Funding the Family Business - How to Keep Your Cash Safe
If you are going to start a family business, you will generally need an initial amount of personal money. There are quite a few ways that you can obtain this and also invest it - this article will look at the pros and cons of each.
Gaining Shares in the Business.
One common way to justify a cash injection into a new business is through equity finance. Shares carry dual benefits whether the company succeeds or not. For example if the company succeeds, you receive dividend payments and the shares should be sellable at a profit. However if the company fails, you can receive capital gains tax relief on the losses. As well as this, as long as the shares purchased are new issues and are not transferred to you, then there are certain income tax reliefs that also apply to any losses.
Equity finance also carries some risks and frustrations. Depending on the amount of capital you are investing, it is likely that you will be a minority shareholder. Therefore you have very little influence over the major decisions the company makes. A minority shareholding can also be quite difficult to sell and you could run the risk of selling at a much lower premium. Not only this, but dividends are only declared at the director's say so. They can only be forced in extreme circumstances. Finally, if the company should become insolvent, shareholders are the last to receive any money from the appointed liquidators.
In light of this, whether or not to choose equity finance as a method of investment depends on the size of the capital contribution and hence your anticipated shareholding. It also depends on the relationship you have with the company directors and your faith in the company's success. It is always advisable if acquiring shares to seek legal assistance from specialist commercial lawyers in composing a shareholders agreement. This will run concurrently with the articles of association belonging to the company, but will address any matters personal to the shareholders.
Providing a Loan.
One common way to fund the family business is to loan some money to the company on terms that are more favourable, and therefore cheaper, than if you use a bank. Don't forget that if you ask for interest on the loan, you will then have to pay income tax on it. It is ill advisable to agree the terms of the loan verbally as these could be disputed at a later date. If you form a professional loan agreement then the contracted terms must be obeyed and if breached you become entitled to sue the company for the money lent.
If the company fails and your loan monies are lost, then there are capital gains tax reliefs available to you. If the company is a success then you will receive your investment back with interest.
One more way to protect your investment is to look for some security for the loan. How the security is taken is dependent on the size and nature of the business; you could for example seek a floating charge over the company's assets or debtors. You should remember that any fixed assets, such as property, might already be being used as security by a mortgage.
As mentioned above, when the company repays the loan you are limited to receiving the capital and interest only. In order to make the loan more attractive and potentially profitable for you, an agreement can be made that facilitates the conversion of the debt into company shares at some point in the future. This conversion can be dependent on the performance of the business.
Cash Gifts.
When it is possible, a gift is the perfect cash injection for a company as there are no inherent liabilities acquired with it. Each person has an annual tax free gift allowance of £3,000, although if they have not used all of their previous year's allowance, this can double to ٤,000. However as many gifts for businesses will be much more than this you must be aware of inheritance tax implications. The gift can be a 'potentially exempt transfer', meaning that if the donor dies within 7 years of making the gift, it is still liable to be counted for inheritance tax purposes. If the giftor did die within the 7 years then inheritance tax is payable at 40%, the gift would however receive taper relief depending on exactly when the giftor died.
For advice on how to safeguard any injection of capital into the family business, make sure you instruct specialist commercial lawyers.
About the Author
Tim Bishop is senior partner at Bonallack & Bishop (http://www.bishopslaw.co.uk ), Salisbury Solicitors with a team of specialist commercial lawyers. He has grown the firm by 1000% in 13 years and has plans for further expansion. Tim is responsible for all major strategic decisions, seeing himself as a businessman who owns a law firm.
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