For entrepreneurs and business owners, placing shares in a trust ahead of an IPO can provide valuable peace of mind during a complex transaction. Find out more about the specifics of pre-IPO trusts below with Ocorian's Sharon Yam.
One of the most significant decisions an entrepreneur or company founder will make is whether to list on a stock market. While the rewards can be considerable, the initial public offering (IPO) process is inevitably complex, typically involves multiple parties, can take a long time to complete, and is not always guaranteed to reach the finish line.
More personally for company founders, IPOs typically raise a host of questions regarding their own wealth planning, not least how they can protect their shares in the company – not only for themselves, but ultimately their family members.
As a result, many consider establishing a trust prior to IPO to hold their personal shares and employee stock option plan (ESOPs) in their companies. Indeed, 30 of the 147 companies that went for an IPO on the Hong Kong stock market in 2020 opted for such a structure.
A pre-IPO trust is simply a trust structure set up before a trigger event or exit happens. It could technically be any trust – such as a discretionary trust or even a reserved powers trust. Critically it helps protect assets not only after the IPO but also during the listing process when things can go wrong.
Benefits of a pre-IPO trust
Essentially, as with any trust, when a pre-IPO trust is set up, the shares of the founder (or of any senior executives) are handed over to a professional trustee. The benefits of doing so can be significant. Broadly, a pre-IPO trust can be used for an individual key employee to consolidate his own shares and stock options for his own family's succession planning, or an employee benefits trust (EBT) that holds company shares and stock options for the benefit of a group of key executives.
Pre-IPO trusts can also be used to maintain privacy, as it is necessary in the company prospectus to declare its shareholder list – and in this instance it will be the trustee of the pre-IPO trust, not the settlor.
Other key benefits include:
- Protection from claims. The trust, if properly drafted, should protect the shares from any claim by creditors.
- Succession planning. Trusts provide for future generations while protecting the assets from taxes, estate duties and issues around probate in the event of the settlor's death. Importantly this applies whether the listing has happened or if the settlor is incapacitated prior to the IPO.
- Limiting stamp duty. If the company going to IPO is an offshore entity, then transferring the shares prior to listing may reduce the duties on the said transfer depending on jurisdiction.
- Optics. For EBTs, instead of having a long list of individual employees and investors as shareholders, they could be consolidated into a pre-IPO trust, where the trustee as a regulated financial institution is the named shareholder on file.
- Control. By consolidating company shares in an EBT instead of individual key executives, the company has more control over its shareholding amidst staff movements.
A pre-IPO EBT can also avoid the 'bloating' of shareholder lists. A lot of tech firms, for example, will only be profitable several years down the road. So, there will be a lot of fundraising rounds – each of which increases the shareholder list. This increases the risk of the company being deemed as a public company (e.g. >50 shareholders in some jurisdictions), and makes the paperwork such as collecting shareholders' signatures exceptionally cumbersome. By consolidating all those shares under a structure like a pre-IPO trust, the admin involves only the trustee as the single shareholder.
When should a pre-IPO trust be established?
In the simplest of terms, planning for a pre-IPO trust should start as soon as the decision has been made to list. It could even be as early as the seed or early series rounds, where the value of the company is not yet too prohibitive for any stamp duties from share transfers. Not only can the trust take some time to establish, but as mentioned earlier, it can help protect the shares should anything happen to the settlor prior to listing. A pre-IPO trust would make sense in this instance because shares have not yet a high net asset value (NAV) and therefore won't incur high stamp duties when you move them around. In Singapore, this could be 0.2% of the purchase price or NAV of the shares, whichever is higher.
There are also technical considerations around the settlor. If all the shares are attributed to the settlor and as they are the one who settles the shares into the pre-IPO trust, anti-avoidance legislation issues around controlled foreign company (CFC) may arise. However, if a client comes to us early in the structuring process, it is possible for the board of directors to stand as counsel to guide the trustees – provided the settlor is comfortable with this approach.
Taking appropriate advice
It is not uncommon for business owners and wealthy individuals to consider wealth and succession planning only when a significant family event, such as divorce or the death of a family member, occurs. Similarly, it is understandable that in preparing for an IPO, business succession and corporate governance matters will take the highest priority. However, a pre-IPO trust can play a major role in protecting assets before, during and after the listing as well as long into the future, so it should not be an afterthought.
This means ensuring that the trust is set up not only in accordance with the settlor's wishes but also in a way that is compliant with the rules in the jurisdiction in which it is being established. This even extends to technicalities such as reporting requirements once the listing has taken place, which may be dependent on the reporting threshold of the stock market in question and whether there are aggregation issues with other holding companies.
Each trust will be very personal and unique and appointing the right partner who can ensure that the trust deed is written correctly is critical. As is ensuring that the trustee can then administer the trust in accordance with both the law and the settlor's wishes.
This is arguably more important because the pre-IPO trust likely will not exist in isolation and will run alongside the listing itself. Clients will often have kickstarted the IPO conversation with their bank and with their lawyers and the bank itself may have a trust company or they may well work with an external trustee who could set up and administer a pre-IPO trust.
Ultimately, the benefits of a pre-IPO trust can be significant, provided it is given as much care and attention as the listing itself.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.