Family investment companies as successors to trusts? The value of voting rights

Various governments over the years have legislated to make trusts less flexible and more costly as a means of storing and controlling family wealth.

Tax professionals have moved increasingly to recommending other structures, including limited companies with the generic description of family investment companies.

It is very common for such companies to be created with two or more classes of shares: there will be shares with votes but with little or nothing in the way of economic rights. There will then be further classes of shares with economic rights but without votes: these shares are entitled to dividend income but with no control as to the amounts or timing of such largesse.

Such a structure enables parents to keep a white-knuckle grip on the wealth. The offspring, wayward or otherwise, are dispensed cash sums in the form of dividends as circumstance and occasion demands.

How is the value allocated between the voting and non-voting shares in such a structure? Should all of the value be related to the economic rights? Even with no economic rights, does the ability to turn the distribution tap on and off have value in itself, despite the absence of cash flows?

Evidence regarding the differentials between voting and non-voting shares in the stock markets deliver conflicting messages of limited value: various paired studies have been undertaken, notably in relation to the rich stream of data from the US market. There are various challenges with these studies:

• Many of the studies do not control for differences other than voting rights: some of the nonvoting shares have enhanced or diminished economic rights when compared to the voting shares;
• Some of the companies have a controlling block of voting shares held by a small number of founding insiders. In these cases, the inclusion of some voting shares in the public float does not alter the power dynamic, which is held centrally;
• There is considerable deviation within and between the studies regarding the percentage pricing difference between voting and non-voting shares. In simple terms, there is a lot of noise in the data;
• Some of the studies include cases of non-voting shares being priced at a premium to voting shares. Even the cleverest brains applied to this circumstance are unable to divine a logical explanation, despite their best endeavours.

If there is any central tendency within the swirling data, it is that voting shares in the markets are valued at a premium of some 2% over identical, but non-voting, shares.

This conclusion does not offer much assistance when considering the value of control within a family investment company.

In the past, the bid premiums offered or paid in takeovers of public companies have frequently been misinterpreted as control premiums. Premia of 30% to 40% in the Anglo-Saxon markets (and rather lower premiums elsewhere) have been considered to reflect the value of control.

The thinking is now increasingly of cash flows: this means, in turn, that the bid premiums are viewed as a synergy dataset. Under this interpretation, they reflect the additional value that is thought to exist from harvesting the synergy benefits available to only one or two market participants.

There is limited guidance available from court decisions, but there is one case with some authority, as it was subject to two levels of appeal. This was the New Zealand divorce case of Holt v Holt, which was decided by the Privy Council, the highest judicial authority available (Privy Council (New Zealand) [1990] UKPC 34).

The subject company was LJ Holt Limited, a company which owned a 7,000-acre cattle and sheep farming estate on New Zealand’s South Island.

There was one A share and 999 B shares. The A share had 10,000 votes and each B share had one vote. The A share therefore held 90.9% of the voting rights. The economic rights were pari passu, with the A share entitled to 0.1% of distributions and realisations.

Voting control gave Mr Holt very significant benefits: “the farm could be run at a profit or at a loss depending on the amount which the husband chose to spend on the upkeep and improvement of the farm.” There were no significant profits to be had: “in 1983 the farm was run at a profit roughly equal to reasonable remuneration for the work of the husband in running the farm.”

The husband’s ownership of the A share meant that he was the squire of a 7,000-acre farming estate; he was lord of all he surveyed. The written decision included a memorable description: “the A shareholder is more nearly in the position of a tenant for life impeachable for waste.”

His position was described: “…if he would like to farm the estate and enjoy the advantages of being a farmer in the Wairau Valley as long as he likes, drawing reasonable remuneration, he cannot be interfered with.” The B shareholder could obtain northing without the cooperation of the A shareholder.

The Privy Council drew pictures of three hypothetical exits in the form of propositions to the B shareholders: they all involved the A shares being valued at 50% of the value of the whole.

The New Zealand Court of Appeal had confirmed a value for the entire company of $640,000. The A share had been valued at $150,000 from the perspective of the B shareholders. The value equated to 23% of the whole. The Privy Council’s musings suggested that this could have been increased to 50%. However, they had no wish to interfere with the decisions of the lower courts.

Does the family investment company have a close parallel in Holt v Holt? With an investment company, we might expect there to be a recurring surplus after reasonable management costs. The voting shares could however determine that such surpluses were to be invested in further investments. Outside an action under section 994 Companies Act 2006, the non-voting shares would have no power to alter those arrangements. As with Holt v Holt, their rights may relate to long-term capital appreciation only.

There is a distinction in that there was no prospect of recurring profits with the Wairau Valley estate. Such profits would normally be expected from an investment company. There is a requirement for directors to consider the declaration of dividends each year if they are to withstand a section 994 petition. A weary mantra that the profits were needed in order to develop the investment activities would be recognised, over time, as a stale litany devoid of substance.

There is a further distinguishing feature: the voting shares can control an expanding investment business, but this does not have the same cachet as presiding, as virtual lord of the manor, over a 7,000-acre farming estate.