Transferring ownership of company shares can be a complex business, but it’s something that most business owners, and their advisors, will need to think about at some point during the life of the company. But do you fully understand the impact of transferring these shares? And what are the important pitfalls to be aware of?
Helen Robinson, Partner at HW Business Law, explains the need to balance the need for tax-efficient share ownership against the founder’s need for control of the business.
When does it become necessary to transfer company shares?
When you found a new business and form a limited company, the initial founders will all be issued with an agreed number of shares. But, over time, it’s likely that your accountants and tax advisors will suggest transferring some of your personal shares over to other people – usually your spouse, children or other family members.
Not all shares have the same rights, however, and when transferring shares to third parties there are usually different rights attached to these shares, with the founder retaining power of veto. This helps you, as the founder/s, to remain in control of the business, while also giving family, employees or new directors an interest in the business.
Share options as a means of incentivising your staff
Retention of talent is a major requirement these days, with many companies struggling to find and retain the key people needed for the successful running of their business.
Enterprise management incentive (EMI) option schemes are a great way to attract and retain the best people, by creating new classes of shares and defining the rights of those shares. But there are some important considerations to think about when creating an EMI scheme.
- Ownership and control – some founders will have concerns around how the company shares are divided up. Existing shareholders may have to sell some of their shares if you set up an EMI options scheme, and the worry is whether such a move will dilute the ownership and control aspect for you.
- Tax considerations – transfers of shares to a spouse are exempt from inheritance tax (IHT) . But with transfers to other family members, they could be hit with up to 40% IHT on their gain. One very efficient option is to create a family investment company (FIC) which allows you to pass the benefit of the shares on to children and grandchildren, reduce the tax exposure and still have control as the owner or founder.
- Selling the company – if you’re planning to sell the company in the near future, it’s important that you own all the shares. A buyer won’t want to see that the company shares are owned by family and employees; they’ll want a clean company structure, where they can buy with no hassle. So, you need a mechanism in place where shares can be bought back at the point of sale.
In my experience, very few businesses actually think about these considerations in advance, underlining the importance of sound legal advice and clear planning.
Planning ahead when it comes to share ownership
Most owner-managers are good at concentrating on sales and profit, but not so good at thinking about the company structure, the legal considerations and making tax-efficient choices. Often, the company documentation is out of date and the articles of association no longer do what they were set up to do – and this can cause all kinds of problems further down the line.
Having a shareholders’ agreement in place is essential – and we’ll cover this in our next blog post . In a nutshell, the shareholders’ agreement sets out what happens when it comes to paying dividends, selling shares, or selling the company. Without this agreement, things can get quite sticky. What happens when a founder dies and leaves their money to charity, or a director goes through a messy divorce and there are questions over their spouse’s share rights?
By planning for these eventualities, and getting everything formalised in a shareholders’ agreement, you protect yourself and the company from hassle at a later stage.
Taking a preventative approach to tax planning
Minimising your tax exposure on share transfers is obviously an important consideration. Tax planning will save you money, but it can also be difficult from a legal perspective.
The ideal approach is to aim for preventative measures (the right legal structure and agreements) rather than cure (tax planning after the fact). Life can throw plenty of unexpected challenges in your path, so you’ll be in a much better position if you’ve planned ahead and have taken preventative measures where possible.
Key areas to think about include:
- Keeping your company documentation up to date – keep your articles of association and shareholders’ agreements updated whenever there are changes to share ownership, so you have all the correct information formalised and legally recorded.
- Have death clauses in your agreement – you can have a clause in your shareholders’ agreement that shares must be sold if a majority shareholder dies. In this instance, the company, or other shareholders, can buy these shares and increase their stake.
- Take out insurance where necessary – shareholders can take out an insurance policy against a shareholder dying. This policy usually pays out a cash sum, allowing you to buy back shares from the deceased shareholder.
- Plan for any ‘bad leavers’ – if there’s a falling out and a ‘bad leaver’ sells their shares to a competitor, this can cause all kinds of issues. A situation with a bad leaver should trigger the selling of their shares, so you need to think about preemptive protection against this sort of thing.
- Include a clause around divorce – an aggrieved spouse can be a big problem and you should be working this scenario into your legal structure. The courts can order that shares must be sold, or that the spouse is entitled to more shares, so you need a protective clause from the start to prevent this.
Changes to the transparency of share ownership
There are potential changes on the horizon around corporate transparency and share ownership, which could have a significant impact for founders and their advisors.
Currently, if you transfer shares, you don’t have to tell Companies House. You must keep a register of members in the company, but this documentation isn’t available publicly online. It tells you what shares there are but not the transfers or new ownership.
Under the proposed changes to company law, any transfer of shares would have to be logged at Companies House. This transparent approach is already in action for records held by the Land Registry, and would help give a full picture of who owns company shares. When setting up shareholdings, verified ID records of all shareholders are required and the long-term aim is that the whole process will go paperless and digital, as per the recent Making Tax Digital (MTD) initiative.
It’s worth factoring these changes into your planning and letting your advisors know that you want a clean, organised entity where all the relevant shareholder information is readily available.
Helping you plan for the unexpected
So, how do you ensure that your share transfers are watertight?
The key is to plan for many eventualities and to have the foresight to set up your articles and shareholders’ agreement in the most comprehensive way. It’s important to have these mechanisms in place so you don’t end up running around like a headless chicken when (and if) the worst does happen.
HW Business Law can consult on share transfers and will act on your behalf to protect your share ownership. We’ll help give you achieve the ideal balance between what’s best for your tax planning and what’s best for the long-term success of the company as a whole.