Share classes represent different types of shares issued by the company, each with unique rights and responsibilities. These may include voting rights, entitlement to dividends, or rights to the company’s assets upon liquidation.
Introduction
Family investment companies (FICs) are increasingly popular for managing and preserving family wealth across generations. These private limited companies are designed to hold and grow investments, providing an alternative to traditional family trusts. By combining the benefits of company structures with tailored share arrangements, FICs offer a strategic tool for tax efficiency, wealth protection, and succession planning.
A critical element of any FIC is its share structure, which determines how control, income, and ownership are distributed among family members. Share classes play a pivotal role in balancing family dynamics, enabling tax-efficient strategies, and aligning with long-term objectives. Whether the goal is to allocate voting power, control dividend distribution, or ensure seamless wealth transfer, understanding share classes is key to optimising the potential of an FIC.
This article explores the concept of share classes within family investment companies, detailing their purpose, benefits, and impact on the overall structure. By gaining a clear understanding of this essential component, families can make informed decisions and tailor their FIC to meet their unique needs.
What Are Share Classes?
Share classes refer to different categories of shares within a company, each with specific rights and responsibilities. In the context of a family investment company (FIC), these share classes allow families to allocate ownership, voting power, and income distribution in a way that reflects their unique needs and goals. By dividing shares into distinct classes, families can tailor the company’s structure to achieve financial efficiency and maintain harmony among members.
Each share class grants specific rights to its holders. These typically fall into three main categories:
Voting Rights - Some shares allow holders to vote on company decisions, such as appointing directors or approving major changes. Voting rights are often a key consideration in maintaining control over the company.
Dividend Rights - Different share classes may determine how profits are distributed. For instance, one class might receive a fixed dividend, while another may depend on residual profits.
Capital Rights - These govern how proceeds are distributed if the company is sold or liquidated.
Key Differences Between Share Classes
The main difference between share classes lies in how they allocate these rights and responsibilities. For example:
Ordinary Shares - These typically provide full voting rights, dividend entitlements, and claims to capital on liquidation.
Preference Shares - These often prioritise fixed dividends over other classes but may lack voting rights.
Non-Voting Shares - These grant access to dividends or capital but exclude the holder from decision-making.
Redeemable Shares - These can be bought back by the company under certain conditions, providing flexibility in managing ownership.
Benefits of Share Classes in an FIC
The ability to customise share classes offers several advantages. Families can distribute shares in a way that ensures fairness among members, even when their roles and contributions differ. For instance, non-voting shares might be assigned to passive members, while voting shares remain with active participants. This structure helps avoid conflicts while maintaining effective control.
Moreover, the flexibility of share classes supports tax-efficient planning. Families can allocate dividends to those in lower tax brackets or structure shares to minimise inheritance tax exposure. These advantages make share classes a cornerstone of a well-designed family investment company.
By understanding the purpose and function of share classes, families can establish a solid foundation for managing their FIC effectively, ensuring both harmony and financial success.
Common Share Classes in Family Investment Companies
Family investment companies (FICs) often use a range of share classes to address the varied needs of family members. Each class serves a specific purpose, allowing families to balance control, income distribution, and tax efficiency. Below are some of the most commonly used share classes in FICs and their unique characteristics.
1. Ordinary Shares
Ordinary shares are the most straightforward class, typically granting holders full rights to voting, dividends, and capital distributions. In an FIC, these shares are often allocated to family members who are actively involved in managing the company.
Voting Rights: Ordinary shares usually carry full voting rights, giving holders a say in key decisions such as appointing directors or approving financial changes.
Dividend Entitlements: Holders may receive dividends, although the amount is often discretionary, depending on the company's performance.
Capital Distribution: If the company is wound up, ordinary shareholders share in the remaining assets after debts are paid.
2. Preference Shares
Preference shares are designed to prioritise specific benefits, such as fixed dividends, over other classes. However, they typically lack voting rights, making them ideal for passive family members who seek income but do not wish to be involved in decision-making.
Fixed Dividends: Holders are entitled to a set dividend amount, often paid before dividends are distributed to ordinary shareholders.
Reduced Voting Power: These shares usually come with limited or no voting rights, ensuring that control remains with other family members.
3. Non-Voting Shares
Non-voting shares offer an effective way to provide income rights to family members without granting decision-making power. These shares are commonly used to include younger or passive family members in the company structure.
Dividend Rights: Non-voting shareholders may still receive dividends, offering financial benefits while limiting their influence over the company.
Control Retention: By excluding voting rights, these shares help keep control centralised among active participants.
4. Redeemable Shares
Redeemable shares allow the company to buy back shares from holders under specific conditions, providing flexibility in managing ownership over time. These shares can be particularly useful in succession planning or when family dynamics change.
Flexibility: Redeemable shares enable the company to adjust its share structure as needed, such as buying back shares from retiring family members.
Exit Options: They provide an avenue for shareholders to exit the company while ensuring the family retains control of its assets.
Why Use Different Share Classes in a Family Investment Company?
The ability to create tailored share classes is one of the key advantages of a family investment company (FIC). By assigning different rights to specific share classes, families can optimise tax efficiency, manage income distribution, control decision-making, and implement effective succession planning. Below, we explore the main reasons why families choose to use different share classes in their FIC structure.
1. Facilitating Tax Efficiency
Tax efficiency is often a primary motivator for establishing an FIC, and the careful use of share classes plays a crucial role in minimising tax liabilities.
Dividend Allocation: Different share classes allow dividends to be directed to family members in lower income tax brackets, reducing the overall tax burden. For example, non-working or younger family members might receive shares with dividend rights, while high-earning members hold shares without such entitlements.
Inheritance Tax (IHT) Mitigation: Share classes can be structured to gradually transfer wealth to younger generations, reducing the taxable estate of senior family members. Non-voting or redeemable shares are often used for this purpose, allowing senior members to retain control while transferring financial benefits.
Capital Gains Tax (CGT) Efficiency: By issuing shares with varying rights, families can manage CGT liabilities when transferring ownership or selling shares.
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The flexibility offered by share classes ensures that families can design a structure that aligns with individual circumstances while staying within legal tax guidelines.
2. Controlling Dividend Distribution
FICs often generate income through investments, and managing how profits are distributed is critical. Share classes allow families to tailor dividend rights to suit their needs and objectives.
Customised Payments: Fixed-dividend preference shares can be issued to family members who seek a steady income, while discretionary dividends on ordinary shares provide flexibility to retain profits for reinvestment.
Preventing Over-Distribution: By limiting dividend rights to certain share classes, families can control cash flow and ensure the company’s capital base is preserved for future growth.
Tax-Effective Payments: Share classes can be structured to ensure that dividends are distributed in a way that minimises income tax exposure for the family as a whole.
This level of control ensures that the company’s income is distributed in a manner that supports the financial needs of family members while protecting the company’s long-term interests.
3. Managing Voting Rights Among Family Members
One of the biggest challenges in a family business is balancing decision-making power among active and passive participants. Share classes can be designed to allocate voting rights strategically, ensuring effective governance and avoiding disputes.
Active vs Passive Members: Voting shares are often issued to family members actively involved in managing the FIC, while non-voting shares are given to those who benefit financially but have no role in decision-making.
Centralising Control: Senior family members can retain control by holding shares with enhanced voting rights, ensuring they oversee major decisions even as ownership is passed down.
Avoiding Conflict: By clearly delineating voting and non-voting shares, families can avoid misunderstandings and power struggles, particularly among younger generations.
This structure ensures that the FIC operates efficiently while respecting the contributions and roles of each family member.
4. Succession Planning
Succession planning is a critical consideration for families using an FIC. Share classes provide a flexible framework for transitioning ownership and control across generations.
Gradual Wealth Transfer: Shares can be gifted or sold to younger family members incrementally, allowing them to take on greater financial responsibility over time without disrupting the company’s governance.
Maintaining Control: Senior members can retain voting shares to oversee decision-making while transferring non-voting or redeemable shares to the next generation.
Exit Planning: Redeemable shares provide flexibility by allowing the company to buy back shares from retiring or departing members, ensuring a smooth transition of ownership.
By using share classes strategically, families can ensure a seamless transfer of wealth and leadership, safeguarding the FIC’s future success.
How Share Classes Affect Control and Decision-Making
In a Family Investment Company (FIC), share classes play a critical role in shaping control and decision-making. By assigning different voting rights to specific share classes, families can manage how power is distributed among members, ensuring that the company's governance aligns with their goals and dynamics.
Allocating Voting Power
Voting rights determine who has influence over key decisions in the company, such as appointing directors or approving strategic changes. Share classes allow voting power to be customised based on family roles and involvement.
Ordinary Shares: Typically granted to family members actively managing the company, ordinary shares come with full voting rights, allowing holders to influence strategic and operational decisions.
Non-Voting Shares: Designed for passive members, these shares allow holders to benefit from dividends or capital growth without participating in governance.
Weighted Voting Rights: Some families issue shares with enhanced or restricted voting rights, enabling senior members to retain control while gradually transferring ownership to the next generation.
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Strategically allocating voting power helps maintain effective governance and ensures that decision-making authority remains with those best equipped to manage the FIC.
Balancing Control Between Active and Passive Family Members
One of the most significant challenges in an FIC is balancing the interests of active and passive family members. Share classes provide a practical solution by separating ownership from control.
Active Members: Voting shares are often reserved for family members actively involved in managing the company, giving them the authority to make decisions. This ensures the FIC is guided by those with a deep understanding of its operations and objectives.
Passive Members: Non-voting or limited-voting shares can be issued to family members who are not involved in the company’s management but still benefit from its financial success.
This approach reduces the risk of conflict, as it clearly delineates roles and responsibilities. By centralising control with active participants, the company can operate efficiently without unnecessary interference, while passive members still enjoy financial returns.
Tax Implications of Different Share Classes
The choice of share classes in a Family Investment Company (FIC) has significant tax implications, influencing how dividends are taxed, how inheritance tax (IHT) liabilities are managed, and the treatment of capital gains. A carefully structured share class arrangement can help families optimise their tax position while meeting financial and succession planning goals.
Dividend Taxation Considerations
Different share classes allow families to distribute dividends selectively, which can be a powerful tool for tax efficiency.
Tax Rate Optimisation: Dividends can be paid to family members in lower income tax brackets, reducing the overall tax burden on the company’s income. For instance, children or non-earning family members may hold shares with dividend rights, while higher-earning members hold shares without dividend entitlements.
Flexible Distribution: Share classes such as preference shares with fixed dividends or ordinary shares with discretionary dividends enable families to control how profits are allocated, aligning distributions with individual tax circumstances.
By tailoring dividend payments, families can minimise personal income tax liabilities while ensuring fair distribution of the company’s profits.
Potential Inheritance Tax Benefits
Share classes also play a key role in managing inheritance tax (IHT) exposure, particularly when passing wealth to future generations.
Gradual Wealth Transfer: Shares with limited voting rights, such as non-voting or preference shares, can be transferred to younger generations during the lifetime of senior family members. This reduces the taxable estate of older generations while allowing them to retain control through voting shares.
Business Property Relief (BPR): Although FICs do not always qualify for BPR in the same way as trading businesses, the use of specific share classes can still support effective estate planning by structuring ownership and control separately. A FIC with 50%+ of its capital value coming trading businesses will qualify for BPR but as trading companies are sold the shares can be rebased with some small CGT being paid then freezing their value.
Strategically gifting to multiple types of trusts or selling shares over time reduces the risk of large IHT liabilities upon the death of key family members.
Capital Gains Tax (CGT) Implications
The use of share classes can also impact how capital gains are taxed when shares are sold or transferred.
Tailored Transfers: Non-voting or redeemable shares can be transferred to family members at a lower value, potentially reducing CGT liabilities.
Freezing Value: By issuing growth shares to younger generations and retaining fixed-value preference shares for senior members, families can “freeze” the value of the estate, shifting future growth to the next generation without immediate CGT consequences.
Setting Up and Structuring Share Classes in a Family Investment Company
Creating an effective share structure for a family investment company (FIC) requires careful planning and collaboration with legal and financial advisors. A well-structured share arrangement ensures the company meets its objectives, including tax efficiency, control, and succession planning. Below are the key steps to establish and tailor share classes in an FIC, along with the critical considerations to address.
Steps to Creating a Tailored Share Structure
Define the Family’s Objectives
Begin by identifying the family’s short-term and long-term goals. Are you prioritising tax efficiency, preserving control, or facilitating wealth transfer across generations? These objectives will guide the choice and design of share classes.
Choose the Appropriate Share Classes
Select share classes that align with the family’s needs. Common options include:
Ordinary Shares - For active family members involved in managing the company.
Preference Shares - For those seeking a fixed income with limited control.
Non-Voting Shares - For passive members who benefit financially without participating in governance.
Redeemable Shares - For flexibility in adjusting ownership, such as buying back shares from departing members.
Determine Rights and Responsibilities
Assign specific rights to each share class, including voting power, dividend entitlements, and rights to capital on liquidation. Clearly define these in the company’s articles of association to avoid disputes.
Incorporate Succession Planning
Structure share classes to facilitate the gradual transfer of ownership. For example, issue non-voting shares to a trust to hold for younger generations while retaining voting shares for senior members to maintain control.
Draft the Articles of Association
Work with legal advisors to formalise the share structure in the company’s governing documents. This step ensures the rights, responsibilities, and conditions attached to each share class are legally enforceable.
Key Considerations with Legal and Financial Advisors
Tax Implications
Consult a tax advisor to evaluate how the share structure impacts dividend taxation, inheritance tax (IHT), and capital gains tax (CGT). The right structure can significantly reduce tax liabilities while ensuring compliance with tax laws.
Family Dynamics
Ensure the share structure reflects the family’s dynamics. For example, balancing control between active and passive members or addressing potential conflicts through clear voting and dividend rights.
Flexibility for Future Changes
Include provisions for adapting the share structure over time. This may involve creating redeemable shares or allowing for new share classes to address changing family needs.
Legal Compliance
Ensure the share structure adheres to company law and is documented correctly in the articles of association. Failure to comply can result in disputes or penalties.
Professional Advice
Collaborate with both legal and financial professionals to navigate the complexities of share structuring. Their expertise is crucial to avoiding costly mistakes and ensuring the FIC operates effectively.
Pros and Cons of Using Multiple Share Classes
Family Investment Companies (FICs) often utilise multiple share classes to provide flexibility and customisation in managing family wealth. While this approach offers numerous advantages, it also presents certain challenges. Here’s a closer look at the pros and cons of incorporating multiple share classes in an FIC.
Benefits of Flexibility and Control
Tailored Dividend Distribution
Different share classes enable precise control over how profits are distributed. For example, parents can hold preference shares that provide fixed dividends, while children hold ordinary shares that grow in value.
Enhanced Succession Planning
Share classes allow for the smooth transfer of wealth between generations. Non-voting shares, for instance, can be allocated to younger family members, ensuring they benefit financially without influencing company decisions prematurely. Shares can also be issued to trusts to hold until they are 18 or 25 years old or held for multiple generations as part of an estate plan.
Control Over Decision-Making
By using voting and non-voting share classes, founders or key family members can retain decision-making authority while still involving others in the financial rewards of the company.
Tax Efficiency
With strategic planning, multiple share classes can help minimise tax liabilities. For instance, certain share classes can be structured to favour lower-income family members, reducing the overall family tax burden. A combination of trusts holding different share classes can mitigate the vast majority of IHT & CGT.
Potential Risks and Complications
Complexity in Management
Introducing multiple share classes can complicate company administration. Tracking the rights, responsibilities, and tax implications of various shares requires careful documentation and ongoing management.
Potential for Family Disputes
Differentiating shares can lead to misunderstandings or disagreements among family members, especially if roles and benefits are not clearly defined. This is particularly true when one group feels they are unfairly excluded from control or financial gains.
Increased Scrutiny from HMRC
Complex share structures can attract attention from HM Revenue & Customs (HMRC), especially if they appear designed primarily for tax avoidance. Ensuring compliance with tax laws is critical to avoid disputes or penalties.
Legal and Administrative Costs
Setting up and maintaining multiple share classes typically requires input from legal and financial advisors, which can increase operational costs. Regular reviews are essential to ensure the structure remains compliant and aligned with family goals.
