In the majority of cases, the biggest difference between a family business and a non-family business is the importance of legacy. The business, after all, has been created and developed with the intention of eventually being passed down through generations, and the legacy of that business, while it will involve the commercial success created, will go above and beyond purely financial issues.
Legacy encompasses both the ethos and values of the business, often involving issues such as working practices (a commitment to sustainability, for example), philanthropic activity, the role played in the wider community and the reputation the business enjoys.
When the time comes for the founders of a family business to step aside, the way in which the succession is handled can have a huge impact on the preservation of this legacy. In many cases, the business will be passed on to the next generation, but this is not always a viable option.
There may be no family members wishing to take over control of the business, or none with the requisite skill-set, and in circumstances such as these the preservation of a family business can become more problematic.
When There Is No Natural Succession Pathway
For a business which isn’t family owned and has less of a focus on legacy preservation then the route of selling to a third party is clearly the simplest and quickest means of passing the business on, particularly if the current owners wish to walk away from the business entirely.
In simple terms, the owners of a business being sold in these circumstances will seek to secure the best price possible, and though assurances about the future operations of the business may well be sought, once the sale has gone through the new owners will be free to run the business as they wish.
For the owners of a family business keen to see the ethos of the business maintained in the future, this can mean the third-party sale option is fraught with risk. While the creation of documents such as a mission statement and governance structure for the business could help to make it clear exactly what the long term intentions of the current owners are, they will not be binding in any way on new owners, and nor is it possible to place restrictive covenants on the new owners as part of the terms of the sale.
For these reasons, many owners of family businesses who find themselves unable to arrange succession directly to another family member opt, instead of selling the business, to switch to an employee ownership model.
The Benefits Of Employee Ownership
The main advantage of the employee ownership model is that it means the people responsible for taking over the ownership and running of the business will, as a matter of course, be instilled with the culture and ethos of the business and, in many cases, will have worked within the business for a number of years.
Not only will they have an innate understanding of what the legacy of the business is – having helped to put that legacy in place – but they will also be ideally placed to pass their deep-rooted knowledge of the business on to future employees.
Once the decision to opt for employee ownership has been made, the current owners have the freedom to choose a model which reflects the degree to which they wish to step away from the business or, alternatively, a wish for the family and the business to remain associated.
If the owners decide on a minority employee shareholding, for example, then the family in question will still own the majority of the business. This could be a viable option for those families in which the next generation are not ready to step up to fully-fledged ownership.
The employees in this arrangement will either buy shares on an individual basis or have them purchased by an employee trust which then holds the shares on behalf of multiple employees.
As well as enabling the family to retain a degree of control over the business – and therefore the business legacy – this model will free up capital from within the business, and empower the workforce to feel they have a tangible stake in the future prosperity of the business.
Other owners settle on retaining a minority shareholding in the business, with the rest of the shares being sold to employees. As above this could take the form of individual share purchases or the creation of an employee trust or, in many cases, a combination of the two.
Families opting for this model feel they still have a stake in the business moving forward at the same time as accessing much more of the capital held within the business. There are also a couple of tax advantages to this particular employee ownership model:
Owners who transfer ownership of more than 50% of their shares to an employee trust will generally not have to pay capital gains tax (CGT) on the sale
The employees taking ownership of the shares will be entitled to a tax free annual bonus which, currently, could be as much as £3,600
There is also the option of full employee ownership for those families who wish to take the maximum amount of money from the business whilst handing over the direct, hands-on role in running it.
The employee share ownership structures will be as outlined in the previous examples, and families who wish to continue to have an influence over the direction of the business, and therefore preserve the legacy, can ensure that this is the case in a number of ways.
The simplest means of doing so is for members of the family to continue working within the business, or to take on the role of governing an employee trust, if one has been created. Further certainty can be created by ensuring that the constitution of the employee trust – the document setting out how the trust will operate – contains stipulations such as family trustees being able to veto decisions which they feel would negatively impact the legacy of the business.
Decisions in this category might include things such as sale to an independent third party, a fundamental change in working practices or a relocation.
Employee Ownership Trusts (EOT)
The sale of shares to an employee ownership trust (EOT) generally follows an expert valuation from an impartial third party engaged by the shareholders and the trustees. This valuation will then form the basis of the share sale, which takes place in one of three ways:
Shares are sold at market value or another sum, but a significant amount of the purchase price will be left unpaid as ‘deferred consideration’. This is then a debt owed by the trustees to the shareholders (in this case the family members) and the debt is paid back from the trading profits of the company in several stages.
Shares are sold at market value or another sum and the amount is paid in full, by the EOT borrowing the money required from a third party.
In some cases the family may opt to sell the shares to the EOT for a nominal fee, basically gifting the shares to the employees.
In order to avoid liability for CGT the following criteria must be met:
The business transferring shares to the EOT must be either a trading company in its own right or the principal company of a larger trading group.
The EOT needs to meet a requirement known as the ‘all employee benefit’ requirement. This means that the assets held by the EOT need to be held for the benefit of all eligible employees, although the trustees of the EOT are able to vary the benefits in order to reflect factors such as the length of service of particular employees, salary differences or the number of hours worked.
The EOT should not have held more than 5% of the shares in the business before the transfer took place, and must hold more than 50% - giving the EOT a controlling interest – at the end of the tax year during which the transfer takes place.
The number of family members who continue to be directors or employees, and any persons connected with these directors or employees, cannot make up more than 40% of the total number of employees of the family business.
Should you require support on establishing an employee ownership model or would benefit from advice on the most appropriate model to safeguard the future of your family-owned enterprise, the team at Buckles can offer impartial, experienced guidance on all aspects of ownership transferal. Contact us now to discuss the options available.
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