A significant number of family businesses do not have a succession plan in place. Failure to address this is likely to be to the detriment of the business in the long-run. The family need to decide what the future of the business looks like, and crucially which family members, if any, wish to be involved.
The future success of family businesses is likely to require them to professionalise the business, and in doing so, look to external talent to provide the expertise necessary to ensure longevity. But the greatest roadblock often for family businesses is incentivising this external talent to join and remain loyal to the family business.
Incentivising employees can be achieved where a distinction is drawn between the wants and needs of the family and those of the business. Only then can employees feel they have the bandwidth to operate successfully without, for example, being subservient to family relationships. A tool to facilitate this in the context of incorporated businesses is to implement an employee-ownership mechanism; to reward employees by providing direct participation in the equity of the company or by creating future share options. Structures available (for incorporated businesses) include transfer of direct ownership, the imposition of an Employee Benefit Trust (EBT) or the granting of Enterprise Management Incentive (EMI) share options to employees. Let’s explore the use of EBTs and EMI share options.
How does an EBT operate?
Typically, an EBT is a discretionary trust for the potential benefit of employees of the business, established by a loan or a gift from the company (the settlor) to the trust to then acquire shares in the company. Whenever the settlor-company wants the EBT trustee to consider exercising its discretion (i.e. transferring shares to a particular employee beneficiary) it will usually send a recommendation letter to the trustee setting out how it would like the trustee to act.
The nuts and bolts of establishing an EBT
The board of the company will need to approve the terms of the trust in a board minute and clearly set out their reasons for establishing it. The terms of EBT will typically provide that the shares are held for the benefit of present (as well as past) employees of the business and their families and other dependents. It is common for the EBT trustees to be professional trust companies, often outside the UK (typically in the Channel Islands). This avoids conflicts of interest between the trustee and the company and can also offer UK tax advantages. The documents that need to be put in place between the company and the EBT will depend on how it is funded, i.e. loan agreement or contribution agreement, and thereafter, potentially a share acquisition agreement and shareholder agreement. Specific tax advice should also be obtained both on creations and throughout the duration of the EBT.
EMI share options
EMI share options are a tax-incentivised employee share scheme, specifically designed to help small and medium-size businesses recruit and retain employees, an aim which chimes with the desires of family businesses. EMI share options can be used—provided certain conditions are satisfied (including the company having 250 or fewer employees and gross assets of less than £30 million/$39 million)—to grant share options over shares family companies to employees, either directly or by way of future allotment of shares in the business. There are limits on the amount of EMI options employees can hold and a company cannot grant EMI options over more than £3 million ($3.9 million) worth of shares at any one time. The plan itself must be registered with HM Revenue and Customs.
Family businesses can maintain control by dictating the terms of any share options agreements with employees and their ability to exercise the options, for example, not allowing exercise of the options until such time as the business is sold. A commonly used format also provides for the share option to fall away on the employee leaving the business, so employees are encouraged to be loyal to the business. Share options could be offered in lieu of cash bonuses, if appropriate, and are something to be considered as part of an employee's remuneration package as a whole.
Employee ownership: An effective succession planning tool
As seen with the well-publicised success of the John Lewis Partnership Trust and, more recently, the example set by Julian Richer (pictured) of Richer Sounds, businesses who motivate and reward their employees usually inspire their loyalty and commitment. Richer, who does not have any children, wants to leave his family business on death in the hands of employees who “operate in a responsible manner” and offering incentives through an EBT based on “commitment, trust and respect” is his way of securing the long-term future of the business.
Employee-owned structures are designed to encourage and reward employees, not only to help secure the long-term future of the business, but can ensure higher performance and commitment levels from employees in the short-term and are certainly worth serious consideration.