now, my brother is in charge of repairs, my father new construction, and I manage the overhead. I was wondering if we should develop our own individual LLC's - my brother for repairs, mine for management services, and my father for new construction? My father is also getting older and I want to make sure when he retires he receives 33% of profits for the rest of his life, as he started the business. Can our separate LLCs form a partnership? What would you recommend?
- Michael, San Antonio
Dear Michael: Since you are each concentrating on different aspects of the business, formalizing your separate concerns might seem like a good option at first glance, but the experts we spoke to thought you might be inviting in one large and unnecessary headache.
"It really doesn't make that much sense to have three companies," said Brian Liu, chairman and co-founder of LegalZoom.com, a web-based legal document service. Imagine the complexity of inter-company transfers alone. Who would own the office? How much rent would that LLC charge the other companies? If one LLC is offering management support services to the others, how much will it bill?
The only reason he could think of that would make it a good choice is if one part of the company, say new construction, was taking on substantial risk and you were looking to shield the other two. Absent that, forming three LLCs, or a forming a partnership between three LLCs, will only increase the cost and complexity of your work, particularly when it comes tax time and you are faced with three separate returns.
"It's going to be a nightmare," Liu said.
Mark Britton, CEO and co-founder of Avvo, a web site that helps consumers deal with legal matters, agreed.
He wondered if your father's DBA (shorthand for "doing-business-as") is currently a limited liability entity. If not, at a minimum, he suggested you form one to shield your collective personal assets from the business's liabilities.
As for three separate LLC's? Probably not a great idea, Britton said.
"It sounds like you are considering this to shield all of you from one another's liabilities. The problem is that, if the liability stems from your plumbing business, a smart lawyer will cover the bases by suing all of your LLCs anyway. My sense is that the separate LLCs will not buy you much, and if you are really worried about disproportionate liability, you might consider indemnification agreements (e.g., your brother agrees to pick up the tab for any liability you or your father incur because of his repair operations.)"
Your LLC's could form a partnership, but again, the experts we spoke to questioned the wisdom of such a move.
"I'm not sure why you would want to," Britton said. "This seems to be adding a lot of complexity to a fairly simple situation. In some states it may also expose you to double taxation. Have all of your rights laid out in a single LLC agreement, and you won't need a partnership agreement."
So if you're now convinced three LLCs isn't the way to go, how do you ensure your father gets 33% of profits for life?
That one is easy.
"In your LLC operating agreement, simply specify that your father will receive 33% until the date of his death," Britton said. "LLC operating agreements are typically very flexible and the LLC members can split up rights/responsibilities in any way they see fit."
Barbara Weltman, author and small business expert, added that your desire to pay out your father after retirement would make better sense if the family were in one entity anyway and there was a buy-sell agreement among owners.
Last thing: All the experts we spoke with had the same caveat - the law of limited liability entities is state-specific so be sure you know Texas rules and regulations or hire someone who does.
A few sources to help with Texas law: Texas Secretary of State Phil Wilson has an extensive FAQ on incorporating in Texas on his web site. Britton's site has a section where you can pose questions to real lawyers and Liu's site has a FAQ section on incorporating in Texas.
Colleges and universities with business schools or strong management departments often have great resources for small business owners. One example is the Small Business Development Center at Texas State University in San Marcos which offers free confidential counseling to small businesses.