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All change please: family businesses in an enterprising economy

The wellbeing of owner-managed and family businesses is central to the strength of the European economy as a whole. These firms account for more than 70% of employment in the EU and make a major contribution to economic output in all member countries. They provide a continuing source of entrepreneurial energy within the existing EU and are sure to play a key role in evolution of the economies of the new member states.

As the European Commission has underlined in its recent Green Paper, entrepreneurship is a key engine of growth and innovation, essential to the development of a prosperous Europe, and there is a major role for family businesses in stimulating a more entrepreneurial culture – but only as long as those responsible for policy-making at both the national and the European level ensure an operating environment which encourages these firms to innovate and grow. This paper identifies some of the areas where GEEF believes action is needed.

The qualities of owner-managed and family businesses
Owner-managed and family businesses are sometimes classified as small and medium-sized enterprises (SMEs), but in fact they come in many different scales and structures. Some are indeed SMEs, while many have global reach and substantial turnover. All should be encouraged to see the European single market as their natural home market. Whatever their size, they share a number of important qualities which bring special benefits to society and to the economy where they operate.

- They have a stable capital structure, usually backed by family finance and providing a sustainable long-term structure, strategy and performance.
- They are able to take a long-term view of both staffing and investment, and are less concerned with short-term shareholder value. Their investment horizon allows contra-cyclical investment.
- They tend to be more labour intensive, less capital intensive. There is less hire-and-fire, but a high capacity for employment creation.
- Innovation can be achieved at relatively lower costs, drawing on internal sources of capital and re-investment of profits.
- There is usually a strong local commitment, so these businesses make a substantial contribution to the economic, social and environmental quality of the communities where they are established.
- They have a strong enterprise ethic, uniting a long-term strategy for the business with an awareness of environmental and social responsibility.
- They foster entrepreneurial instinct at the family level, often acting as incubators for new companies.
- Many are active as mentors to a new generation, helping young people to learn more about business and stimulating the entrepreneurial culture.

Taxes on business transfer
Within the next decade a significant number of companies in Europe will face a transfer of ownership, mostly because of demographic trends. The European Commission's Expert Group on the Transfer of Enterprises reckoned that 610,000 businesses a year, accounting for 2.4 million jobs, would change hands in the coming decade. Many of these are family firms and about one-third of European owner-managed and family firms are run by men and women aged between 50 and 60 years old. A smooth transfer of these businesses is in the interests of economic prosperity in Europe and is highly significant for Europe's competitiveness. As European Commissioner Erkki Liikanen has said: "Europe's growth and employment performance relies on the enterprise sector. In order to achieve the Lisbon objective [for Europe to become the most competitive and dynamic knowledge-based economy in the world by 2010], we cannot afford to lose viable enterprises in the transfer phase."

The European Commission calculates that up to 1.5 million enterprises could close because of succession problems in the next 10 years, with the consequent loss of more than six million jobs. Many of these closures and job losses will arise from the difficulties encountered by family firms when transferring their assets from one generation to another or when selling to a third party.

GEEF's main concern is over capital taxation, such as inheritance tax, gift tax or capital gains tax, which some European governments still impose on the retirement or death of the owner. These pernicious taxes often enforce the liquidation of company assets and shrinkage or closure of the firm, with corresponding loss of jobs. The costs to the economy arising from such closure, including social security costs and the loss of future corporate taxes and income tax, often almost certainly outweigh the one-off boost to revenue arising from the capital charges.

Such taxes are a deterrent to the early transfer of the business, when greater participation of a younger generation might be desirable to introduce more dynamism into the firm. They oblige capital which is tied up in the business to be liquidated and are a major disincentive for entrepreneurs thinking of expanding their own enterprise or taking over a going concern. They penalise responsible action by owner-managers who know the time has come for change, but also know that the fiscal burden on the company will defeat the object.

The European Commission has consistently stressed the need for national authorities to create conditions that allow a smooth transfer. GEEF welcomed the Commission's recommendations in 1994 and 1998 and the conclusions of the Expert Group on Transfers in 2002. Some EU countries have subsequently modified their tax regimes, but substantial further progress is needed. As a basic principle, neither the donor nor the recipient in a business transfer should be penalised in relation to those assets which stay within the enterprise.

There is every indication that those member countries which have been sensitive to the damage caused by such capital taxation and have adjusted their tax regimes accordingly have seen a major boost to entrepreneurial activity.

Recurrent taxation
The potential for growth in owner-managed and family businesses in some European countries is seriously undermined by recurrent taxation imposed on private ownership of the capital. Even where profits are retained within the business for new investment they are attributed as the personal income or capital gain of the entrepreneur. This is a major disincentive to expanding the business and undermines one of the main potential strengths of the family firm – the ability to fund expansion from retained internal resources.

In those countries where such recurrent taxation is applied, it is more expensive for a family company to build up its equity base than it is for an independent enterprise. Thus, they increasingly depend on loan capital for any expansion. In some member countries this problem has become a threat to the very existence of owner-managed and family firms.

Elimination of the negative effect of such recurrent taxation would create a more positive environment for building owner-capital, as entrepreneurs would no longer suffer a disadvantage when investing in their own businesses and employees would be encouraged to reinvest dividends on shares which they owned in the firm. This aspect should become an element in the debate that the European Commission has initiated on the taxable base for corporate taxation.

Cross-border issues
Certain taxation problems relating to cross-border investment within the European single market are a major discouragement to family firms wishing to expand their activities in other member countries. GEEF is following developments on two current questions:

- The impact of inheritance tax where business assets are located in two EU countries which do not have a bilateral double taxation treaty between them. France, for example, may impose 55% inheritance tax on the assets of a deceased German entrepreneur in addition to the German inheritance tax. The European Parliament Petitions Committee is currently examining a relevant case.
- Capital gains tax imposed on a company from another member country when it withdraws its investment from France – the European Court of Justice is currently examining the freedom of establishment implications of a particular case.

Responsible ownership
The issue of corporate social responsibility (CSR) is receiving increasing attention within the EU, with an intense debate under way as to how social and environmental concerns could be more effectively integrated into the daily operations of businesses. However, for most owner-managed and family firms responsible ownership is already a central tenet of their existence, with both ethical and business considerations determining their approach. The location of these firms and its management are often closely linked. They have a special role in their local community which is both personal and corporate and many such firms make a major contribution to the life of the locality and the quality of its environment.

It would be counter-productive for CSR to be imposed on companies through prescriptive regulation and bureaucratic requirements. Each family company will have its own distinctive relationship with the community where it is based, depending on the location of its plant or office, its workforce and its customer base. Imposition of formalised conditions will be counterproductive and less responsive to the practical needs of the area.

Owner-managed and family businesses play a vital role in the European economy in terms of capital investment and employment, so the economy as a whole will suffer if the health of these companies is weakened by excessive regulation at the European and national levels. The creeping extension of EU employment legislation is a particular concern, where the added burden of administration for companies as a whole far outweighs any particular benefits for individual employees and undermines employment prospects for the longer term.

It is in the interests of both companies and workforce to have a framework of employment law that provides flexibility – while at the same time protecting workers from treatment which is obviously unfair. GEEF is concerned that the draft EU Treaty currently under discussion should not introduce new commitments for employment legislation at European level and in the process undermine the dynamism of family businesses.

Major obstacles
An unfriendly business environment for owner-managed and family businesses, with hostile tax provisions and over-regulation, has damaging effects on the European economy. It undermines the sustainability of existing businesses and discourages expansion, while sending negative messages to entrepreneurs who might otherwise think of setting up new enterprises. It is a major obstacle to the creation of the entrepreneurial culture that all the European institutions recognise as a vital driver for a more dynamic European economy and which is so important for both the present member states and for the countries which will join the EU in 2004.

Stimulation of business enterprise is a prerequisite for the creation of wealth for society as a whole, but GEEF has noted that the Charter of Fundamental Rights currently being considered under the EU Constitution merely 'recognises' the freedom to conduct business, while offering substantial protection to those who are employed and to those seeking employment.

GEEF will continue to press policy-makers at European and national level to create a business environment for owner-managed and family businesses which will stimulate their development and promote their continuity and competitiveness by removing existing obstacles and disincentives and so releasing their full potential.

Owner-managed and family businesses have a significant role to play in the strength and dynamism of the European economy. These firms account for more than 70% of the jobs and a high proportion of economic output in all the EU member countries. Family business investment horizons are long-term and governed by a strong sense of social responsibility and its employment policies tend to be contra-cyclical. It is a vital source of entrepreneurial skills at a time when Europe is in great need of such skills.

GEEF believes that – given the appropriate fiscal and social conditions – owner-managed and family firms could make an even greater contribution to Europe's enterprise economy. This has been recognised by the European institutions, including the Commission, but much still remains to be done in areas such as taxation, where the responsibility rests with national governments.

GEEF continues to press for action on some key issues:

- Taxation on business transfer. One in three businesses is expected to change hands over the next 10 years, but the fiscal regimes in some EU countries, especially inheritance tax, gift taxes and capital gains taxes, are forcing the withdrawal of capital from viable firms, leading to their contraction or closure.
- Recurrent taxation. Some member countries impose capital gains or income taxes on funds which are ploughed back or retained within the business, imposing a continuing drain on the firm's capital base.
- Cross-border issues. The single market has great potential for family businesses, but significant obstacles are emerging for firms which wish to establish themselves in more than one member country, such as double inheritance tax and capital gains taxes.
- Corporate social responsibility.  Owner-managed and family enterprises have a strong but informal social and environmental commitment, which would be damaged if prescriptive regulation were forced upon companies. 

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