Lifecycle of a Business – Setting up a Family Investment Company
19 July 2023
News
Setting up and running your own business is an amazing achievement. It requires vision, creativity, motivation and stamina.
On occasion, it can even bring you fame, riches and fortune. But it can also result in reams of paperwork and cause sleepless nights. And as someone once said to me about children “It doesn’t get easier, it just changes”, so the same can be said for your business throughout its lifecycle. From setting up to exit, it will force you to consider issues that you might not previously have known anything about and it will need you to make many decisions, sometimes very quickly. What it certainly is not is mundane.
With this in mind, the corporate team at Forsters, together with some of our specialist colleagues, has written a series of articles about the various issues and some of the key points that it may help you to know about at each stage of a business’s life. Not all of these will be relevant to you or your business endeavours, but we hope that you will find at least some of these guides interesting and useful, whether you just have the glimmer of an idea, are a start-up, a well-established enterprise or are considering your exit options. Do feel free to drop us a line or pick up the phone if you would like to discuss any of the issues raised further.
So, First Things First…..
Setting up a Family Investment Company
Family investment companies, or “FICs” as they are commonly known, have become increasingly popular over recent years and are now widely used by wealthy individuals for succession planning purposes. They offer a number of tax advantages over trusts, and are also popular with international clients from jurisdictions that do not recognise trusts, and who may feel uncomfortable with involving a professional trustee company in their affairs.
From a legal perspective an FIC is just like any other private limited company. In April 2019 HMRC set up a unit to look into FICs and their use by wealthy families, which gave rise to concerns that HMRC was considering taxing FICs in a different manner to other companies. However, the unit was disbanded in the summer of 2021 having found no evidence that FICs were being used for tax avoidance purposes, and whilst future changes to how FICs are taxed and regulated cannot be ruled out, for the time being at least it seems that HMRC will continue to treat them in the same manner as other companies.
An FIC is simply a company that holds assets that would otherwise be held by family members personally. FICs can be used to hold a wide variety of assets, including cash, investments and property. Detailed tax advice needs to be taken before an FIC is established, but assuming the decision is made to use an FIC, set out below are some of their typical characteristics.
Funding the FIC – FICs can be funded either by way of shareholder loan or equity, but probably the most popular way is by using redeemable shares. The advantage of this is that it allows the individual setting up the FIC to extract funds from the company in a tax-efficient manner should the need arise.
Voting shares – In addition, the individual setting up the FIC will usually be granted voting shares. These tend not to carry any economic rights (such as rights to dividends or capital on a winding-up), but they give the individual complete control over all shareholder decisions, such as the appointment of directors, amendments to the company’s articles, and so on. The individual setting up the FIC will usually act as the company’s director (sometimes with his or her spouse acting as a second director), which gives him or her control over the company’s day-to-day decision making too, such as how funds should be invested and when dividends should be paid.
Alphabet shares – The final class of shares that are typically used are shares that carry economic rights but no voting rights. Each child of the individual setting up the FIC will usually be granted their own class of share (hence the term “alphabet shares”), but each of these classes tends to have identical rights. Crucially, however, having multiple classes of shares means that dividends can be declared on only one class of share at a time, thereby enabling the individual who set up the FIC to channel funds to whichever of his or her children might need them at the time (whether for a deposit to buy a house, set up a business, pay for school fees, and so on).
Transfers of shares – As its name suggests, an FIC is an investment company owned by, and established for the benefit of, the members of a family. As such, the articles of association of an FIC will normally contain very tight restrictions on the transfer of shares, which are designed to ensure that ownership of the company remains within the family. Typically, transfers of shares are only permitted to blood-line descendants of the individual setting up the FIC, or sometimes blood-line descendants of that individual and his or her spouse together. Great care needs to be taken in considering whether spouses of children, adopted children (and adopted grandchildren), illegitimate children (and illegitimate grandchildren), etc. should be able to hold shares – the answer will be slightly different depending on each family’s circumstances.
Pre-emption rights – Typically, pre-emption rights on the transfer of shares will not be included in an FIC’s articles. This is for two reasons – first, because the list of who can hold shares is usually very tightly defined (see above), and therefore there is no need to include further protection by including pre-emption rights; and secondly, because if an adult child of the individual who set up the FIC wishes to transfer their shares in the FIC to their own children (i.e. the grandchildren of the individual who set up the FIC), it wouldn’t be appropriate for other shareholders to be able to intervene and prevent that transfer by exercising pre-emption rights.
These are just some of the ways in which FICs differ from normal trading companies in the way they are set up, though there are many others and expert advice should be taken if you are considering using an FIC. Forsters has significant experience in establishing FICs, whether for nuclear families living in the UK or extended families living across the world. To find out if a family investment company is the right approach for passing on wealth to your family, please do get in touch.
Disclaimer
This note reflects the law as at 19 July 2023. The circumstances of each case vary and this note should not be relied upon in place of specific legal advice.
Divided We Plan: Alastair Laing and James Hamilton write for STEP Journal Plus
20 July 2022
Views
Partner, Alastair Laing, and Associate, James Hamilton, both in our Corporate department, have authored an article for the STEP Journal Plus entitled ‘Divided We Plan’.
In their article, Alastair and James outline the considerations for succession planning and the division of wealth in family offices.
The article highlights that a vast amount of generational wealth is predicted to be passed down over the next 25 years and includes an in-depth review of details regarding the structuring of assets through generations, the complicated nature that may occur regarding the division of assets, private equity fund investments, property matters and disparities in value.
The Entrepreneur’s Exit – Avoiding the Legal Pitfalls
21 December 2021
News
The post-COVID bounce back in M&A deals has led a lot of entrepreneurs to consider selling their businesses. Business owners are aware that today’s extremely healthy M&A market will not continue indefinitely and that the window of opportunity will soon begin to close.
This paper looks at the most common legal pitfalls encountered by entrepreneurs selling their businesses, as seen by the Corporate and Private Wealth teams at Forsters. These teams have decades of experience in advising entrepreneurs on business exits. They know the steps every entrepreneur needs to take to get a business in the best legal shape for an exit, as well as what they need to do to manage the tax bill on their gains and maximise the wealth they secure for their families.
Get your business paperwork in order – bidders worry they will be buying problems
A business with its paperwork in order reassures potential bidders – they will see it as lower-risk and more likely to result in a quick, clean transaction. The Corporate team at Forsters often advises entrepreneurs on how best to clean up their paperwork and make their businesses as attractive as possible. The five big issues they see most often are:
Renegotiate business debts if necessary – don’t leave it to the buyer
Not having long-term control over the cost of debt of a target business can be an issue that puts off potential acquirers. Any loan renegotiations that need to take place should be concluded before you open the business’s books to a bidder. Failing to deal with the problem risks them walking away or lowering their bid.
Extend the business’s property leases if they are running out – it makes the business more attractive to an acquirer
A potential acquirer will likely be uncomfortable if a lease on a key property used by the business – an office, factory or retail site – is coming up for renewal shortly after the purchase. Having certainty over future costs is valuable, as is avoiding the disruption of relocating the business. It is well worth getting renegotiations with landlords underway a year ahead of your projected exit point.
Formalise any ‘gentlemen’s agreements’ with staff, suppliers and customers
Another common issue that acquirers dislike is if a business has failed to formalise the agreements it has with its key staff, suppliers and customers. Far too many businesses still operate on long-forgotten ‘gentlemen’s agreements’ with key staff. Senior team members who have been with the business for many years may not have formal contracts in place, creating a risk that they could quickly walk away from the business following an acquisition. Bidders will want to see that senior staff are contractually incentivised to stay with the business for at least 12 months and have oversight of the costs, including their pensions, bonuses, profit shares and any other remuneration.
The same goes for contracts with important customers – it is common to find formal arrangements that expired long ago and have continued on an informal basis. This creates the potential for key clients to be lost without notice periods, impacting turnover without warning.
This risk can impact a valuation or a bidder’s willingness to move forward with a purchase. If this is the case in your business, rectify it before starting the sale process.
Update the shareholder register to avoid costly disputes
Another common issue, especially for startups in industries like technology, is the granting of equity to key staff. While this can be an excellent way to retain important contributors to business growth, if it is done informally and the shareholder register is not properly updated, it can trigger costly and avoidable disputes. If these informal grants of equity were made several years earlier, recollections of the details often differ between the parties and misunderstandings can become litigation when an offer is made for the business. Sit down with those key staff members as early as possible, formalise their stake in the business and update the shareholder register.
Make sure any IP the business holds is protected by patents and trademarks
More and more businesses are seeing the value of the intellectual property they hold make up a significant percentage of their valuation, but this IP only has real value if it is protected by patents and trademarks. Entrepreneurs have seen potential bidders walk away from negotiations after finding that IP the business relies upon is not protected, risking devaluing their investment in the future.
Taking advice from an intellectual property lawyer is vitally important if your business has proprietary systems or owns market-facing brands that form part of its value.
Deal with any difficult ‘legacy issues’ the business has
Bidders are always on the lookout for anything they might deem to be ‘skeletons in the closet’ for a business. During a business’s early years, entrepreneurs often file issues away under ‘to be dealt with later’. The Corporate team at Forsters say examples of this kind of issue that entrepreneurs may have to deal with before they try to sell their businesses include:
Ensure the business used furlough properly – and deal with it if there are any problems
In the early days of the pandemic, there was plenty of confusion around the furlough scheme and a lot of businesses made claims that later turned out to be in error. HMRC is now hunting down businesses that owe money because of incorrect furlough claims. It is far better to deal with these issues proactively rather than waiting in hope that HMRC misses it. There are likely to be significant penalties for businesses that made claims HMRC deems to have been ‘fraudulent’ and there will be little sympathy for those who did not come forward to report it voluntarily. Acquirers will not be keen to purchase a business with a risk of this kind.
Unwind any ‘problematic’ transactions from the company’s history
It’s not particularly unusual for businesses to have long-buried compliance issues dating back to their early days as a startup. When the books are turned over to a potential bidder, those issues have a tendency to come back to the surface. If, for example, a director purchased a car for personal use through the business, it can be a significant red flag to an acquirer that there are other governance problems. Any business owner with issues of this kind would be well advised to unwind any of these transactions before they put an M&A deal at risk.
Prepare your heirs inheritance by getting your taxes in order
A key driver for many entrepreneurs to build a business in the first place is the desire to provide wealth and comfort to their families. A key part of being able to do this successfully is to prepare your personal tax situation to maximise your gains – and by extension, their gains – from selling your business. The Private Wealth team at Forsters say that the two big issues for entrepreneurs to be aware of here are:
Don’t gift your children cash from the sale – you may overpay tax, and you will miss the chance to protect the money (e.g. from divorce)
It is common for entrepreneurs to want to pass on some of the capital generated by the sale of a business to their children. Taking advice on the most tax-efficient way to do this is important. Completing the sale then gifting your children cash is rarely the best way. Capital Gains Tax savings can be made if shares are given to children before the sale.
Also, shares in a business typically qualify for Business Property Relief (BPR) from inheritance tax, which means that before the sale there is a unique opportunity to transfer assets into trust for the children. After the sale, a gift of cash into trust would suffer an immediate 20% inheritance tax charge. Having assets in trust can ensure that the children receive benefits only as and when they are ready, and can provide protection on divorce. An outright gift of cash offers no such protection.
Be careful about leaving too much cash in the business – your heirs will end up paying too much IHT
As mentioned, one of the key tax reliefs available for entrepreneurs passing on shares to their children is Business Property Relief (BPR). But if there is too much cash in the business, the relief may be limited.
Make sure there is a solid rationale for the business holding cash, such as a planned programme of capital investment. Ensure this is documented and that your heirs stick to the plan.
Think about how to manage your own capital gains tax bill
Capital Gains Tax can act as a significant deterrent to entrepreneurialism. Even the Government recognises this, having put in place tax reliefs like Business Asset Disposal Relief (formerly Entrepreneurs Relief) to encourage investment in business growth. The Private Wealth team at Forsters say that this relief is not the only way for entrepreneurs to reduce their CGT bills when they exit a business.
Planning to move abroad after selling your business? Consider doing it before that to reduce your CGT bill
Many entrepreneurs plan a relaxing retirement overseas once they have exited their business. However, few consider the possibility of moving overseas before the sale of their business, which can offer significant tax advantages. If you become resident outside the UK for tax purposes for six years, you may not be liable to UK CGT on the sale of your business during that time. If it works for your personal circumstances, it may be worth accelerating your permanent move out of the UK to save yourself what is likely to be a very substantial tax bill.
Becoming a serial entrepreneur? Business Asset Rollover Relief can defer your CGT bill while you grow your wealth
Business Asset Rollover Relief (BARR) allows an entrepreneur to defer the payment of a CGT bill by investing their capital gain into a new business. The CGT bill from the first business sale doesn’t become payable until the second business is sold. That can be very powerful – if your second business is successful, your personal wealth may make the CGT bill from the first business relatively insignificant.
Conclusion
For an entrepreneur, making the most of the post-COVID bounce back in the M&A market is possible so long as you take the right advice. Just as when building the business in the first place, preparation is important. Your business didn’t become successful by chance – it became successful through careful planning and wise decision making. Apply the same approach to your exit and you give yourself the best chance of a smooth transaction and an optimal price.
The Corporate and Private Wealth teams at Forsters are here to advise entrepreneurs on every aspect of their business journey, from startup to growth and exit.
From growing a business to starting a family or handing over control of that business to the next generation, every individual has their own goals to aspire to. Our Private Wealth lawyers advise our clients throughout this family life cycle, providing the legal advice required for specific transactions such as purchasing a home or selling a business, whilst also advising on the long-term opportunities for succession and estate planning.
Forsters’ Corporate Quartet recognised in Spear’s 2021 Legal Index
16 August 2021
News
We are pleased to announce that four of our Corporate Partners have been listed as Top Recommended lawyers in the 2021 edition of the Spear’s Corporate Lawyers Index:
The index recognises the best Corporate lawyers to high net worth individuals, with significant expertise in advising on high-value transactions.
Spear’s is distinctive for ranking a wide range of leading advisers and is described as an “indispensable guide” to the top lawyers for private clients.
A Forsters team led by Head of Corporate, Craig Thompson, and Associate, James Hamilton, advised Net-a-Porter founder Mark Quinn-Newall’s Neurotribes investment fund on the sale of its substantial stake in Cult Beauty to The Hut Group for £275 million.
A cross departmental team, led by Client Relationship Partner, Craig Thompson, and Senior Associate Daniel Bryan, has advised long-standing client, Greybull Capital, on their high-profile purchase of the McLaren Group’s Applied business division.
The future of family business in pandemic recovery – Stuart Hatcher and Alastair Laing write for CampdenFB
10 June 2021
Views
Corporate Partners, Stuart Hatcher and Alastair Laing, have authored an article for CampdenFB entitled ‘The future of family business in pandemic recovery’.
“The current outlook for the UK economy is positive, and for many the financial effects of the pandemic may not be as bad as originally feared. Time will tell if this is the case, but when investors are in a buoyant, positive frame of mind, deal flow and M&A activity usually follow”, Stuart and Alastair explain.
They highlight that the combination of low interest rates and the availability of substantial funds to support investment will further encourage market activity.
However, despite a positive economic outlook, buyers are treading cautiously in terms of structuring consideration.
Forsters is uniquely placed to advise clients on the acquisition and disposal of trust companies both inside and outside the UK.
Working closely together, our Corporate and Trusts teams advise on all aspects of these transactions, whether structured as a share sale or an asset sale, and whether a private deal or an auction. We also have an excellent network of lawyers with whom we work in other jurisdictions.
