This is the first of a series of articles looking at the opportunities particularly the tax and structuring opportunities before and after a liquidity event for founders or early individual investors in private companies, and highlighting issues that can arise.
In this article we consider difficulties that can arise when a founder wants to transfer shares to family members.
Establishing a start-up with an exit in mind – avoiding barriers to pre-sale restructuring
There are various stages in the lifecycle of a start-up when a founder or material shareholder may wish to transfer part or all of their shareholding to a family member or some form of family asset holding vehicle. This is often to take advantage of valuable inheritance tax planning opportunities prior to an exit (in particular, the availability of business property relief) or may be part for more general wealth structuring or asset protection reasons.
However, the legalities surrounding such transfers are rarely a consideration for a founder when the company is first incorporated. As a result, when a founder does wish to transfer shares further down the line, they may find there are restrictions on their ability to do so, and that they need the consent of the directors or shareholders. By the time of a sale, the shareholders often include various institutional early-stage investors with rights to appoint directors, and these shareholders may demand material concessions from a founder before they agree to consent to such a transfer (especially where consent is requested at the time of an exit, reorganisation or investment round).
The position under the model articles of association
Most start-ups will rely on the model articles of association for private companies limited by shares as set out in the Companies Act 2006, especially where comprehensive legal advice is not obtained when the company is incorporated.
Under clause 26 (Share Transfers) of the model articles, the directors of the company are entitled to refuse to register a transfer of shares at their discretion, and therefore if the company is incorporated using the model articles any transfers by a founder (or other shareholder) to family members or family investment vehicles/holding structures would be at the discretion of the directors. While a founder may be able to appoint and remove directors during the early stages of a company's lifecycle, this right is generally eroded over various fundraising rounds.
Providing for permitted transfers
In order to avoid a situation where a founder/significant shareholder requires consent to transfer their shares to family members, a 'permitted transfer' provision should be included within the company's articles of association.
This provision will generally allow a shareholder to transfer shares to certain family members (which typically includes their spouse or civil partner and children), the trustees of a family trust of which the shareholder or a direct family member is the settlor or a family investment company (which is typically defined as a company of which the shareholder and/or his direct family members are the sole or majority shareholders) without requiring shareholder or director consent. This will allow the founder (or shareholder) to more easily undertake pre-sale re-structuring to, for example, take advantage of available tax reliefs or exemptions.
If you have questions or concerns about structuring considerations when setting up a business, please do not hesitate to get in touch with a member of our Private Client team.
This publication is not intended to constitute legal advice.
