Insights

Many of the clients Robert James Partnership deals with are family firms.  In fact, it is fair to say they form part of the backbone of the UK economy, helping drive the creation of wealth and delivering benefits for society through both employment and support for local communities. Research conducted by the Institute for Family Business in 2008 estimated that they accounted for 65% or 3 million of the total 4.6 million private sector enterprises in the UK economy and roughly 9.5 million jobs.  Unfortunately, as a consequence of the recession, this figure is likely to have changed significantly, in part due to the specific problems they face. These include undefined succession strategy, a disinclination to inject new talent into the business and no established criteria for selecting which family members can have an active role in the business.

The effects of this are evident from research findings released by Barclays which suggested most have no definitive plans for the future, with 61% of owners saying they had made no decision about what would happen when they retired and sadly, 10% planning to close down.  Further research has found that 77% of family firms in the SME sector are controlled by the first generation, only around a third of family firms tend to be passed onto the second generation and one tenth reach the third generation, the rest being either sold or closed down.

In terms of competitiveness, where family firms maintain a policy to recruit for senior positions from amongst family members only, the level of skill coming into the business can be sharply reduced. Such a biased recruitment strategy can also discourage talented people who are not family members from seeking work at a family firm and therefore adversely affect performance.

Introducing a tax efficient incentive scheme, such as the enterprise management incentives scheme (EMI), provides a way for family business owners to retain and attract new talent by offering tax-free share options as an incentive to key employees whilst at the same time, maintaining control of the business.  For qualifying businesses and individuals, EMI is tax efficient because no National Insurance Contributions are payable by the company when either an option is granted or the staff member exercises an option and acquires the underlying shares. In addition, the administrative costs of providing the shares on exercise of the option are deductible trading expenses for corporation tax purposes.

EMI schemes can also be structured to ensure the family retains full control and sole rights to dividend payments and voting whilst at the same time, offering a financially rewarding share of the business to outside employees, which indicates how valuable they are to the firm.

One of the barriers family businesses have perceived with adopting EMI is that without an eventual business sale, something which may not be desirable for the family, employees would not be able to realize the value of their share options.

However there are ways to overcome this which can be achieved by the employer creating an internal market place to facilitate the exercise of options and the purchase of employee shares, typically with the use of an employee share ownership trust. Employees would generally have held their share options for a minimum of 2 years, or perhaps longer if issue criteria demanded, after which time they would exercise some or all of their options, followed by an immediate sale.  Staff would be required to pay tax on any gains up to 28% in line with current rates, with any employees meeting the qualifying criteria for entrepreneurs relief - for instance, being an officer of the company for over 12 months and owning 5% of the total share capital - only having to pay CGT at the 10% rate.

This method of creating an internal marketplace for the exercise of share options is sustainable and the business owner may grant further options to employees at regular intervals.  In recent years I have advised and implemented many share option schemes for family businesses across many industry sectors and this route provides an excellent balance between retaining family ownership and succession, whilst having the ability to cost effectively inject vital new talent to develop the business.  Provided the company has a clear strategy and is growing steadily they have always represented a very powerful and tax efficient motivator, especially in a climate where very high salaries are hard to justify.

Paul Webb is a tax expert and specialist in developing employee share schemes.  To find out more about EMI and the qualification criteria please contact Paul Webb on pw@rjp.co.uk.