Diversification and family businesses: current trends

"Diversification is the only free lunch in investing"

The above quote from Nobel Prize winning economist Harry Markowitz is a staple of financial advice. No credible wealth manager would suggest an investor put the bulk of their assets into one undiversified business, but would instead suggest having exposure to different businesses, asset classes and sectors. We are seeing an increasing number of clients ask why this logic does not apply to their stake in a family company, a trend accelerated by changes to UK tax rules on family businesses.

In this article we explain the issues we have seen families grapple with and potential solutions.

Why don’t families diversify?

A family business with a focused strategy can be a wonderful thing. By concentrating resources in one area they often perform better than businesses that try to cover too many bases. There is considerable academic literature recommending "sticking to your knitting" as a sound corporate strategy.

From the family's perspective, diversification can be particularly tricky even if the family wanted to: diversifying beyond their traditional core business may require external capital, increased need for the expertise of non-family managers, and require a lot of difficult conversations about the purpose of the business. To paraphrase one family member "we have all done very well out of the business – why on earth should we jeopardise that"?

A further consideration is tax. Traditionally, Business Property Relief ("BPR") and Agricultural Property Relief ("APR") meant that an interest in the trading family business or family farm was largely exempt from inheritance tax. The same reliefs do not apply to investments generally and the benefit of the reliefs are reduced or lost completely as a business becomes more of an investment company than a trading / agricultural business. Holding investments in a family business therefore risked exposing the family to a larger tax bill on death.

Why some families are thinking about diversifying now

There have always been discussions within families about diversification. This is especially the case from family members who are not directly involved in the running of the business and who may have a lot of their wealth reliant in the success of the business. It is also not uncommon for a generational change in ownership or management to be a trigger for the business branching out.

Such debates have, however, been given more impetus by recent changes to the tax rules. As many readers will be aware, the rules on BPR and APR are becoming less generous. From April 2026, broadly the rate of relief will be halved to 50%, with assets over £1 million attracting a 20% tax liability on death.

This has had a two-fold impact on family's approach to diversification:

• It has directly lowered the tax advantage of keeping the family's wealth in the one BPR / APR qualifying business relative to having non-qualifying investments.
• It has created a challenge on funding a tax liability on death from the business.

Structures to think about

There are a number of routes available for families who wish to increase the diversification of their wealth that stop short of simply selling up and leaving the business completely.

One interesting approach we have seen is for the sale of non-core assets to fund a pool of cash for investment. The cash could be distributed to shareholders to allow them to invest as they think fit or kept within common family ownership in a family investment company (FIC). For example, we have seen landed estate clients take this approach and sell off land for development and use the proceeds to funds a share portfolio for the family.

For those families who are thinking about an exit, another interesting trend is towards using Employee Ownership Trusts (EOTs). This route provides a tax-efficient way to sell the family business while ensuring the company is left in the hands of its employees (many of whom would have been key to the business's success). With an EOT a trust set up for the employees essentially buys a majority stake in the business, with the sale proceeds being free from capital gains tax. The family can remain involved post-sale and can also benefit from reduced deal risk compared with a traditional sale.