The role of trusts in pre-IPO planning

The initial public offering (IPO) process is a watershed event for most Hong Kong business owners that will have significant implications for their personal wealth. During the pre-IPO planning stage, business owners are focused on enhancing the company’s performance and must work closely with investment bankers, lawyers, regulators and equity analysts, as the company is marketed to and scrutinised by potential investors. It can therefore be easy to overlook their own personal situation.

The wealth and liquidity created during the IPO process will oblige business owners to make some of the most important financial decisions of their lives. A key challenge facing a business owner is how best to transition the wealth accumulated from his or her business to subsequent generations. It is therefore critical to establish an estate plan early the pre-IPO planning phase because the opportunities will generally diminish as a deal moves toward the closing date.

One decision is whether or not to place their equity into a trust prior to an IPO. If an appropriate trust and entity holding structure is used, the entrepreneur can retain control and stewardship of the company while minimising the commercial and emotional frictions that can arise before and after an IPO. This article describes how trusts can operate in the broader context of estate planning and the benefits of transferring share ownership to trusts.

IPO trust structure

Prior to the listing of a company, Hong Kong business owners will generally hold a significant number of shares in the trading company through a holding company. Holding companies may qualify for tax-free dividends from the shares, along with voting rights and value held by the company. They also provide asset separation and protection from risks faced by the trading company in the case of legal issues, tax liabilities and lawsuits. Often the holding company will be based offshore to benefit from improved access to global funding, a stable and business-centric legal system and tax neutrality.

In such cases, the Hong Kong business owner can create an IPO trust and then transfer the shares in the holding company (Holdco) to the trustee. As a result, the shares in the company to be listed (Listco) will be indirectly held by the trustee through the holding company.

It is commonly understood that once the trust is established, legal ownership and control will be passed to the trustees. However, through the careful selection of an appropriate form of trust in a jurisdiction with suitable trust laws, there will be viable options for the wealthy settlor or entrepreneur who is concerned about the security and controllability of their assets. The common features of these trust laws lie in their separation of legal ownership of the trust assets from their control and from the economic enjoyment of the trust by the beneficiaries.

The advantages of an IPO trust

Leaving aside any potential tax benefits, the trust will provide a useful tool to limit the risks attached to the business owner’s shareholding in Listco. It can serve to protect the IPO process from a possible adverse event to the business owner – divorce, incapacity or death – and also assist in reducing the risk of fluctuations in the price of shares.

Following a successful IPO, the IPO trust can provide important family asset arrangements for major shareholders. Having the Listco’s shares in the hands of the trustee offers the potential for lifetime wealth planning, succession planning, avoiding probate, asset protection and privacy, irrespective of the number of family members or any changes from one generation to the next.

When the Listco is listed on the Hong Kong Stock Exchange, the trustee will be disclosed as a substantial shareholder of the Listco, together with the trust and the company founder as the settlor of that trust. However, if an IPO trust is structured as a discretionary trust, then the names of trust beneficiaries will not be disclosed because the beneficiaries’ interests in a discretionary trust are not fixed. They are instead determined by the trustee in accordance with the terms of the trust deed.

Another important element of trust arrangements in IPO planning is the potential of a trust for the benefit of employees. Employee benefit or incentive structures can be provided through discretionary trusts. The rationale for establishing an employee benefit trust (EBT) is primarily to hold shares in the newly formed Listco and for those shares to subsequently be used to provide tax efficient incentives for management.

An IPO advisory team is critical to helping the Hong Kong business owner navigate the complexities and intense demands that emerge when preparing for the IPO process – both in terms of the business impacts and the personal implications of the transaction.

Sovereign Hong Kong can provide business owners with the full range of professional expertise necessary to undertake the planning required for a successful initial public offering.

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