Encouraging entrepreneurship in the family business

The concept of entrepreneurship in a family business is not new. Successful family businesses are often inherently entrepreneurial, as most act and think innovatively to establish and maintain their place in their respective industries. The line between entrepreneur and family business is often blurred.  Indeed, there may be no line at all – there is no inconsistency with being a family business and being entrepreneurial, and a family business owner being an entrepreneur. They are two sides of the same coin.

All businesses need to change over time, to meet challenges, expand into new markets or products, seize new opportunities or simply to make an existing product better, more relevant or attractive for the prevailing market. However, for most family businesses, this entrepreneurial spirt is often balanced by the same inherent traits that make family businesses unique, such as their longer-term outlook and sense of permanence and stability due to their family ownership.

However, entrepreneurship can ultimately benefit a family business beyond the core business. We increasingly see family businesses taking a broader approach to entrepreneurship as a way of encouraging entrepreneurial activity within the business and the family. A successful family business gives the family a number of options to be entrepreneurial outside the core business – essentially, to move from a family business to a business family. The family business remains at the core but the overall family corporate structure is broader and encompasses a wider range of interests. There are many good reasons for this, such as: 

• Expansion
  This may be into new products or areas, either complementary to, or very different from, the existing business. It can often be a good idea for a business to develop and test products separately to the core business, especially if there is a risk associated with them, or to limit distraction from the core business. As such, often expansion will start separately to the core business, especially for ventures that are distinct. International expansion will often need a separate company to ensure compliance with local rules or to establish a presence on the ground.
   
• Diversification
  A new venture may be entirely separate from the core business as a conscious way of spreading risk and investment. A family might wish to use surplus cash to invest in, or develop property, create an entirely new business or as a vehicle for equity investment, such as a venture capital or angel investor. It is not unusual that in time the new ventures may become significant elements of the wider family wealth. The lessons learnt from this process can often feed back into the family business for its wider benefit.
  
  
• Succession
  This can be a difficult subject for family businesses. However, allowing the next generation to create and run a new venture can be a very attractive, and often a lower risk way of involving and empowering the next generation. This allows them to develop and run a business themselves, but within a more protective framework and without the risk to the core business if it does not work. This is often seen as a way of allowing potential successors to gain experience within the wider family structure and is a lower risk way of encouraging and facilitating entrepreneurship in the family.
  
  
• Engagement
  Creating a family structure also helps ensure wider family engagement in a family business. Family members have different strengths and interests and not all family members can run or be involved in the family business. If the family structure can create, fund and assist with different ventures to suit the interests and skills of potentially a wide variety of family members, the family business can engage and sustain more family members in a commercial way. The self-worth of involvement and control of a business within the family should not be underestimated.
  
  
• There need not be a commercial or profit motive in the new ventures. At an extreme, the new venture can simply be there to provide an occupation or outlet for a family member. Where philanthropic giving is important to a family, this can be a focus for the family’s charitable giving.
  
  
• Incentive
  Within new ventures, there can also be a clear link between reward and contribution, which can be more difficult in an established family business. If one particular new venture proves to be successful, the family member that creates and delivers that success is often rewarded in a different way to other family members. This is good for the wider family, as value has been created, and individual family members are incentivised to invest time and energy into the new ventures. This can be a powerful personal motivator but, importantly, the ultimate benefit will fall to the wider family business structure.
• Control
  Retaining the wider family interests in the same corporate structure is a reasonably easy way to maintain the status quo around control. Any new venture would naturally be owned in the same way as the existing business, which takes away questions of control, ownership and entitlement to the new family asset.

Putting in place the right structure for any new venture is important. For many, the overriding consideration should be to protect the existing family business. This is often the continuing source of family wealth and it should not be placed at risk by new ventures. Ideally, new ventures (especially more risky or innovative ones) should be placed into separate corporate structures to ring-fence liability. Creating a separate vehicle would also help with family transparency, as it can be funded and accounted for separately. In a reasonably simple model, a new holding structure is incorporated with the family business as one of the subsidiaries, and new ventures would be established with limited liability in separate wholly owned subsidiaries. Care needs to be taken throughout to ensure that there is no cross-contamination between the different entitles. Neither the holding company nor the family business company should guarantee or otherwise be liable for the new ventures, as protection must be guaranteed to the wider family business group.

Surplus cash is extracted into the holding company – which is sensible for asset protection more generally - and it, in turn, will own new ventures as wholly owned subsidiaries. The holding company can then fund the subsidiaries as it chooses. This could be in the form of an equity investment in the shares or by loan, which might be on soft or commercial terms, depending on the particular commercial drivers.

The holding company will retain overall control (as the sole shareholder), but strategic and operational control of the new venture can be given to the relevant family member. It is, however, sensible that the holding company has the backstop ability to step in and take control of the subsidiary, when needed, to protect the wider group. It will also want to ensure it receives a sufficient flow of information and potentially reserve control over some key decisions, such as material borrowing or the creation of a business plan. The board might also include a wider range of family members to help with oversight (and involvement) in day-to-day management. This would also ensure that the core family business ethos remains at the centre of any new family venture.

In many cases, it is helpful to put in place a degree of structure on the new venture. This is beneficial to both the family – as it is transparent and there are clear boundaries and commitments to the venture – and for the family member who runs the venture – as they are empowered to develop the business but within particular parameters. Therefore, in many examples, the family will approach the structuring of the new venture as if it was an investor in a new business. This may sound overly prescriptive, but the family member may be required to justify the new venture and put forward a business case for evaluation. What is the opportunity and what is the business plan? How much funding will be required?  Will it be by way of an equity investment as a shareholder or by loan? If the latter, will the loans be interest bearing? What commercial metrics will determine success?

These are all good business requirements and appropriate questions, but there need not be a fixed approach. The overall structure will ultimately depend on the individual family circumstances and its view as to how it can best support the new venture and protect the wider family structure.

Recognising a broader approach to entrepreneurship can ultimately benefit any family business. Providing family members with a safe platform to develop their own entrepreneurship interests can develop fundamental commercial skills, independence, and wider engagement with the family business, with a range of commercial and other benefits to the wider family.

If you require further information about anything covered in this briefing note, please contact Anthony Turner, or your usual contact at the firm on +44 (0)20 3375 7000.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.

© Farrer & Co LLP, May 2021