What are the pros and cons of shares in a privately owned family company being held by trustees on behalf of family members, rather than being owned and controlled directly by family members?

Reasons for creating trusts

The main reasons for giving shares to trustees are:

  • to save tax
  • asset protection
  • divorce protection
  • flexibility
  • stewardship.

Tax

In the UK shares in many private companies qualify for 100% relief from inheritance tax and so there is no pressure to transfer shares to trustees to shelter the value of the shares from inheritance tax. To qualify for this business property relief, the main rules are that the shares have been owned for 2 years and the company is not mainly an investment business.

There are other tax considerations but the decision to transfer shares to trustees rather than to individual family members will be influenced as much by the other subjects covered in this article as by tax. The best advice to a family is to take tax advice and combine it with their own views on the following matters.

Asset protection

Trusts are commonly said to offer asset protection. Although this can mean many things it usually means protection from creditors of individual family members. The underlying view would seem to be that the next generation are more likely to be irresponsible owners than their ancestors and trustees can look after the shares until the next generation have become responsible adults. This type of responsibility is usually defined in the trust as being when the next generation reach a certain age.

There are probably equal numbers of cases of young adults being responsible owners and irresponsible owners. It is conventional to rely on age as a marker, but it is not a guarantee; how will an irresponsible 24 year old, suddenly assume a more responsible attitude when they receive shares from the trust at age 25?

If the goal is for the next generation to be responsible owners who understand the rights and responsibilities of ownership, a strategy that might be more likely to produce the desired outcome would be to educate the next generation about the vision and values of the business, how it operates and in particular what owners do and what they get for being owners. If education is the means by which we equip children to cope with all of life’s challenges, it can surely be used strategically to develop a responsible and committed attitude to ownership and wealth.

Divorce protection

Lawyers are unceasing in their efforts to challenge the impression that assets in trust are immune from the re-distributive divorce regime. The approaches vary from trying to challenge trusts as a sham, to seeking an order against a spouse on the basis that the trust is a resource of the spouse that should be used in calculating an award and it is then up to the spouse to work out how to meet their overall liabilities. Nonetheless there is still some protection to be gained in the event of divorce from shares that are held in a genuine trust.

Parents who use a trust for this purpose, however, cannot avoid the judgment this implies about the next generation’s ability to enter stable relationships. Although an increasing number of relationships no longer last a lifetime, some families might want to take a more optimistic view of their children’s choice of partners, and see no need to create a trust to protect shares in the event of relationships failing.

Flexibility

A trust is a very flexible instrument. Depending on the specific terms of each trust deed, funds may be appointed out to other trusts, a trust can be broken or exported to other jurisdictions, the class of beneficiaries can be restricted or added to, trustees can be changed and there can be different types of interest in trust property. So although the trust makes the beneficiaries one step removed from controlling their own wealth a well-drafted trust can still leave a fair amount of flexibility.

This still begs the question, “why not leave individual owners to make these decisions for themselves?”

Stewardship

Placing shares into a trust with carefully selected trustees may be viewed as providing another layer of stewardship to protect the family business for future generations. The trustees, if they take an active interest in their role and the company, can provide an independent counter-balance to board decision making, without the trustees hampering effective commercial conduct of the business.

Do trustees have to be active stewards?

Where the trust property includes a controlling interest in a company it is the duty of the trustees under the general law to keep a close eye on the company’s affairs. Trustees with this level of holding should not sit back and rely only on the statutory accounts and annual general meeting as the sole means of discharging their duties.

However, if trustees have only a minority interest, this duty to take an active interest is reduced. The trustees can still exert significant power when they control over 25% of the ordinary shares because they can effectively block certain resolutions of shareholders that require a majority of over 75%. This raises a question of whether or not a family is comfortable with trustees having power to vote on these matters, especially where the trustees include non-family, like professional advisers.

Aside for the size of the shareholding, professional advisers who act as trustees are in fact often expected to be passive investors and this is often reflected in trust deeds. The adviser’s role is seen largely as providing technical advice and services in relation to trust administration, such as preparing the annual tax return. The level of involvement expected of professional trustees is usually deliberately diminished in the trust deed so that they do not need to enquire into the conduct of the company and may treat the shares like any other investment.

Another possible disadvantage inherent in the idea of trustee stewardship might be that family members who are beneficiaries of a trust feel cut-off from direct ownership involvement in “their” business. This feeling might be exacerbated if the beneficiaries have no influence over appointment and removal of the trustees.

There in fact could be a mismatch between the level of commitment that the family would like future owners to make to the company and the passive interest that may be expected of professional trustees who own shares. This might be balanced by the active involvement of some family members as trustees but it is important for all trustees to understand their fiduciary duty always to act in the best interests of the beneficiaries.

Trust law is focussed on the financial dealings of trustees and their fiduciary duty to protect the value of the trust’s assets for the beneficiaries. If the trustees somehow destroy the value of the assets they hold in trust, the beneficiaries may seek to recover their loss from the trustees. This explains why trustees tend to be financially cautious and want to maximise return and increase the investment value of the shares, as opposed, for example, to diversifying the business into new ventures or spending the company’s money on non-core activities.

Trustees, whether they are family members or professional advisers must be keenly aware of their fiduciary duties. The point can be highlighted by an example of a tough decision that might arise. Say a generous offer to buy the company was received but the individual family shareholders decided to refuse the opportunity for any number of reasons, not all of which are entirely financial. Would the trustees do the same? Not necessarily. They would not be influenced by sentiments like continuing a legacy of ownership and commitment to employees or a local community. Their judgement would be based on what is in the best financial interests of the beneficiaries. The trustees’ perspective might be that their fiduciary duties leave them no option but to accept the offer, whatever the wider family want.

The purpose of this article has been to highlight that the decision to introduce trustees as owners of a family enterprise needs careful consideration, and not just from a technical perspective. The decision reflects many of a family’s values, for example in relation to risk, their trust of each other and the amount of importance attributed to family members having direct control over their own affairs in contrast to their affairs being administered by trustees.

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