Previously, I published a series of articles such as Equity Partnership and Equity Succession in Private Enterprises on the WeChat public account of “Longan (Guangzhou) Law Firm,” which discussed equity allocation and equity partnership mechanisms. Once equity allocation is completed, in what form should shareholders hold the company’s equity? Before discussing this question, let me share an example.

Case: A project company has two shareholders, Founder A and Founder B. Founder A holds a 70% equity stake, and Founder B holds a 30% equity stake. For Founder A’s equity, which holding structure is more reasonable?

I believe that which structure to adopt for holding shares depends on the specific goals Founder A wants to achieve. Different goals call for different holding structures. I will elaborate on this from the following five dimensions.

(I) Debt Risk Isolation Dimension

To prevent the debt risks of the project company from transferring to Founder A, one can utilize the feature of limited liability companies where “shareholders bear limited liability to the extent of their subscribed capital contributions.” A can set up a limited liability company (LLC) as a holding platform, which then holds the equity of the project company.

The equity structure is shown in the diagram below:

Note:

1. The reason A and B jointly establish the holding company is that if the holding company is a single-shareholder company, according to the provisions of the Company Law, A would have to bear joint and several liability for the debts of the holding company, unless A can prove that their personal assets are not commingled with those of the holding company.

2. Entity B should avoid being the spouse or a direct relative of A; otherwise, it is easily determined by judicial authorities as a single-person company in substance.

3. Since shareholders bear limited liability within the scope of their subscribed capital, the registered capital of the holding company does not need to be excessively high.

Legal Basis:

Article 63 of the Company Law: Where the shareholder of a one-person limited liability company cannot prove that the company’s assets are independent of the shareholder’s own assets, the shareholder shall bear joint and several liability for the company’s debts.

(II) Tax Optimization Dimension

From the perspective of tax optimization, a holding platform is generally established (often registered in certain tax havens/tax valleys). The general structure is as follows:

Tax Analysis Comparison:

Q1: Since the tax burden of a holding platform does not present an advantage compared with a natural person shareholder holding shares directly, why consider using a holding platform?

(1) After the dividends and distributions of the project company are distributed to the holding platform (LLC), as long as the holding platform does not distribute dividends to A, no individual income tax (IIT) will be incurred.

(2) If the holding platform (LLC) uses its earnings to invest in other industries, it can serve as a capital operations platform to horizontally develop other businesses, and there is significant room for tax planning.

(3) For a holding platform in the form of a partnership, as long as the partnership makes a profit, the partners are subject to individual income tax regardless of whether profits are actually distributed to them. A partnership holding platform is typically suitable for employee stock ownership plans (ESOP).

Q2: If the project company gets listed and Shareholder A wants to reduce a portion of their shares for family asset allocation needs, how should the equity structure be designed?

As mentioned, the comprehensive tax rate of the proceeds from share reductions through a holding platform (LLC) for Shareholder A is 1 - (1 - 25%) * (1 - 20%) = 40%. Therefore, if the company has an IPO plan and the actual controller intends to reduce some shares for personal living needs, the actual controller can directly hold a small portion of the shares personally, while the holding platform holds the remaining majority.

For example, the following holding model can be adopted:

Description:

1. When the company’s shares are listed, the controlling shareholder generally must commit not to reduce their holdings within 3 years. To maintain the stability of the company’s stock price, large-scale cash-outs by the controlling shareholder are rare.

2. Under this equity structure, Founder A directly holds a small portion of the listed entity’s shares (recommended to be 1%–5%). If Founder A needs to cash out, they can cash out from this portion of shares. At this point, the tax rate on Founder A’s stock cash-out is 20%, which is much lower than cashing out through the holding company.

In actual practice, Bull Electric (Gongniu Group) adopted this structure:

(III) M&A and Restructuring Dimension

Suppose A holds a 70% equity stake in a project company through a holding company, and the book value of this equity is RMB 7 million. A listed company plans to acquire the 70% stake held by the holding company (fair value of RMB 200 million) by issuing new shares. Upon completion of the transaction, the holding company will hold a 5% stake in the listed company (as shown below).

According to Caishui [2009] No. 59, Caishui [2014] No. 109, and Caishui [2014] No. 116, the holding company can opt for special tax treatment in the above transaction, meaning that it does not need to recognize equity transfer income based on the fair value of the equity at the time of the transaction.

In the above case, if Shareholder A directly held the 70% stake in the project company, the transaction would not be eligible for special tax treatment (though taxable income from the equity transfer could be recognized over five years under Caishui [2014] No. 116). Therefore, from the perspective of M&A and restructuring tax policies, holding shares through a holding company is superior to direct personal ownership.

(IV) Capital Operations Dimension

From the perspective of capital operations, Founder A generally needs to establish a holding company to hold the project company’s equity, rather than direct ownership as a natural person. The equity structure is typically as follows:

This holding structure serves the following purposes:

1．The holding company provides guarantees for the debt financing of the listed company (or proposed listed company), thereby improving the credit rating of the listed company’s debt and lowering financing costs.

2．The holding enterprise can stand ready to acquire non-premium assets of the listed company, coordinating resources for the future development of the listed company.

3．Establish a holding company to absorb business segments of the listing entity that are currently unsuitable or premature for listing. When the timing is ripe, these segments can be listed independently (domestically or abroad, A-shares or the New Third Board) or injected into the listed company via private placement.

(V) Wealth Succession Dimension

If A’s children wish to start a business outside the ecosystem of A’s current companies, they can establish a project company through joint external investment by A’s holding company and the children. The holding company will hold a minority stake and the children will hold the majority stake, but the holding company will provide the majority of capital contribution while the children provide only a small portion.

In this manner, the dividend distributions received by the holding company from the project company, as well as the proceeds from share reductions, do not need to be distributed to A first before A supports the children’s entrepreneurship. This avoids the individual income tax generated when the holding company’s profits are distributed to A.

The equity structure is as follows: