Diversifying your investment portfolio is all very well, but it can be tough when the lion’s share of your wealth is tied up in the family business.

Diversifying your investment portfolio is all very well, but it can be tough when the lion’s share of your wealth is tied up in the family business. Paul George, a partner at PricewaterhouseCoopers, looks at the tricky matter of extracting capital from a family firm for investment elsewhere.

Many family businesses are excellent wealth generators, and entrepreneurs may consider the risk of having all their financial eggs in one basket to be an inevitable consequence of building a business that they control.

For family shareholders, however, some of whom may not be involved in running the business, it can feel less comfortable. Investment advisers, too, might well shudder at the concentration of personal wealth and risk in a single unquoted company.

There are generally two obstacles to building a meaningful investment portfolio outside your family business: the difficulty of extracting capital and the fear of losing valuable tax reliefs.

Getting money out
Many family businesses run their finances extremely conservatively, with little or no gearing, modest dividend pay-outs and an overweight balance sheet.

In many cases, though, capital extraction is perfectly achievable over a period of time. Even if it means you have to go to your bank for a loan, it can be worth it given the benefits of a more balanced pool of investments.

Where it fits with your wider strategy, bringing in an outside investor may also make sense. This can work particularly well when you spot an opportunity for aggressive expansion. Specialist private equity investors are increasingly comfortable with taking a minority stake alongside a management team they believe in – and, contrary to received wisdom, are often happy to see their funding flow out of the business and into the family’s personal wealth in order to “de-risk” the family’s financial position ahead of a push for growth.

The tax issue
Tax is another concern for families seeking to spread their wealth across a wider portfolio of investments. As an unquoted trading entity, the typical family business offers its long-term shareholders relief from inheritance tax (through business property relief) and capital gains tax (by gifting shares down through the generations).

Holding an investment portfolio within the same corporate structure as the family business muddies the water, as these reliefs are not available to investment companies. This may not be an issue if only a small portion of the company’s overall capital is invested outside the business, but it’s often safer to extract investment capital and hold it separately to avoid “tainting” the tax position of the trading business.

Taking dividends out of the business for investment purposes would usually be prohibitively expensive, as most family members would be hit hard by income tax. But with planning it is often possible to take investment assets into a separate structure without substantial tax costs.

How it works
Over five years, a family we recently worked with had built a sizeable investment portfolio, consisting mostly of property, inside their company. The investments had done well and made up around 25 per cent of the market value of the business. As advisers, we were concerned that this was undermining the tax status of the holding company.

We advised the family to restructure the business, hiving the investments into a separate structure. Mechanically this involved a number of steps, but most of the process was dealt with in a new temporary holding company created purely for the purpose of the reorganisation, minimising disruption to the commercial activities of the group. When the process was complete, the family was left with parallel investments in the shares of two holding companies: one with the family business and one with the investment portfolio.

The whole plan was reviewed by HMRC and went ahead with their approval. The tax costs were limited to a relatively small amount of stamp duty. In some cases, such a split can be achieved entirely tax free.

The family does not have tax reliefs, such as business property relief, for their shares in the investment structure and are planning their affairs accordingly. The separation of the two structures is allowing them the flexibility to manage the position independently of the way they handle the main investments in the family business itself.

Sometimes, structure guides commercial thinking. A year on from the separation, the family reports that some welcome clarity has developed due to the divide between the different processes of managing the family business and managing the family’s wealth.