Introduction and definition of the mandate
Family enterprises have a central role as employers of the population engaged in productive work in Finland. In Finland, 80% of all enterprises are family enterprises and family enterprises employ more than half of the workforce within the private sector and produce 40% of the total turnover of all businesses (Koiranen, 2002). Public authorities have shown their consciousness of the central role of family entrepreneurship in advancing the vitality of the national economy and the national welfare by setting up the Family Entrepreneurship Working Group to enable discussions on levelling the playing field for family entrepreneurship. The Working Group was commissioned to define the concept of family enterprise. The Working Group was also commissioned to find out what percentage of all firms are family
enterprises and what their significance is for the national economy. It was also hoped that the Working Group would make proposals on industrial policy measures to improve the operating environment for family enterprises.
The tasks of the Working Group:
1. To draft a proposal for a definition of family enterprise: what kind of a firm should be considered a family enterprise.
2. To investigate the number and size of family enterprises in Finland, to analyse their industrial structure and their significance for the Finnish economy and for regional development, as well as to evaluate the position of Finnish family enterprises in international comparisons.
3. If necessary, to come up with proposals on legislative amendments and on industrial policy measures that would be pivotal for family enterprises.
Background
The European Commission introduced a new EU strategy to promote growth and employment at the beginning of February 2005. Of the challenges faced in Europe, the ageing population is closely associated with family enterprises. Approximately one-third of European entrepreneurs, usually a family entrepreneur, will give up business activities within the next ten years. Annually, this affects 610,000 companies and 2.4 million jobs. In Finland, 70,000–80,000 entrepreneurs will give up their businesses during the next ten years due to ageing (Employment Working Group final report, 2003). It has been estimated that this affects approximately 500,000–800,000 jobs.
To make Europe more attractive to owners, investors and employees, the Commission encourages in the Lisbon Strategy the member states to, e.g., direct subsidies to those fields with substantial growth potential and to create a favourable business environment for SMEs. According to the Strategy, growth is created through know-how and innovation. The Family Entrepreneurship Working Group sees that
family enterprises are in a key position to achieve the objectives set out in the Lisbon Strategy.
With the ageing of family enterprise owners, it is a topical issue in family enterprises to consider the continuity of the business. The successor may come from the family, but the firm may also continue through the ownership of the employees or a third party. However, in most cases those planning to become entrepreneurs are encouraged to set up a new business rather than to continue the operation of an existing company. There are many reasons in favour of continuing the operation of an existing company: established products, clientele and jobs and the reputation of the company. The likelihood for an existing company to survive is better than that for a recently established company. Research showed that, e.g., in Austria, 96 per cent of the firms that completed a business transfer survived the first five years after the
transfer. The respective figure for start-ups was 75 per cent. In Finland, approximately half of start-up firms survive the first five years.
It should be possible to avoid situations where the firm’s business activities are terminated – not due to poor competitiveness, but because of fiscal or legal consequences from business transfers or because there is no successor.
The European Commission has motivated national and regional decision-makers to support business transfers to secure the continuity of many viable family enterprises, particularly in the EU. Business transfers can be promoted through fiscal, legislative and financial measures. Levelling and developing the playing field for the existing companies is also reflected in the increased number of start-ups. The Commission emphasises in its Entrepreneurship Action Plan 2004 that political decision-makers, civil servants, commercial organisations and other stakeholders should pay similar attention in their operations to business transfers as to start-ups. There are grounds for this also in the industrial policy, since it was stated in the expert group final report on SME business transfers published by the European Commission in May 2002 that: “existing companies usually retain five jobs whereas start-ups usually create only two new jobs”.
Family enterprises promote growth and maintain and improve employment in the European Union. Evidently, more attention should be paid to industrial policy to promote the development possibilities in these well-established enterprises.
Family enterprises as the backbone and engines of the economy
For centuries, family enterprises have been responsible for social and economic welfare. Although there is no unambiguous definition of family enterprise, researchers have tried to investigate the social significance of family enterprises. Research is based on a certain sample that has been extrapolated to all enterprises. Therefore, the results are only indicative.
Koiranen (2002) has estimated that in Finland family enterprises comprise 80 per cent of all companies, employ half of the workforce within the private sector and accumulate 40 per cent of the total turnover of all businesses. According to the Quo Vadis study (2003), conducted by the Small Business Institute
at the Turku School of Economics and Business Administration, 86 per cent of all Finnish companies are family enterprises. They create at least half of all jobs within the private sector and 75 per cent of those employed by SMEs work in family enterprises. The total GNP share of family enterprises accounts for nearly half of Finland’s GNP. Although the majority of family enterprises are SMEs, up to 20 per cent of the top 500 companies are family enterprises. More than 30 family enterprises are listed on the Helsinki Stock Exchange.
Table 1 shows that the majority (92%) of Finnish family enterprises are micro-companies (fewer than ten personnel). Companies employing more than 50 employees, i.e. medium-size and large family enterprises, comprise only 1 per cent of the companies, but their role is considerably more significant if the extent of their activity is examined (Figure 1). Medium-size and large family enterprises employ 27 per cent of those working in family enterprises and their share of the total turnover of all family enterprises is 32 per cent.
Number of family enterprises according to various indicators
In the Quo Vadis study conducted by the Small Business Institute at the Turku School of Economics and Business Administration, the number of family enterprises was investigated using various indicators. As was expected, the number of family enterprises varies according to the family enterprise indicator used (2). If estimated using a structural and a subjective indicator, a significantly higher proportion of Finnish enterprises are family enterprises compared to the estimates using a functional or a generational-transfer indicator. A closer examination of the material shows that the difference is mainly caused by sole-proprietor businesses, which comprise approximately 40 per cent of Finnish enterprises (number of personnel in companies in 2003). It is also difficult regarding the definition if family members are involved in the sole proprietor’s business activities as wage-earners or as owners. Firms with the family involved in the firm’s operation and ownership comprise approximately one-third of all firms (30%). Eighteen per cent of firms have a history of generational transfer.
Regional significances of family enterprises
Traditionally, family enterprises often operate locally and they are regionally very significant actors. Regionally, family enterprises often function as so-called engines and they have an important impact on the renewal and development of industrial and commercial activities. They are often significant employers locally and create welfare and added value in the community even more widely. Family enterprises function regionally as a base for creating and developing new business activities. According to the Quo Vadis study conducted by the Small Business Institute, family enterprises are regionally rather evenly located in different provinces compared to non-family firms (Table 3). Like all firms, the majority of family enterprises are also located in the provinces of Southern Finland and Western Finland.
International significances of family enterprises
According to the IFERA (International Family Enterprise Research Academy) survey published in the Family Business Review in December 2003, the share of family enterprises of all firms varies in Europe between 60 and 93 per cent (Table 4). The survey is based on independent studies conducted in different countries using different criteria for the definition of family enterprise. In the United States, the share of family enterprises is approximately 95 per cent and in Central and South America it is 65 per cent. There is only limited information available from the Asian countries. One of the world’s oldest family enterprises, Hoshi, was established in Japan as early as in the sixth century.
The share of family enterprises of the GNP is substantially smaller in the United Stated and in Finland in proportion to the number of family enterprises compared to other countries. However, 35 per cent of the 500 largest companies in the United States are family enterprises. Approximately 20 per cent of the Finnish top 500 companies are family enterprises, including Kone Corporation, Ahstrom Corporation,
Wihuri Group, Lemminkäinen Group, Myllykoski Group, Onvest Group and Oy Karl Fazer Ab.
There are many listed and unlisted family businesses around the world, such as Hermés, Danone, Michelin, Peugeot, L’Oréal, Henkel, BMW, Dr. Oetker, Beretta, Barilla, Johnson & Johnson, Kelloggs, Mars, IKEA and Tetra Pak. With the exception of France and the Netherlands, family businesses are more employment-intensive than other companies. Their share of the employed workforce ranges between 50 and 80 per cent.
Securing continuity of family enterprises
According to the survey issued by the European Union in 2002, it was estimated that one-third of the firms in the EU member states would transfer ownership to the next generation within the next ten years. In the 15 member states forming the EU at that time, an average total of 610,000 SMEs were annually transferred from one owner to another with an impact on approximately 2.4 million jobs. Along with
start-ups and growth of business activities, generational transfer is the third main factor in the cycle to improve the competitiveness of Europe (Expert Group report on SME business activity transfers, EU 2002).
Generational transfer will also become very topical in Finland during the coming years. An estimated 70,000–80,000 entrepreneurs will give up their businesses due to ageing during the next ten years (Employment Working Group final report, 2003). This will affect approximately 500,000–800,000 employees. A business transfer means transfer of and continuity of business activities as the current entrepreneur-owner gives up the business. A business transfer can be performed as a generational transfer when the successor comes from the family. The successor may also come from outside the family. According to the Quo Vadis study, 42 per cent of business transfers during the coming years will be implemented as generational transfers, 26 per cent of the businesses will be sold and 7 per cent view closing down the business as the method of transferring the business activities.
The majority of owner transfers naturally concerns family enterprises. It is therefore important that particular attention is paid to the generational transfer and to advancing the operational possibilities for family enterprises.
According to the survey performed by Asiakastieto (Koskenranta-Kouki, 2005), the businesses approaching generational transfer are larger and more solid than an average business. Turnover, balance and the number of personnel in the businesses approaching generational transfer were considerably higher than the key figures in firms in the reference group. Successful generational transfers have a great importance to the national economy.
The Research Institute of the Finnish Economy (Kaseva, 2005) has estimated that in the case that half of the generational transfers should fail, the financial position of the public economy would be impaired by €1.25 billion within four years, lost income tax would increase to €300 million, unemployment and pension expenditure would increase to €800 million and €150 million of indirect tax income would be lost. After four years, the general government net lending would be 0.7 percentage units (Figure 7) lower than that estimated. The number of lost jobs would be 60,000 and that of lost businesses 32,000. To secure continuity of employment and businesses’ capacity to pay taxes, avoiding failure in generational transfer would be the best option for everybody – businesses, employees, public authorities and other interest groups.
Cost-effective growth in family enterprises
The Small Business Institute at the Turku School of Economics and Business Administration has studied growth companies. In this study, it was possible to examine family enterprises separately. The criteria for family enterprises used in this study included: the respondent perceived the firm as a family business; the ownership of family/close relatives is more than 50%; and a member of the family/a close relative works in the company as a wage-earner. According to these criteria, 27 per cent of the firms in the study material were family enterprises. The prevalence of businesses with features of family enterprises, i.e. one of the above-mentioned criteria was met, was slightly higher, i.e. 41 per cent.
Appendix 1 summarises the number of growth companies according to various growth indicators and their shares with regard to the definition of family enterprise (Pukkinen, Stenholm, Malinen, 2005). The percentages indicated in the Appendix describe, per each indicator, the share of firms meeting the criteria out of all firms in each group.
In this comparison, only one statistically significant difference was observed, indicating that the growth in family enterprises has been more profitable than in other SMEs. Indicative differences between family and non-family enterprises can be interpreted to appear also in partial international growth orientation and in the actual growth of the market share. In both these, the growth of family businesses has been or is expected to be stronger than in other firms. The figures in the table partly show that family businesses have grown slightly more than other businesses or they have a slightly more positive attitude towards growth. However, these differences observed between family and non-family enterprises are only suggestive.
The Kasvun ajurit survey (2005) issued by the Confederation of Finnish Industries states that a growing firm is usually owner-driven and the owner is strongly committed to objective-oriented and sustained growth and development. A growth firm is not industry-bound. According to the report, growth firms show controlled risk-taking: growth is usually financed with income financing. Aptitude to expanding
the ownership base is limited, suggesting that the entrepreneur desires to keep his autonomy and independence. These features of growth entrepreneurship are very similar to the special features of family enterprises described in the next section. Family businesses have a positive attitude towards growth and their growth is profitable.
Continuity – a prominent characteristic for family enterprises
Family enterprises share many similar characteristics, even if they are very different from one another. A family business may be small or large, listed or unlisted, and it can operate in any line of business. A common feature for all family enterprises different from other companies is that family, business and
Defining family enterprises
The main issue on competitiveness in the Lisbon Strategy of the European Union and in the green paper on entrepreneurship is securing the continuity of enterprises. This also secures employment. As was previously agreed, the policy programme on entrepreneurship leaves open the question on how to promote generational transfers and the continuity of businesses. To support the life-cycle perception presented here, a similar extensive social discussion and decision-making process is required covering all interest groups and resulting in improved awareness and knowledge of family entrepreneurialism.
Therefore, action at both national and community level is required. The Constitution of Finland (§ 18, 11.6.1999/731) prescribes that public authority should protect the workforce. Considering the characteristics of family enterprises and considering that they create employment, it should be investigated whether a definition of family enterprises is required on the national level that would support and specify the legislation, for example, in connection with reforms of the legislation on inheritance
and that of the Companies Act. It should be considered whether a separate law on family enterprises is necessary to enable a better definition of the grounds as to how the society can advance, as proposed here, long-term accumulation of company assets creating employment.
A community-level consensus is also required for the recommendation to promote continuity of family businesses and transfer of company ownership to secure continuity of entrepreneurship and thus also employment. Taking into account the particular features of family businesses described here, as well as their importance to the national economy and in creating employment, this consensus can be mainly
built on the same principles as the European Commission recommendation (96/280/EC) on SMEs with the objective to promote the efforts of national governments to encourage and support SMEs.
Family enterprises are not officially defined, which impedes the gathering of statistical information on family businesses. Decision-makers need statistical information on family businesses to support their decisions and to assess the effects from these decisions. It is difficult to obtain statistics on family enterprises and their activities since there is no definition of family enterprise. In the academic world, the criterion of a family enterprise has varied between share of ownership, strategic control, participation of different generations in the operation of the business and the intention to maintain the firm as a family business.
Various indicators for family enterprises
The study “Quo Vadis the Finnish Family Business” conducted by the Small Business Institute at the Turku School of Economics and Business Administration used the following indicators to investigate the essence of family entrepreneurship.
Subjective indicator
The easiest way to define a firm as a family enterprise is to ask the owner-entrepreneur or similar whether he thinks that the firm is a family business. Thus, the answer obtained is either yes, it is a family business, or no, it is not a family business. The weakness in this method is that the concept of “family business” is not – despite its apparent simplicity – by any means unambiguous to the respondent. Operationalisation of the concept is easy but the reliability of the obtained results suffers.
Structural – ownership-based indicator
The definition often internationally used is based on the family control in the firm. A firm is a family business if a family owns more than 50% of the firm, or if for any other reason it has control over the firm. Surprisingly, the basic concepts ”family” and ”enterprise” may be difficult. From the view of using this indicator, sole entrepreneurs in particular and those with no family are problematic for the definition. One may wonder whether a sole entrepreneur has a business or whether a person with no family has a family.
Functional indicator
The definition should include a functional dimension describing the “presence” of a family in the firm. In this study, family involvement in the business activities was defined by two questions: does any other family member have a share of the ownership in this firm and is any other family member a wage-earner in the firm?
The above description creates a three-level indicator whereby family enterprises and non-family enterprises are separated by a “grey area”. There are firms with only some characteristics of family enterprises.
Generational transfer completed indicator
According to this indicator, a company is a family enterprise only when it has completed a generational transfer.
Working Group’s definition of a family enterprise
When the Working Group pondered the concept of family enterprise, the starting point was ownership-ased control. The Working Group approached the issue of control through owners in different forms of companies (Table 6).
The ownership base in the control of business activities
Family entrepreneurship measured by various indicators exists in all forms of companies, more in some company forms and less in others. At the beginning of its life cycle, a firm usually operates as a one-man business or as a partnership. As the business grows and develops, the company form chosen is usually a limited liability company.
The company may later go public when e.g. searching financing for its growth. The Working Group considered it important that the definition be unambiguous and easy to update. The definition should be neither too narrow nor too broad. Too-broad definitions do not distinguish family enterprises sufficiently from non-family enterprises and too-narrow definitions limit them into too small groups. The Working Group ended up with a multi-layer definition of family enterprise in which the concept of family enterprise functions as a kind of umbrella above the concept of family business, i.e. only company-form family businesses.
The Working Group issued a more detailed definition of the concept of family business. The starting point for the definition was the control of the family or kin that is expressed in the definition as the majority of the vote. In calculations of the majority of the vote, the Working Group also considers indirect ownership (structural indicator) to be significant.
A special feature in family enterprises is that the family and the company are intertwined. This is considered in the definition by the requirement that at least one representative of the family or kin should be involved in the operative or administrative management of the family enterprise (functional indicator).
The definition of a family business excludes commercial and business activities of a natural person who can be called an entrepreneur, a businessman or a self-employed person. In this form of business activity, the assets and liabilities of the entrepreneur are in his ownership without a general partnership, a limited partnership company or a limited liability company between the entrepreneur’s person and the business activities. The business or profession of the entrepreneur cannot be separated from the entrepreneur and they therefore form an entity. In these forms of business activity, no company assets transferable from one generation to the next will be created.
The Family Entrepreneurship Working Group defined a family enterprise as follows.
A firm is a family enterprise, if:
1. The majority of votes is in possession of the natural person(s) who established the firm, in possession of the natural person(s) who has/have acquired the share capital of the firm, or in the possession of their spouses, parents, child or child’s direct heirs.
2. The majority of votes may be indirect or direct.
3. At least one representative of the family or kin is involved in the management or administration of the firm.
4. Listed companies meet the definition of family enterprise if the person who established or acquired the firm (share capital) or their families or descendants possess 25 per cent of the right to vote mandated by their share capital.
Funding and taxation – the challenges of generational transfer of a family enterprise
The demanding process of generational transfer, with the current challenges in financial and fiscal obligations, decreases solvency, reduces the possibilities for investment and development and reduces the ability to take risks as well as the stability of employment and the creation of new jobs. This also affects the decision as to whether the business should continue as a family enterprise or whether to give up the business. The common objective for society and enterprise-owning families is to secure the continuity of business activities in Finland. Financial arrangements in a generational transfer include the use of equity loans, subordinated liabilities or the so-called mezzanine financing. The use of subordinated loans and mezzanine financing-type loans in generational-transfer situations has been increasing. Family enterprises are also significant contributors to the tax income collected by the State and thus levelling the playing field for businesses through the means allowed by taxation is also essential. Legislative reforms and changes in the interpretation of various tax laws affect family enterprises and their owners substantially more often and with a greater impact than other companies. Although taxation of natural persons and enterprises is separate, greater importance should be given to the unity of family and kin than is given in current taxation practices. It is clear that our society needs growing and successful family enterprises. Controlled growth and success necessitate increases in the company assets, i.e. growth indicated by the firm’s balance sheet and increases in the taxable net assets of the firm. The importance of this has already been taken into account in the current tax legislation where increases in net assets may at the same time increase the amount of dividend subject to single taxation.
Funding to secure employment in and continuity of family enterprises
There are particular challenges in financing generational transfer. Generational transfer does not typically increase company assets – on the contrary, capital is typically reduced when distributable retained earnings are used for redemption of shares from the owners giving up their partnership or when the firm pays extra dividends to cover the taxation consequences from generational transfer. Redemption of shares from the previous generations leads to increases in the amount of the firm’s and the successor’s liabilities, leading to an at least temporarily decreased stability of the firm and reduced creditworthiness. It is typical in these situations that the assets of the firm to be purchased cannot be used as security collateral to finance the purchase of shares and therefore collateral deficiency is almost always created. To arrange financing in these situations, new funding instruments have been introduced, such as subordinated loan and mezzanine financing products, for which it is typical that higher risk-taking leads to higher interest costs to finance a transition period that is more susceptible to risks.
Firm’s financing structure
The new Companies Act currently in preparation (May 2005), according to which subordinated loans are no longer considered part of the equity, will reduce the equity ratio in many family enterprises. This will create a problem, since the Basel II framework on banking coming into force at the beginning of 2007 connects the margins of bank-issued business credit more closely than before to the firm’s equity ratio. At the same time, the pressure in pricing of the margins for bank-issued subordinated loans in comparison to ordinary credit will increase substantially.
The interpretation of the Committee for Corporate Analysis (Yritystutkimus- neuvottelukunta, YTN) plays a significant role, if subordinated loans meeting the provisions in the new Companies Act will not be considered part of the equity. The YTN defines the equation formula to be used by banks, e.g. when calculating the solvency of a business. The YTN should determine that subordinated loans should still in the future be considered as part of the equity.
Generational transfers may not be such an appealing investment for professional capital investors due to the low profit expectation associated with them. Their attractiveness is also reduced by the limited possibilities for the investor to detach from the investment. Capital investors detach from their target firms within a limited investment period of three to seven years, either by selling the firm to a new owner
or by listing it on a stock exchange. This method of detachment is not very suitable for generational-transfer situations where the objective is to keep the firm in the ownership of the family.
There are no actual products to finance generational transfer aiming at continuity of ownership. Banks offer loans, mezzanine financing and subordinated loan products for generational-transfer situations. Additionally, Finnvera corrects this deficiency in the market by offering various financing products for generational-transfer situations: entrepreneur loans, capital loans and capital guarantees that are suitable as such also in generational-transfer situations.
The entrepreneur loan granted by Finnvera is intended for payment of a contribution or for increasing the share capital in a limited liability company, general partnership or limited partnership as well as for purchase of shares or interests. The entrepreneur loan is an entrepreneur’s personal loan. It can also be granted to several persons establishing the same company. Those applying for the entrepreneur loan
should be shareholders in the limited liability company with a share of a minimum of 20% of the share capital and the right to vote or he should be a partner in a general partnership or the general partner in a limited partnership company. The applicant should participate in the business activities with full-time work input and earn his livelihood from the firm.
The capital loan granted by Finnvera is intended for financing the working capital created as a result of investment, product development and growth as a part of other Finnvera funding. It can also be used for financial arrangements in company acquisition and generational-transfer situations. The capital loan is not allowed to carry a collateral from a debtor company or corporate and it is entered on to the balance sheet as an equity item. The amount of a capital loan is usually €20,000-3,000,000 and the term of the loan is normally five to six years, up to ten years. No collateral is required from the firm for a capital loan, but in some cases the owners have issued a personal security. The supply and use of the capital guarantee in the Finnvera product range has been very limited. The role of the Finnish Industry Investment in generational-transfer arrangements has been very limited so far.
Tax incentives for corporate assets to create jobs
In generational transfer, the owner-business entity does not create completely new corporate assets and it does not bring a positive cash flow to the firm. In generational transfer, inheritance and gift taxes levied from the successor usually fall to the firm for payment since the successor has to finance the taxes using dividends or by taking a loan from the firm. Inheritance and gift taxes thus put a strain on the firm’s financing structure and impair the possibilities for the successor to carry out their responsibilities as an owner. In the worst case, the fiscal consequences of generational transfer may form an obstacle for keeping the firm as a family enterprise. It may be necessary in such a situation to consider selling the family enterprise partly or entirely to an external owner to secure the financing of the generational transfer. Since there are so few potential domestic buyers and as the business market is so small in Finland, the only option is often to try to find foreign buyer candidates for the business.
Personal income tax as well as the combined effect from capital income tax, inheritance tax, gift tax, asset-transfer tax and net-worth tax currently levied on natural persons put Finnish owners of company assets in an unequal position with regard to institutional and foreign owners. Additionally, a family enterprise is levied income tax on the firm’s business income.
Inheritance and gift taxation in generational transfer
When transferring family-enterprise capital from the parents to the children by means of inheritance or a gift, it is often necessary due to the capital tied up to the business to divide the ownership of the business between several children or other beneficiaries to implement the principle of equality. The transfer of company assets as an inheritance or a gift is promoted through tax relief. A condition for tax relief is, however, that a minimum of 10 per cent of the ownership is transferred to each successor at a time. However, current tax-relief regulations do not take into account any possible previous acquisitions of ownership in the same company by an heir, but meeting the criteria for the relief is considered separately each time for each transference. If the family enterprise has different sets of shares with different rights and with different rights to vote, the criteria for the relief are not met even if the generational transfer would mean that of the majority of the number of votes is transferred concurrently with a transfer of shares less than 10 per cent. This causes problems particularly in listed family enterprises. On the other hand, obtaining relief in accordance with the Inheritance and Gift Tax Act (perintö- ja lahjaverolaki, PerVL) does not necessitate a family relationship between the person leaving an inheritance and the heir.
Centralising ownership is usually not economically possible for the successor of the business since he has to compensate the other heirs for the value of shares in the estate. Division of the ownership into smaller shares of ownership leads to a situation where the ownership is scattered among such a large group that the 10 per cent ownership required for the tax relief cannot be achieved. This leads to unequal treatment with a consequence that the transfer of company assets causes a significantly higher total tax burden than in a situation where the relief is obtained.
To enforce the intent in the relief regulation, a provision should be included in the Inheritance and Gift Tax Act that when transferring stock or shares entitling ownership in a farm or a firm within the family, the transferee should be entitled to tax relief independently of the magnitude of the share in the ownership inherited or received as a gift. This would facilitate keeping together the fragmented ownership that is still under the control of the family. This would particularly promote the possibility of keeping the ownership within Finnish hands.
Company assets subject to relief in the Inheritance and Gift Tax Act
The assets owned by a firm can be divided into three different income sources for taxation purposes. These income sources are business income, agriculture income or personal income. After the reform of the legislation on generational-transfer relief, a question emerged on targeting the relief particularly towards company assets categorised as business income. The guidelines issued by the National Board of Taxes state that it is possible to grant relief on gift tax on that part of the shares entitling the person to ownership of company assets. According to this guideline, if a substantial part of the company assets are subject, according to the Income Tax Act, to the taxable so-called Income Tax Act (TVL) income source, it is possible to decide when levying the gift tax that the assets subject to the TVL income source are not regarded as subject to relief.
Tax exemption should be particularly favoured on the assets regarded as a TVL income source when the assets in the firm can be shown to have accumulated during years of entrepreneurship and when the above-mentioned division in income sources has not been questioned in the company income taxation.
In practice, considering assets subject to relief means that the tax to be levied is based on the book value of the assets. As the book value is often lower than the current value, due to e.g. frontloading depreciations, imposing tax on the basis of the book value is more favourable to the taxpayer compared to taxation on the current value. The taxation practices applied by tax offices and the guideline issued by the National Board of Taxes in June 2004 led to a major disagreement on the interpretation of the calculation of the share value when applying the relief regulations. The guideline issued by the National Board of Taxes and the gift tax decisions issued by some tax offices are not in line with the clear position taken in the justifications of the legislation reform passed in the Parliament that the legislation reform should not affect the grounds for the relief itself, but the established practice for granting the relief should be followed and it should be targeted towards all assets owned by a firm. If part of the tax imposed on the company’s assets is based on the current value in generational-transfer situations, this will lead to increased taxation compared to the previous practice, whereas the objective of the legislation was to facilitate the implementation of generational transfer. Appeal processes are already ongoing due to decisions that are not in line with the justifications of the legislation reform, but the position to be taken by the Supreme Administrative Court may still be pending for some time. Predictability of and equality in taxation before the law provides that the assets of a limited liability company carrying on business activities should be considered as such subject to relief. This way, the factitious conflicts in the interpretation can be discarded in one stroke and it is easier for the owners to be prepared for the future generational transfers and the taxation consequences from them.
An example of the amounts of inheritance and gift tax
The following example illustrates how the relief referred to in § 55 in the Inheritance Tax Act affects the taxation of the heirs. The example shows clearly that when there are no prerequisites for continuing the business or for the share of ownership, the amount of tax levied becomes manifold. In this example, heirs A, B, C, D, E and F represent an ownership of 5-30 per cent. Beneficiaries A and C continue in the firm (taxation practices provide full-time employment and/or membership in the board) and as they have received a share of ownership of a minimum of 10 per cent in the firm, they are entitled, on the basis of § 55 of the Inheritance Tax Act, to 40 per cent relief of the taxable value as well as an interest-free payment period of five years. Heirs B, D, E and F are not granted relief and thus the amount of tax levied is calculated using the current value of the share of the ownership subject to taxation and the tax is liable for payment immediately.
Capital gains taxation in generational transfer and other comments on taxation
The increase in capital gains taxation has complicated ownership transfers in many family enterprises implementing generational-transfer situations. According to current legislation, in a generational transfer exempt from capital gains tax the beneficiary should be a child of the incumbent or a direct heir of this child, or his sister, brother, half-sister or half-brother. The above-mentioned list is complete and thus this regulation on tax exemption is not applied to a transfer to e.g. nieces and nephews. It is typical in many generational-transfer situations that the firm purchases the shares held by the incumbent since the successor does not have the economic means to personally purchase the shares.
The group of beneficiaries limited only to close relatives complicates controlled generational transfer, particularly in old and successful family enterprises. The capital gains tax relief applied in generational transfer should also be expanded to apply to other transfers inside the owner family on similar grounds, i.e. provided that the purchaser continues the business activities for a certain period of time. In preparation for the new Companies Act, purchasing the firm’s own shares has been considered as one way to distribute the assets of the firm. As the new Companies Act under preparation (May 2005) also takes a positive stance on the purchase of own shares, an amendment to the tax legislation, particularly for generational transfer, as described above would be warranted.
A 1.6 per cent asset-transfer tax is levied regardless of the implementation method of the generational transfer whether the successor purchases the shares or the company purchases shares from the incumbent. In this regard, family enterprises are not equal to similar purchases on the stock exchange that are exempt from the asset transfer tax. The abolition of asset-transfer tax from purchases of shares associated with generational transfer would be consistent with the current legislative development considering that this concerns an asset transfer within the family.
Generational transfer is often implemented through the firm purchasing its own shares from shareholders using assets from distributable profits. The shares purchased by the firm are usually made void later on. According to current legislation, such purchase of a firm’s own shares from a shareholder may be considered as a disguised dividend. The current taxation practice does not allow shareholders to give up their shares gradually.
Reform of group contribution legislation
In taxation, a significant factor often impairing the competitiveness of family enterprises is group contribution, which is a method often used by institutional investors and major corporations to balance the result between different companies and through this to reduce the group’s total tax burden. With the group contribution, the company can subsidise a loss-making company belonging to the same group and
this subsidy is a deductible expense in taxation for the donor. One of the conditions is that, e.g., the inter-group ownership between the companies is more than nine-tenths (9/10). In many family enterprises, the ownership in companies belonging to the same group of owners is distributed between several family members.
Promoting family enterprises and ownership
The action proposals presented by the Family Entrepreneurship Working Group are particularly related to securing continuity in family enterprises and to promoting Finnish ownership. Public authorities should create an operating environment encouraging family entrepreneurship and they should also create the best possible conditions for continuity, renewal and growth of family business activities. The European
Agenda for Entrepreneurship by the Commission of the European Communities also considers it important that a fair environment for risk-taking is created and unnecessary obstacles are removed. This should also be one of the main objectives in industrial policy. When creating an industrial strategy, the importance of family enterprises should be taken into account in, e.g., development of new business
activities and in pursuing an improved standard of living and in striving to increase national wealth. To achieve this objective, efficient integration and the correct allocation of private and public resources is necessary.
The action proposals presented by the Working Group focus on the issues of how society can improve the operating environment for family enterprises and promote their continuity and growth. The action proposals are also linked to the reforms implemented in several European Union member states indicating the direction of development.
The examples are taken from the expert group final report 2002 on SME business transfers published by the European Commission and from the final report of the MAP 2002 project as well as the GEEF (European Group of Family Enterprises) Benchmarking Study 2005. The actions proposed by the Working Group are not just independent ideas but they are also measures implemented elsewhere to remove unnecessary obstacles for the continuity and renewal of well-established business activities and to promote positive economic development in line with Government industrial policy. The Working Group proposes that:
(1) The Government Strategy Document 2006 should include the measures proposed by the Family Entrepreneurship Working Group to improve the operating environment. The Working Group also considers that most of the measures proposed can be implemented under the Entrepreneurship Policy Programme led by the Ministry of Trade and Industry and coordinated by the Entrepreneurship Policy Programme.
Why statistics on family enterprises should be developed
Attempts to investigate the number and importance of family enterprises have been made in some studies, but the results are only indicative since actual statistics on family enterprises are lacking. As the Working Group heard experts from the National Board of Taxes, Statistics Finland and National Board of Patents and Registration of Finland, it concluded that it would be technically possible to provide statistical information on the basis of the existing authorities’ practices and information. In the trade register, family enterprise would be one information item on the company properties, like e.g. line of business, turnover or number of personnel. The statistics on family enterprises should be developed to make the Finnish system the best European practice. When a definition is available and statistical information is obtained, an annual report could be published on the importance of family enterprises, e.g. as a part of the current entrepreneurship review. Resources are required to achieve all this and, e.g., Statistics Finland could receive a commission from the Ministry of Finance. The Working Group proposes that:
(2) Adequate resources should be allocated to Statistics Finland to allow it to develop statistics creation on family entrepreneurship, as necessary, in cooperation with the National Board of Patents and Registration of Finland and Finnish Tax Administration, to enable monitoring of business activities and of development of family enterprises in separate reports and as a part of, e.g., the entrepreneurship review issued by Ministry of Trade and Industry. The starting point for the development of statistics should be the definition proposal drafted by the Family Entrepreneurship Working Group.
Public corporate funding to encourage generational transfer and the successor’s aptitude for growth
Public authorities can support family enterprises in their transition periods by creating instruments to facilitate generational transfer and to encourage growth. Public funding is particularly important for the regional development of business activities. Support provided to, e.g., a company in North Karelia, may avoid the loss of many jobs in remote areas. Securing sufficient allowances for public financing institutions, e.g. Finnvera plc and Finnish Industry Investment, for financing growth and generational transfer in family enterprises should be secured in the state budget. The Finnvera entrepreneur loan can also be granted to support generational transfer, but Finnvera should, while offering its products, highlight more prominently that its products are also suitable for generational-transfer situations. It can be seen that there is a need for products complementing private financing. A more extensively offered Finnvera capital guarantee could facilitate obtaining the so-called patience capital, i.e. long-term capital for the generational transfer of a business. If bank loans and capital loans were guaranteed by Finnvera, the cost of bank-issued financing could also be reduced as their price demands would be considerably lower. It can be estimated that demand for and the significance of capital guarantee would increase in generational-transfer situations if it is proactively developed and offered and obstacles are removed to develop its supply. This could also be promoted if the state bore a part of the losses from Finnvera’s capital guarantee, as is the case in other Finnvera domestic financial products. Industry Investment should also have a clear role in mezzanine financing for generational transfer. This would mean that Industry Investment should develop a new generational-transfer programme. The capitalisation of Industry Investment should be continued to secure the extent of the financing programme. The primary task for
Industry Investment would be to offer equity loan financing, but it should also be able to offer unsecured loans and mezzanine financing products. The generational transfer projects financed by Industry Investment could focus on the relatively large family enterprises with the turnover of more than €10 million and with a financing requirement of €0.5–10.0 million. The efficiency of the financing would be supported by the generational transfer plan issued before financing. The Working Group proposes that:
(3) When developing the operation of Finnvera plc and Finnish Industry Investment, their financing products and services should be directed to promoting family business transfers and growth.
One possible role distribution in domestic financing between these special financing institutions could be that Finnvera starts an extensive supply of capital guarantee and would thus respond to the lack in the market of loan financing, capital loans and share-capital investment as a guarantor, particularly for SME family enterprises. Industry Investment would again respond to the lack in the market of equity loan funding mainly for relatively large companies.
Taxation reform to support employment and growth
As mentioned in Section 2, generational transfer or closing down the business will become topical in the near future in approximately one-third of Finnish family enterprises. Planning and implementation of generational transfer belong to the most significant and risk susceptible periods in the life cycle of a family enterprise. In addition to the family members’ personal, firm-related and business-related issues, the entire scene of preserving the preconditions for the business operations and the financing of the ownership transfer should be taken into account. Generational transfer does not create new assets or income, and transfer of the business activities to the successor is needlessly burdened when income taxation of the incumbent and the successor, inheritance and gift taxation of the successor as well as taxation of the transferred business and asset-transfer taxation on the assignment are taken into consideration. Even when there are no taxation consequences from the generational transfer, it is one of the major risk factors for the continuity of business activities, and thus tax legislation should be made as simple and predictable as possible. Because of the current tax legislation, family enterprises have to invest their resources for tax planning in generational transfer and for financing the tax burden of the successor
whereas when considered from the point of view of society and of the operation of family enterprises, investments should be focused on securing the commercial prerequisites and also preparing the successor of the family enterprise for securing the operation of the enterprise in the future. The current legislation needs swift adjustment and simplification of the regulations. The Working Group proposes that:
(4) When developing and reforming inheritance and gift taxation, inheritance and gift taxes on company assets should be abolished from all shareholders in unlisted family enterprises, and in listed firms from those shareholders that are owners meeting the definition of majority (25% of the votes) in the family entrepreneurship.
When amending and developing the legislation, adjunctive consequences from the net-worth tax abolition in 2006 should be taken into account. As the net-worth tax is abolished, it would be of primary importance that the definitions of current value in various tax types are harmonised and a potentially separate regulation is prepared for situations when the value of the assets is assessed. A separate regulation for the assessment of the value could improve the predictability of taxation and equality of taxpayers. Furthermore, the concept of company assets in accordance with the Inheritance and Gift Tax Act should cover the entire company assets and the division into TVL income source should be abolished. The relief in the capital gains taxation applied in generational transfer should be expanded to also apply to transfers between parties other than close relatives. Purchase of the firm’s own shares as part of the generational-transfer process should not be treated as a disguised distribution of dividends.
Promotion of research and training on family entrepreneurship
Systematic research on family entrepreneurship has been started only very recently. In Finland, research on family enterprises was practically initiated only in the 1990s. The first joint meeting of family business researchers took place in March 2002. The major role of the research is to support the enterprise policy by producing relevant and exploitable objective information to support political decision-making. The research filters to the policy the effects and changes in the field. Research allows assessment of the effects from various actions and programmes to the operation of family businesses. Research also elicits new points of view affecting the operation of and the preconditions for family enterprises that political decision-makers should be aware of. Research may, at its best, be a useful tool for enhancing the efficacy
and quality of political actions and for improving allocation of these actions. For instance, it has been assessed in public debate that the significance of family enterprises and generational transfers to the national economy is considerable. In reality, there is only a limited amount of more detailed information and it is not adequately based on research data. As for the credibility of Finnish research data on family enterprises, it should be based on credible data, which again requires that statistical information on family entrepreneurship should be created. Another interesting research area would be the growth of family enterprises and the effect of existing businesses on the creation of new business activity. To enable comparisons between various studies, it would be of utmost importance that the same definition of family enterprise, e.g. the one proposed by this Working Group, should be used. High quality and useful research on family entrepreneurship requires closer cooperation between family enterprises and the universities. The Working Group thus suggests that university-level research on and training in family entrepreneurship should be promoted and supported, and conditions for co-operation between family
enterprises and universities should be created. Co-operation with family enterprises is also important when implementing family entrepreneurial training at all levels. The theme of family entrepreneurship in family entrepreneurial training should be included in the strategic intent of the education administration (National Board of Education and Ministry of Education) as a continuum from all-round entrepreneurial
education up to university-level education. It would be best if some secondary education institutions and polytechnics in particular were to specialise in family entrepreneurship. The Working Group also proposes that family enterprises should be included in the strategic intent of the Academy of Finland.
The Working Group proposes that:
(5) In education and science policies, the status of family entrepreneurship should be reinforced and all education levels should invest in family entrepreneurial training in line with the continuum idea, and co-operation between family enterprises and educational institutions should be encouraged.
European examples
Co-operation between public authorities and business life to facilitate generational transfer
It is also necessary to develop co-operation between public authorities and businesses as well as efficient co-ordination of their resources to facilitate generational transfer. Co-ordination could be improved by establishing a certain type of operational centre to advance co-operation between the various actors. Those participating in the activities of this centre and supporting its operation could include the Ministry of Trade and Industry, Finnvera plc, Finnish Industry Investment, the Association of Family Enterprises (Perheyritysten liitto ry), the universities and other necessary public and private actors. This centre could, e.g., promote and monitor the efficacy of public or private actions to advance generational transfer, serve as a data bank, and serve as a public utility network leaning on the existing organisations in various regions and develop co-operation between various public actors, particularly in education and research
to strengthen the continuity of family enterprises and Finnish ownership. This possible Centre for Family Entrepreneurship could also function virtually, for example, in connection with the www.yrityssuomi.fi portal. The Working Group proposes that:
(6) A survey on the needs and resources should be performed for establishing a family entrepreneurship centre that would function in line with the public-private principle and its tasks.
The objectives for the Centre for Family Entrepreneurship could include e.g.:
• joining forces of the existing private and public service providers;
• serving as an expert and a mentor to the incumbent and the successor in generational transfer;
• creating an information network between the public and private sectors for family entrepreneurial issues;
• increasing the expertise of public authorities in the challenges faced by family enterprises;
• advancing ownership of family enterprises, counselling and training in business management and leadership;
• promoting research on family entrepreneurship.
To achieve its objectives, the Centre for Family Entrepreneurship would co-ordinate counselling in generational transfer, which would be facilitated, as proposed by the Working Group, by using a service voucher. Its tasks would also include promoting awareness on generational transfer and development of mentoring. The Centre for Family Entrepreneurship could function on the same principle as the
Women’s Enterprise Agency.
Good examples of the counselling services to be offered to family enterprises include the ViestinVaihto programme and the brochure Yrittäjä – Kuka jatkaa työtäsi issued by the Employment and Economic Development Centre. The ViestinVaihto programme can help to support SMEs in a generational-transfer situation to prepare for the generational transfer process and to implement the selected options and decisions in a controlled manner. The programme consists of three company-specific consultation sessions. As a result, the company receives a written generationaltransfer plan with action plan recommendations.
The brochure Yrittäjä – Kuka jatkaa työtäsi is a programme to support generational transfer, helping the entrepreneur to evaluate the situation in his firm and to prepare for the ownership transfer. This service is provided by the Employment and Economic Development Centre for Uusimaa and the Ministry of Trade and Industry with their partners (www.yrittajat.fi/kukajatkaa).
Once a solution has been found to the financial and fiscal challenges related to the generational transfer, there is still a long way to go before the generational transfer can be said to be successful. In generational transfer, 20% consists of hard factors (financing, taxation and legislation) and 80% consists of soft factors (e.g. interaction and family relations). The training programme should be performed as a so-called public-private co-operation project in which a family entrepreneurship community (e.g. the Family Business Network Finland with its interest groups) could serve as a significant expert body. The Working Group proposes that:
(7) An extensive training programme in family business transfer should be developed where the generational transfer would be regarded as interaction between the incumbent and the successor.
Important target groups for the above-mentioned programme could also include civil servants and consultants that are involved with these issues. The Working Group feels that a system of incentives is needed for planning generational transfer in good time, facilitating interaction between generations, assessing the risks and possibilities in generational transfer as well as various implementation options. This has already been partly implemented in the Viestinvaihto service provided by the Employment and Economic Development Centres. Since the public supply does not in this regard correspond to the number of companies in certain regions, a service voucher or another similar form of support could be developed to encourage firms to use generational transfer-related services. This would respond better to the needs of the firms in various regions. It would be possible to use the service voucher to finance at least half of the limited number of counselling and assessment services as well as training in entrepreneurship and for continuing the business as an owner. In the memorandum of the advisor group for growth entrepreneurship, service vouchers are mentioned as a way to enable purchase of business services, and service vouchers have also been discussed in the Suomalaiset yrityspalvelut Working Group. When applying and implementing the propositions of the above-mentioned Working Group, the propositions of the Family Entrepreneurship Working Group should also be taken into account. The Working Group proposes that:
(8) A service voucher or another similar support form should be introduced to evaluate and to activate family business transfers in firms to enable the firm to purchase those consultation services they need from the open market.
A firm using a service voucher would be responsible for submitting the basic information in the evaluation report to the organisation that issued the voucher, since this would enable determining a schedule for the generational transfer as well as the firm’s status in the generational-transfer process. This would provide information on the generational-transfer status in our companies, since accurate information has been lacking until now. Financing the service voucher system and organising the practical issues through the Centre for Family Entrepreneurship would be more cost-efficient to the state and more efficient than building a separate organisation. The objective for communications is to awaken the incumbent generation to plan the generational transfer in good time and also to encourage the new owner and entrepreneur generation to assume responsibility. The best results are achieved through long-term dialogue between various interest groups. The dialogue would be made available by arranging annual seminars on family entrepreneurship similar to that in 2004 in co-operation with the Ministry of Trade and Industry and together with the service providers as well as by producing information materials.
The Working Group proposes that:
(9) Organising national family entrepreneurship events should be continued in co-operation with the Ministry of Trade and Industry and service providers, and owners of family enterprises should be encouraged to plan the generational transfer in good time.
Family entrepreneurship on display
The continuity of family enterprises has also been considered important on the level of the EU. As part of the Lisbon Strategy and to strengthen employment and competitiveness, it is proposed that during its EU Presidency in 2006 Finland will aim to highlight the societal importance of family enterprises and generational transfers. The objective is to advance the continuity of family enterprises all over the EU. The Working Group considers that this requires concrete actions and an international seminar could function as such. The Working Group proposes that:
(10) An international family enterprise conference be organised in association with the EU Competitiveness Council meeting convening in Jyväskylä in summer 2006.
Monitoring of implementation of and the effects from the actions
It is important that family enterprise activities and implementation of and effects from the actions proposed by this Working Group are actively monitored. The Working Group proposes that:
(11) The implementation of the Family Entrepreneurship Working Group proposals is monitored on an annual basis in the Cabinet Finance Committee, which is recommended to integrate generational transfers and strengthening the Finnish ownership into its agenda.
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