Investing in a family business?

I have been considering investing in my girlfriend鈥檚 family business. What paperwork / documents do I need to get to ensure that I am becoming part owner of the business? I don鈥檛 want my investment to be mistaken for a loan and I want to be able to proof, in the future, that this is a source of income for me.

Business and "family" don't work. What happens if you break-up with this girlfriend? You are stuck owning a portion of the business. I wouldn't even recommend it if you were married. Find somewhere else to put your money like a Roth IRA.

First you need to understand how your family's business is organized. Is it a corporation, a limited liability company, a general partnership, a sole proprietorship?

Then you need to understand how the relationship will work -- will you be guaranteed a share of net profits each year? Who determines what part of net profits goes back into the business to fund capital investments or improvements and who determines what goes out to you? Do you take into account the salarties they are paying themselves or do your in-laws get to pay themselves and then they split the remainder. What happens in a bad year -- do you still get a guaranteed distribution (probably not but do you get made whole the next year).

Also, how much do you get to have say on the company? What if they want to go out and layer a bunch of debt on the company? Or go into the pornography business? Or they decide to pay all their workers $100,000 a year because they are feeling generous -- thus reducing net income to zero. Do you have a veto? Do you even have a vote?

What happens if you want to sell, they want to sell or if one of them dies or gets divorced -- do you have a right of first refusal on each other or the right to tag along if they sell out. And how are taxes treated? If its an LLC or general partnership then you will recognize income regardless of whether you get distributions so you need to make sure you understand how that's handled.

Once you understand the kind of entity and have agreement on those key areas (economics during the life of ownership, management, disposition, tax treatment) then you should go and get a lawyer, tell him what you want, and get it drafted up. But as shorthand this is what you'll need:

1. If they are an S corporation or a C corporation you'll want a stock purchase agreement and a shareholder's agreement and you may want to amend the articles of incorporation (which are the formation documents on file with the state).

2. If they are an LLC or a partnership you'll want to amend the operating agreement (also called an LLC agreement in some jurisdictions) if its an LLC or the partnership agreement. The document that's on file with the state probably does not need to be amended.

2 other thoughts:

1. Make sure you understand what you are getting yourself into -- if its a general partnership you'll be generally liable (meaning your house, assets, etc.).

2. Why not a loan? You could do a loan with a set % return. It certainly protects you in the downside situation.

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