Family businesses in the UK come in all sizes, from all sectors, and are based all over the country. Some have been operating for hundreds of years and are deeply embedded in their communities. Others are first generation businesses with much of their story ahead of them. All face the same challenge when the current stewards near retirement age. Can the family business continue beyond the tenure of the current owners? In light of the upcoming changes to inheritance tax (IHT) reliefs announced in the October 2024 budget, there has never been a better time to consider the future: for the sustainability of the business; and the family’s aspirations for preservation and growth of their capital.

Many families and their businesses have benefitted from IHT relief when shares in the family business pass to the next generation on the death of a family member. Where a trading business is carried on (note the exception for investment businesses such as property rental or investing), unquoted shares in trading companies benefit from Business Relief (sometimes known as Business Property Relief, or BPR). The relief is currently available on up to 100% of the value of the shares on the death of the family owner or another ‘chargeable transfer,’ such as a gift of shares into trust. The relief is also available at reduced rates on assets used in trading businesses, and on controlling holdings of quoted shares. The reduction in IHT payable on the deceased shareholder’s estate due to the availability of Business Relief has ensured that business continuity and independence is secured as there is no risk of the business being sold in order to pay an IHT liability.

From April 2026, IHT rules are set to become less favourable. The 100% rate of Business Relief will be capped at £1Million, with the value of the shares above this being eligible for only 50% relief. For deceased business owners with shares valued in excess of £1Million, their estate will have to come up with cash to settle the IHT bill. Where the estate does not have sufficient liquid assets, this could potentially result in the forced sale of the family business. Thinking to the future and planning proactively can provide business owners with peace of mind, knowing that their business legacy can continue, and their families can be provided for in a way that works for both the family and the business.

Planning for succession during the current owners’ lifetime gives the business the best chance of thriving into the future and continuing the family business legacy while allowing the family to receive a fair return on their investment in the business. Considering management succession in parallel with future ownership ensures a focus on the economic needs of the business. Business leaders, whether family or non-family, are chosen to be dynamic and with the ability make strategic decisions to secure the future of the business rather than owners holding on to shares in the family business in order to minimise tax, as may have happened in the past.

Planning for family business continuity

Family business owners will often have spent their entire careers nurturing and growing a business that reflects the family’s values and reputation – it’s their name above the door. They will rightly want to protect and extend that culture and legacy. The business may have been supported by the hard work and commitment of both family and non-family employees and family owners will be motivated to protect the workers and communities that have contributed to business sustainability and success over many years.

Where there are relatives willing and able to take on all or some of the responsibilities of the exiting family owners, the most obvious succession solution is to keep the business in the family. But there is an alternative solution that should also be on every family business’ succession agenda – different from a trade sale or management buy out: transferring the business to the extended business family with a move to employee ownership.

An employee ownership transition allows the business legacy to be preserved and extended by the people who know the business best – its employees. And it fulfils what in our experience are the key succession objectives of many family business owners:

• the culture and values that underpin how the business is run will be retained;
• a fair return on the family owners’ investment in the business, providing the family with financial security;
• continuity and independence of the business is secured for the long term;
• job security for employees;
• family members can have the opportunity to work in the business in the future;
• if the family wishes, they can have continued family ownership in the future; and
• business owners and their families can choose to invest collectively in other assets such as other business activities, or if family members have other aspirations, to consider non-business investment opportunities to preserve and grow their capital.

Introducing non-family owners is a big step for any family business but unlike other non-family succession options, employee ownership allows the unique culture, vision and values of the family business to be preserved. The new non-family owners have worked in the business – often for many years – where the culture is entrenched. The business’ commitment to its employees and the local community is preserved and contractor and supplier relationships are protected. Business continuity is secured for the long term while allowing the family to extract its capital and plan for a future that’s financially secure independent of the business.

What is employee ownership?

Employee ownership is where all employees have a significant and meaningful stake in a business. This means that some or all of the ownership is transferred to employees. The employee ownership model is established around a number of clear principles and choice of structures that have the flexibility to suit the circumstances of most businesses.

100% employee owned

In a move to full employee ownership the family sells all of its shares and extracts a fair financial return on its investment in the business, usually over a number of years – or generations. The business legacy can continue safe in the hands of those who know it best (its employees), and the family can get creative (or maybe they’d rather keep it simple) when thinking about what they want to do with the wealth they extract from the business.

The transition to 100% employee ownership can be structured in a number of ways. Shares can be transferred to non-family employees individually (direct employee ownership) or into a trust which will hold the shares for the benefit of all the employees (indirect employee ownership). It is also possible to use a blend of the two.

In the direct ownership model, employees become individual shareholders in their companies. Shares are usually acquired using a share scheme. There are a number of tax advantaged shares schemes in the UK. As direct shareholders, employees can influence the direction of the company and can benefit financially as the company grows. Most companies oblige shareholders to sell their shares when they are no longer employees of the business.

Indirect ownership is when some or all of the shares are held collectively for the benefit of all the company’s employees, usually using an employee ownership trust (EOT). The EOT model gives employees many of the benefits of ownership without them being obliged to buy shares directly from their own cash. If structured properly, an EOT is a tax efficient vehicle.  For example, if an EOT purchases at least a majority of the shares in a company, the payments to the exiting owners can be made free from Capital Gains Tax and employees can benefit from an annual income tax free bonus of up to £3,600.

The EOT is intended to be the long-term custodian of ownership in the structure. Where a family business sells to an EOT, continued family representation can be built into the structure. For example, the family may be able to appoint one or more of the trustees of the EOT for a period of time, or, in some cases, in perpetuity.

Hybrid approach with retained family ownership

In this model, at least a majority of the shares in the family business will usually be held in an EOT to provide stability for the company and a proportion of the shares retained by the family. This allows the family to continue to participate in decision making, remain custodians of the business and get cash out of the business for their retirement. Employees are given the opportunity to participate in and benefit from the success of the business via collective ownership of the shares held by the EOT, but the family has a say over the things that really matter to it.

Using the hybrid approach, some shares may also be made available to key non-family employees to reward them for their commitment to the business. Individual shareholders may have voting rights within the governance of the business and can have additional financial benefits such as income from dividends and capital gains if they sell their shares at a profit. It is also possible to set up a tax efficient share option scheme for key employee which can incentivise them to lead and grow the business into the future. The employee ownership model is flexible and can be structured to meet the needs and aspirations of businesses and their family owners.

Preserving and growing capital with family investment vehicles

The capital extracted from transferring the shares in the family business to the extended business family via an employee ownership transition can of course be used by the sellers individually, but for families wishing to continue to own assets collectively, there are tax efficient structures that can be implemented to enable this next phase of the family’s collective investment strategy.

Family Investment Company (FIC)

A Family Investment Company or FIC is a private company used for managing and preserving family wealth, offering a tax-efficient way to hold and pass on assets. Usually, the business owner will incorporate the company and introduce their family as shareholders. The FIC can hold a variety of assets on the family’s behalf giving flexibility for making investments, allowing capital to grow, and income to generate for whoever needs it at any given time – all dependent on the needs and aspirations of the family. For example, the FIC could provide capital when a child wants to purchase their first home; lend start-up capital for family members looking to embark on a new business venture; hold a property portfolio; or simply invest the family’s capital in a range of investments managed by a third party on the family’s behalf.

Creating different classes of shares allows separation of control and economic benefits in the FIC. Parents often retain voting shares and therefore the ability to make investment decisions, while adult children hold non-voting shares for dividends (income) and capital growth. It is typically preferable from a legal and tax perspective if shares for the benefit of minor children are held in trust (see below).

FICs pay corporation tax on profits, often lower than personal income tax rates and potentially tax-free depending on the type of income generated. In addition, transferring shares in the FIC to family members can reduce the value of an individual’s estate for inheritance tax purposes (though care needs to be taken to prevent triggering capital gains). Family Investment Companies offer a tax-efficient, flexible, and protective framework for managing family wealth across generations.

Discretionary Trust

If protecting assets is a priority, a discretionary trust may be the best option. A trust is a legal arrangement where assets are transferred to trust by an individual (typically the parents, known as the settlors) and legally owned by trustees (who might also be the parents), with the beneficial ownership held by the trust’s beneficiaries (typically children and future generations). The key feature of a discretionary trust is the discretionary power given to the trustees to decide how and when to distribute income or capital among the beneficiaries. This flexibility allows trustees to respond to changing family circumstances and needs, making it a versatile tool for estate planning and wealth management.

From a tax perspective, discretionary trusts offer several advantages. They can help mitigate inheritance tax exposure by removing assets from the settlor’s estate, provided certain conditions are met. The assets held in the discretionary trust are generally not within any individual’s estate, which can be useful where there are unpredictable family dynamics. Additionally, income generated within the trust can be distributed or loaned to beneficiaries who may be in lower tax brackets, potentially reducing the overall tax burden.

However, trusts are subject to their own tax rules, including potential charges on the trust’s income and capital gains, as well as periodic inheritance tax charges. It is essential to seek professional advice to navigate the complex tax implications and ensure the trust is set up and managed in compliance with legal requirements. But if set up and administered correctly, a discretionary trust can protect family assets over generations and gives the trustees (often senior family members) the power to make investment decisions in the best interests of the beneficiaries – the wider family.

Both discretionary trusts and Family Investment Companies can be useful vehicles for looking after income and assets for families in a tax efficient manner. Either vehicle can hold a wide range of investments, e.g. trading businesses, properties, stocks and shares portfolios, bonds etc. Each family is different, and no one size fits. However, with specialist advice, FICs and discretionary trusts can be tailored to meet families’ financial needs and their collective investment aspirations.

What are your next steps?

Succession is inevitable, but it’s surprising how many people put off thinking about it until very late in the day. With so many family businesses facing transitions over the next few years in a tax environment where transferring shares on death is becoming less attractive, it’s essential that family business owners know all the succession options available to them, so they can find the best way forward for themselves, their businesses, and their families.

This resource was co-authored by Louise Fisher, Senior Manager from Baxendale Employee Ownership and Amy Barrows, Manager from Claritas Tax