Should Founders Set Up an Asset Management Company? Legal Issues to Check Before Moving Your Shares

Hello, I'm Noriaki Asato, Representative Attorney at LegalAgent.

As their businesses grow and the value of their company's shares rises, founders sometimes ask me whether they should set up an asset management company. In practice, the registration procedure for incorporating the company that will serve as the asset management company is not particularly difficult in itself. What calls for careful consideration is the stage at which the founder moves their own shareholding into that new company. This is because a transfer of shares constitutes a transfer for tax purposes, is subject to restrictions in investment agreements and shareholders' agreements, and may require a detailed explanation of the actual control structure in a future listing examination.

How an Asset Management Company Works and Why Founders Consider One

An asset management company is an arrangement in which assets that the founder holds personally, such as shares in their own company or real estate, are moved from the founder's personal name into a separate corporation that the founder controls and are managed there. The usual structure is a so-called two-tier holding arrangement: the founder holds most of the shares in the asset management company, and the asset management company holds the shares in the operating company.

Commonly cited reasons for adopting this arrangement include consolidating the company's shares with inheritance in mind, passing voting rights to a successor in one block, and more flexible management of funds by having dividends received by a corporation. However, whether these benefits exist and how large they are varies greatly depending on individual circumstances such as family structure, the breakdown of assets held and the outlook for the share price, and it cannot be concluded across the board that the arrangement saves tax for everyone. Determining the concrete effect presupposes a detailed simulation by a certified tax accountant.

From a legal perspective, what should be sorted out in advance is that, before even weighing the tax advantages and disadvantages, the act of transferring shares to the asset management company itself engages several legal restrictions.

The Rules on Deemed-Transfer Taxation When Shares Are Transferred

When a founder transfers shares they personally hold to an asset management company, whether by sale or by gift, the transaction is treated for tax purposes as a transfer of assets from an individual to a corporation. National Tax Agency Tax Answer No. 3217 explains that where land or buildings are sold to a corporation at a price below one-half of fair market value, capital gains are calculated using the fair market value, rather than the actual sale price, as the amount of revenue, and it cites Article 59 of the Income Tax Act and Article 169 of the Order for Enforcement of the Income Tax Act as the governing provisions.

These provisions are not limited to land and buildings; they apply to any asset that gives rise to capital gains, including shares. The core provision is Article 59, paragraph (1), item (ii) of the Income Tax Act. That item makes "a transfer for consideration of an amount specified by Cabinet Order as a significantly low price (limited to a transfer to a corporation)" subject to deemed-transfer taxation. As to what counts as a significantly low price, Article 169 of the Order for Enforcement of the Income Tax Act provides that it is an amount less than one-half of the value of the asset at the time of the transfer. In other words, if a founder sells their shares to their own asset management company for less than one-half of fair market value, the founder is deemed to have sold the shares at fair market value, whatever the actual transaction price, and income tax on capital gains is imposed accordingly.

Note that a transfer at a price of one-half of fair market value or more does not fall under that item, but Income Tax Basic Circular 59-3 states that where a transfer to a family company falls under Article 157 of the Income Tax Act (denial of acts or calculations of family companies, etc.), capital gains may be calculated using fair market value. In addition, on the side of the asset management company that acquired the shares at a price below fair market value, the difference from fair market value may be subject to corporate tax as a gain from receipt of a benefit.

Because the shares of an unlisted startup have no market price, the first practical hurdle is how to calculate this "fair market value." Income Tax Basic Circular 59-6 provides that fair market value in this case is calculated in accordance with Circular 23-35 Common-9 of the same circulars, and sets out a treatment under which, if there are actual sales examples, the value is the price from recent sales that is recognized as appropriate, and if there are no sales examples or the like, the value is calculated, subject to certain modifications, in the manner of the valuation methods for unlisted shares in the Basic Circular on Property Valuation. For a company that has issued classes of shares, the existence of sales examples is determined for each class of shares, so the price of the preferred shares that investors subscribed for in the most recent funding round does not necessarily become the fair market value of the founder's common shares. The level of fair market value varies greatly depending on the valuation method adopted, such as the share price in the most recent funding round, the net asset value or the comparable industry method. Because a mistake in calculating the share price could cause the transfer to be unintentionally treated as a low-price transfer, leading to unexpected taxation or penalty taxes, this valuation work is an area that should be led by a certified tax accountant.

Restrictions Under Investment Agreements and Shareholders' Agreements

In a startup that has raised funds from outside investors, the shares held by the founder are often subject to transfer restrictions or prior-consent provisions under the investment agreement or shareholders' agreement. Accordingly, when the founder seeks to move their shares to an asset management company, the first step is to check whether doing so would breach those contractual provisions. In addition, many startups restrict the transfer of their shares in their articles of incorporation, and to transfer transfer-restricted shares to an asset management company, the founder must obtain the company's approval under the procedure in Article 136 and the following articles of the Companies Act (under Article 139, paragraph (1) of the Companies Act, unless the articles of incorporation provide otherwise, approval is by resolution of the board of directors in a company with a board of directors, and by resolution of the shareholders' meeting in any other company).

There are broadly two points to check. First, whether there is an exception permitting the transfer of shares to an asset management company. The transfer restriction clause in a shareholders' agreement generally prohibits, as a rule, transferring shares to a third party without the investors' prior consent, but some agreements provide, as an exception, that a transfer to the founder's relatives or to an asset management company the founder controls may be made without consent. If no such exception can be found, the founder needs to consult the investors before moving the shares and obtain their prior consent or an agreement to amend the contract. Even where an exception exists, some agreements make it conditional on prior notice to the investors or on the asset management company itself joining the agreement as a party, so the content of those conditions also needs to be checked.

Second, whether the asset management company is included in the definition clauses for "founder" or "management shareholder." Shareholders' agreements customarily include a definition such as "including a corporation substantially controlled by the management shareholder" so that obligations imposed on management shareholders, such as non-competition obligations, the obligation to devote themselves exclusively to the business, and restrictions on disposing of shares, are not rendered meaningless by interposing an asset management company. Whether such language is present determines whether, after the new company is established, the same discipline as applies to the founder personally also extends to that asset management company. Moving the shares without checking the contractual provisions could even lead to the investors pursuing liability for a material breach of contract.

The overall picture of shareholders' agreements and the points to check are also covered in detail in What Is a Shareholders' Agreement?. When considering a transfer to an asset management company, the first step is to directly review the originals of the investment agreements and shareholders' agreements you have on hand.

Impact on the Listing Examination and the Shareholder Structure of the Asset Management Company

Holding shares in the operating company indirectly through an asset management company is one of the issues on which securities companies and audit firms request additional explanation during IPO preparation. In the listing examination, how shareholdings by the founder and other related parties affect the continuity and stability of management is examined rigorously. This is because, with an asset management company in between, explaining who exercises the voting rights and who actually makes decisions becomes more complicated than where the founder holds the shares directly. In addition, the Securities Report for New Listing Application (Part I) contains a section for describing the "transfer of shares, etc. by persons with special interests, etc.," and transfers of shares to which persons with special interests, etc. were party during a certain period before listing are described together with the number of shares transferred, the price and the reason for the transfer. A transfer from the founder to an asset management company may also be subject to this disclosure.

Standards such as what specific materials and explanations will be required in the examination, and what shareholding ratio will be accepted as stable shareholding, depend largely on the individual judgment of the lead managing securities company and the stock exchange conducting the examination, and definitive standards cannot be stated across the board. If you are considering setting up an asset management company before listing, a realistic approach is to consult the lead managing securities company and the audit firm at an early stage and confirm how it will be treated in the examination.

The capital design of who will be the shareholders of the asset management company itself is also an essential consideration. If the founder alone holds 100% of the shares, it is clear where the voting rights exercised through the asset management company lie. On the other hand, some designs prioritize inheritance planning and add a spouse or children as shareholders of the asset management company.

Bringing in relatives as shareholders creates the risk that the voting rights in the asset management company itself will become dispersed due to a future inheritance or disagreements among family members. If the voting rights in the asset management company are split, the founder may no longer be able to decide important matters of the operating company beyond it as they wish. Setting up an asset management company does not fundamentally eliminate the risk of dispersed voting rights; it is necessary to understand, at the initial design stage, the structure under which the place where dispersion occurs effectively just moves from the shareholder register of the operating company to the shareholder register of the asset management company. If relatives are to be shareholders, the safe course is to provide, through the articles of incorporation of the asset management company or an agreement among the parties, for the manner of exercising voting rights and transfer restrictions at the same level as for the operating company.

The Right Timing for Incorporation and the Transfer of Shares

As for when to set up the asset management company and transfer the shares, because the tax cost tends to be easier to contain while the share price is low, an early stage before the share price jumps due to listing or a large funding round makes it easier to keep options open. If the transfer is completed while the valuation is low, the fair market value that serves as the basis for deemed-transfer taxation is itself low, so the tax burden associated with the transfer can be kept small.

On the other hand, interposing an asset management company at an early stage after founding also means that the burden of adjusting the investment agreements and shareholders' agreements increases each time a funding round is carried out. If the agreements already signed have no special provision for transfers to an asset management company, negotiations with existing investors to amend the agreements will arise, and in each new funding round it will be necessary to discuss how to incorporate the asset management company into the definition of management shareholder. The tax reason that a low share price is advantageous and the legal reason that it is preferable to act while contractual relationships are simple tend to point in the same direction, but priorities have to be judged in light of the funding schedule.

Therefore, the decision whether to set up an asset management company and the decision about when actually to move the shares need to be considered separately. Whether to incorporate is a question bearing on the overall policy for inheritance and business succession, while the timing of the transfer is a question determined by balancing the share price level against contractual restrictions. It is important to consider both aspects in step, consulting both a certified tax accountant and an attorney.

Practical Steps: Advancing Legal and Tax Work Together

Consideration of an asset management company divides into an area where verification of the tax effect is a prerequisite, and an area where legal restrictions such as investment agreements, shareholders' agreements and the listing examination must be cleared in advance. If you begin considering this once the value of your shareholding has grown, the safe approach is first to review the investment agreements and shareholders' agreements on hand to confirm whether a transfer to an asset management company is possible, and then to consult both a certified tax accountant and an attorney. Related perspectives on building consensus among shareholders and organizing shares with a future exit in view are also covered in If You Have M&A in View, Review Founder Shares and Shareholders' Agreements Early.

If the transfer is carried out while overlooking contractual constraints or the treatment in the listing examination, it may later lead to disputes with investors or increase the burden of responding to the examination.