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Family Businesses

What are the most common problems with family businesses?

Personal conflicts often cause problems in family businesses. For example, one family member may feel that another isn’t pulling his weight, family members who work for the business may resent interference from other family members who don’t, or two family members may simply dislike each other.

Brothers and sisters may feel that they are being unfairly treated, particularly when a younger sibling is more senior than an older one. There can also be tensions between different generations. Problems can include a parent wanting unwilling children to take over the business, or a ´retired´ parent continuing to interfere.

Other employees, who are not members of the family, can resent any favouritism (real or imagined) shown to members of the family.

Of course, family businesses also face all the commercial challenges of any business. These can be made more difficult if the business has become set in its ways, or simply lacks the management expertise needed. Family businesses can find it difficult to grow if the family are unwilling to involve external investors or management.

How can we minimise the risk of disputes over the running of the business?

 

How can we minimise the risk of disputes over the running of the business?

As with any private company, you should have a shareholders´ agreement. This (together with the company’s memorandum and articles of association) establishes the ground rules for how the business will be run. The process of preparing the agreement allows you to talk over major issues and agree how they will be approached. (If your business trades as a partnership, you can achieve the same effect with a partnership agreement.)

You may also want to have some form of ´family charter´. Preparing this can be a good way of talking over issues that do not fit as comfortably within the more formal framework of a shareholders´ agreement. For example, discussions can include talking about what family members expect from each other. The family charter can also involve members of the family who do not take an active role in the business or who do not own shares in it. Regularly reviewing the family charter can be a part of promoting good communication between family members.

Two general approaches often seem to reduce the likelihood and intensity of disputes:

• Family members who work in the business are treated without favouritism.

• The family makes a conscious effort to keep some distance between ´business´ and their private lives.

 

 

What can I do if family members who work for the business don’t get on well together?

What can I do if family members who work for the business don’t get on well together?

In principle, you would hope to be able to deal with the problem in the same way as with any two employees who don’t get on together. You may be able to talk through the problems with the individuals concerned and negotiate an agreement. If one individual is clearly behaving inappropriately - for example, deliberately sabotaging the other’s work - you could invoke your disciplinary procedures. It may be possible to organise for the two individuals to work in separate areas of the business, minimising the opportunities for conflict. Or you may decide that the best solution is to ask one individual to resign.

In practice, solutions like these may not be easy when you are dealing with members of your own family. One option is to use an independent mediator to negotiate a resolution of the dispute. Where mediation fails, it may be possible to use an arbitrator - who can impose a solution if the parties cannot agree among themselves. Ideally, you will have planned ahead and family members will have agreed to dispute resolution procedures as part of your shareholders´ agreement or family charter.

 

 

What can be done if a family shareholder is using their shares as a weapon in a family feud?

What can be done if a family shareholder is using their shares as a weapon in a family feud?

You can take steps to minimise the risk of a problem like this arising in the first place. One option may be to retain majority ownership of the shares yourself (though this might not suit your tax planning) or to issue family members with shares that do not carry voting rights.

Ensure that the shareholders´ agreement includes appropriate dispute resolution procedures. Commonly, these include some form of ´buy-sell´ arrangement that provides a mechanism for feuding shareholders to either sell their shares, or buy the shares of their opponent, at a fair price.

You can also try to build a consensus that business decisions will be taken on the basis of what is best for the business, rather than to pursue private agendas. This can be done informally or as part of agreeing a family charter (see question 2).

The problem is more difficult when a feud arises without any prior agreement on how to deal with it. You may be able to negotiate a resolution by appealing to individuals´ self-interest: pointing out that the damage to the business is hurting everybody. It may also be worth reminding people of their legal responsibilities. Decisions - and feuds - often take place between individuals acting as directors rather than shareholders. As directors, they have a legal responsibility to act in the best interests of the company.

Ultimately, the best solution is often to encourage one individual to sell their shares. Even without a shareholders´ agreement specifying how this should be done, you can make an offer and negotiate a price. Where existing shareholders don’t want to pay for the shares (for example, because of insufficient personal funds) but are unwilling to allow outsiders to buy them, it may be possible to arrange for the company to buy the shares back.

 

Can we stop a family shareholder giving shares to the ´black sheep´ of the family?

Can we stop a family shareholder giving shares to the ´black sheep´ of the family?

The company’s memorandum and articles of association, or a shareholders´ agreement, can include restrictions on share transfers. For example, share transfers might require the approval of the board, or existing shareholders might have the right of first refusal on any shares being offered by another shareholder.

 

What sort of issues should we cover in a shareholders´ agreement for a family business?

What sort of issues should we cover in a shareholders´ agreement for a family business?

Issues that should be covered in a shareholders´ agreement include:

• How directors are appointed and how the board will take decisions.
• Dispute resolution procedures.
• How the business will be financed and how profits will be distributed.
• Rules on transferring shares, including what happens when a shareholder dies.
• Rules on employment of family members.
• Rules restricting shareholders from competing with the business.
• Rules protecting confidential information.
• Agreements protecting external shareholders

 

 

Are there any restrictions on employing family members?

Are there any restrictions on employing family members?

In general, no, unless employees are legally required to have specific qualifications or experience.

In practice, even if you wish to encourage your children (for example) to work for the business, you should require them to at least meet the entry requirements you place on other recruits. Otherwise you risk having incompetent family employees who do not feel the need to apply themselves and are resented by other employees. Other shareholders, particularly from outside the family, may also object if you employ unsuitable family members.

You may wish to include a requirement like this in your shareholders´ agreement. Not only does this make the position clear, but it also makes it easier for you to refuse to recruit unsuitable family members.

 

Can we favour family members over non-family employees?

Can we favour family members over non-family employees?

Favouring family members might indirectly discriminate against other employees (for example, or a particular race or gender). You could therefore face a claim of discrimination from an employee who feels unfairly treated.

In any case, it makes business sense to treat all employees equally. Favouring family employees unreasonably is likely to lead to a less effective workforce and resentful employees. Other shareholders may also object to excessive promotion or remuneration for family members.

 

Should we encourage our children to work for the business?

Should we encourage our children to work for the business?

Having your children work for the business can have advantages: often, the children share your values and your commitment to the business. However, employing your children in senior roles may also lead to a narrow-minded outlook compared to employing outsiders. Many families encourage their children to join the business, but only after working elsewhere for at least a couple of years.

Of course, if your children have other ambitions, it may not be a good idea to pressure them into working for your business. Where you have more than one child, you will also need to consider how well they get on together and what roles each could have in the business. Pre-empt trouble by making it clear that younger children may be promoted over the heads of their older siblings.

 

Are there any restrictions on appointing family members to the board of directors?

Are there any restrictions on appointing family members to the board of directors?

Your shareholders´ agreement (or the company’s articles of association) may contain restrictions, but that would be very unusual. A few specific types of business, such as investment companies, also require directors to have particular qualifications.

Apart from that, family members can be directors (so long as they are not the company’s auditor or an undischarged bankrupt, and have not been disqualified from being a director). They are, however, expected to exercise a degree of skill and diligence in carrying out their duties - the standard that could reasonably be expected of anyone carrying out their job in the same circumstances. It would not, for example, be appropriate to appoint a family member with no financial training to be finance director.

 

Can I give my spouse a salary so that we take money from the business in a more tax-efficient way?

 

Can I give my spouse a salary so that we take money from the business in a more tax-efficient way?

Paying your spouse a salary can be a cost-effective way of reducing your overall tax bill if your spouse pays tax at a lower marginal tax rate than you. However, there are restrictions to prevent you artificially reducing your tax bill in this way:

• You can only pay your spouse if he or she actually works in the business.
• The salary you pay must be commercially justifiable - in other words, not excessive for the work your spouse does.
• You must actually pay the salary (rather than merely making a book entry for a notional salary).

It should be noted that these rules apply to paying any family member. The rules also apply to offering perks such as a company car or contributions to a pension fund.

 

Can we pay dividends instead of salaries to reduce our tax bill?

Can we pay dividends instead of salaries to reduce our tax bill?

You can pay dividends instead of salaries. However, paying a dividend may offer little advantage. This is because the first £10,000 of profits is usually taxed at 0%, but any profits distributed as a dividend attract corporation tax of at least 19%.

Paying dividends may still offer tax advantages, as dividends are not subject to employers´ and employees´ National Insurance. However, the Inland Revenue keeps a close eye on companies that sell the services of the shareholders (or partners). Special rules apply if, had you not worked through your company, you would have been considered an employee of the client you did the work for. These ´IR35´ rules mean that you are required to pay tax and National Insurance contributions on a ´deemed´ payment as if you had been paid a larger salary rather than dividends.

You may want to take advice on the most tax-efficient way to take an income from your business, particularly if you think the IR35 rules may apply to you.

 

How can we attract additional financing into a family-controlled business?

 

How can we attract additional financing into a family-controlled business?

As with any business, you need to convince external investors or lenders that the business has good prospects.

If you are seeking a loan, you also need to convince the lender that they will be repaid. Commonly you will offer the lender security such as a mortgage over a property. Where your company does not have sufficient assets to provide adequate security, a lender may ask you for a personal guarantee.

If you are asking outsiders to invest in shares, you need to convince them that they will be treated fairly. Although company law provides some protection for minority shareholders, this alone will not be enough for many investors. You may also need to enter into an appropriate shareholders´ agreement.

The shareholders´ agreement is likely to include restrictions preventing you from ´milking´ the business for your own benefit. For example, the shareholders´ agreement might include limits on family members´ salaries. It is also likely to include a mechanism allowing shareholders to sell their shares to the company or to other shareholders if they feel unfairly treated, and specifying how the shares will be valued.

 

How can we bring in outside investors but still retain control?

 

How can we bring in outside investors but still retain control?

To retain control of your business, you need to control decisions taken at general (shareholder) meetings and decisions taken at board meetings.

If you are only raising a limited amount of external investment, keeping control of general meetings may be straightforward. If you own more than 50% of the shares - and voting rights - you are usually in control. It may also be possible to retain control while owning less than 50% of the shares: for example, by offering external investors non-voting shares.

So long as you control shareholder meetings, and have an existing majority of the board of directors, you should also be able to keep control of the board.

However, you may have to accept limitations on your control in order to attract outside investors in the first place. Typically, you would negotiate a shareholders´ agreement that protects their interests (see question 16). Even so, it should not be necessary to accept conditions that restrict your ability to take legitimate commercial decisions.

Commonly, any shareholders´ agreement will also include restrictions on external investors. In particular, other (e.g. family) shareholders may have the right of first refusal should an external investor wish to sell their shares.

 

Do we have to take account of minority shareholders´ interests and wishes?

 

Do we have to take account of minority shareholders´ interests and wishes?

You are required to take account of them to the extent laid down by company law and by any shareholders´ agreement.

As far as general company law is concerned, the two key requirements are that the directors should act in the best interests of the company, and that shareholders should be treated equitably. Using the company for the private benefit of the family is therefore prohibited, though in practice it can be very difficult for a minority shareholder to do anything about it.

A shareholders´ agreement may grant minority shareholders additional rights. For example, a minority shareholder might be entitled to nominate one or more directors to the board. This would at least ensure that the minority shareholder could express their views at board meetings.

 

How do I protect my family against the possibility of the business collapsing?

How do I protect my family against the possibility of the business collapsing?

Establish your business as a limited company so that business assets and liabilities are separate from your personal assets. Try to avoid, or limit the extent of, any personal guarantees you are asked to give for business borrowings.

Avoid concentrating all your and your family’s wealth in the business. The consequences of a business collapse can be particularly severe if several family members work for the business, or if all your savings (and your pension fund) are invested in the business.

Ensure that your spouse has some clearly defined personal assets, including a separate bank account from you.

If you need to ask family members to invest in your business, only ask for amounts they can afford to lose. Where possible, ask for secured loans or investment in preference shares, so that family members will rank higher in your list of creditors if the business collapses.

Be aware that for these steps to be effective, you need to take action in advance. Once your business is in trouble, paying off family creditors or granting them extra security is likely to be ineffective: steps like this can be overturned by the court. Similarly, you cannot simply withdraw capital, or sell assets to family members at discounted values: in the worst case, you might be charged with fraud and the directors made personally liable for the business debts.

You should also note that protecting your family’s interests might limit your options for financing the business. For example, external lenders are likely to be reluctant to lend to a company with limited equity and where all available security has already been pledged against family loans. If your business is struggling, but you feel future prospects are good, your only alternative to insolvency may be to ask family members for unsecured investment.

 

How can I make sure I will keep control of the business if I get divorced?

 

How can I make sure I will keep control of the business if I get divorced?

In general, your spouse is likely to have a claim to a share in any assets. This applies even if you have worked to build up your business while your spouse has been a ´homemaker´: the courts may well decide that you each contributed equally (though in different ways).

Once divorce proceedings are underway, you are unlikely to be able to remove your spouse’s claim to a share of the business. You may be able to negotiate an agreement where you retain, say, the business, but your spouse gets a correspondingly large share of other assets (such as the house or your pension fund).

If the business constitutes the majority of your assets, this approach becomes more difficult. You may be able to retain the business by borrowing to pay your spouse. Ultimately, you might be forced to split the business or to sell it to a third party. This may itself cause extra problems if you create a tax liability.

There are steps that may help to protect your business against the possibility of a divorce in future. Suitable terms in the shareholders´ agreement may help, as might appropriate terms in a pre-nuptial agreement. However, in the event of a divorce, a pre-nuptial agreement might be overridden to reach a fair financial settlement. A more effective option may be to hold shares in trust, for the benefit of the family, rather than directly; you may be able to include this as part of a tax-planning exercise. This is a complex area where you will need to take advice.

 

If there is a divorce in the family, can we get shares back from an ex-spouse who is no longer a family member?

If there is a divorce in the family, can we get shares back from an ex-spouse who is no longer a family member?

You can include terms in the shareholders´ agreement requiring anyone who ceases to be a family member to offer their shares back to the company, at a pre-determined price. However, this could have consequences for the way a divorce court orders assets to be divided: if the requirement to sell the shares back reduces their value, the spouse may be entitled to a correspondingly large share of other assets.

An alternative may be to grant family members and their spouses shares that carry the same right to dividends but are non-voting. A former spouse who retains non-voting shares after a divorce is likely to welcome a fair offer for them, and in any case will at least be unable to interfere in the running of the business.

Or you might choose to put shares in an appropriate trust - for the benefit of your family - rather than transferring them directly to family members.