Trading up – how your company can become an investment vehicle for the long term
Family Investment Companies (FICs) offer a way for families to co-invest together. An FIC’s constitutional documents can ensure there are good processes around decision making for the family wealth.
Funding Investment Companies
FICs can be funded in a number of ways, including loans or share subscription. Alternatively, an existing family owned trading company could be converted to a FIC.
Why would you do this?
Ordinarily, as company owner-managers look towards retirement they will sell their trading company (trade sale) or sell their assets and release the resulting cash (asset sale). However, an alternative (if slightly rare) approach, is to cease trading and to convert the company to an investment vehicle and roll the money into future investments.
To help explain this, there are two basic diagrams below. The red arrows indicate a taxable event, the green arrows, a tax neutral event. The first diagram shows the usual flow of funds when a company ceases trading and then released funds are later invested through either a trust or an investment vehicle. This note does not consider trusts in detail but it is of course worth noting that if the “Investment Vehicle” in the diagram was replaced with a trust (and beneficiaries instead of shareholders) then the payment into trust could be subject to a 20% inheritance tax charge.
In contrast, by converting the company to an investment vehicle, an owner is able to achieve the same outcome more efficiently, as shown in the second diagram.
How do you retain control?
Trusts rely on Trust Deeds, companies rely on their Articles and Shareholders’ Agreements. Articles are a public document which set out the rights attached to shares and govern how the company operates. Shareholders’ Agreements are private agreements between the shareholders and can go further than the Articles.
It is possible to split the shares into different classes – for example, one class with voting rights but no rights to capital, and one with rights to dividends and capital but no voting rights. Voting shares can be held by the parent so they retain control and the others can be gifted to the next generation. Additionally, there is no reason why the voting shares could not be gifted to a third party, although this can have tax consequences so advice should be taken in that regard.
“I am not ready to gift everything yet”
Unlike other assets, such as property, gifting shares in investment vehicles can be a good way of passing on some value but not everything all at once. It is possible to have other share classes which have capital and dividend rights in addition to any other classes such as those referred to above.
Business Property Relief – does it apply?
BPR does not apply if the company is not trading. The focus of this article has been on investment companies, but it is possible to apply the principle of separating control through different share classes to trading companies and thereby ensure the relief will be available; the exact rights and drafting must be carefully considered.
This is a complex, but important, area to consider, both whilst a company is still trading and as owner-managers begin to think about stepping back from their businesses. Once established an investment company allows for many of the upsides of traditional trust structures without the expense or perceived opacity of trusts.