It is increasingly common for significant families/family offices to invest together for investments or projects of significant size.
Effective structuring of the co-ownership vehicle is of vital importance to ensure optimal operating and tax efficiency. This article examines the significant issues arising.
Principles behind the selection of a co-ownership structure
The key principles underlying the selection of an effective coownership structure are:
- tax efficiency for the coinvesting families particularly where, as is often the case, families come from multiple jurisdictions;
- efficiencies of administration and cost. Families need to be wary of a heavy degree of expensive administrative superstructure at the level of the co-ownership vehicle;
- a structure that can feature segregated cells or share classes for different families can be helpful not just for tax purposes but also to facilitate different exit strategies;
- structures that are easy to replicate for future investments or can be used for a number of investments meeting a preagreed strategy;
- structures that are robust from a tax and regulatory perspective.
Co-ownership vehicles are effectively joint ventures and it is vital to agree at the outset how the venture is to be run and governed.
The contents of a suitable “joint venture” agreement between the families is likely to cover:
- the financing of the investment, amounts to be invested by each family, and, depending on the nature of the investment, provisions for funding future capital calls;
- representing the interests of coinvesting families in the investment. Is there a dominant family (in investment terms) who will manage and monitor the investment on behalf of the other families? It may be that a member of a dominant family will represent the interests of the family on an advisory committee or similar at the level of the co-investment;
- there may be a list of “reserved matters” that need unanimity between the families:
- restructuring of the investment;
- exercise of the voting rights for major events at the level of the coinvestment;
- providing liquidity for families who need to exit early (eg sale of one family’s interest to another investing family or to new investors);
- administration of the coownership vehicle and payment of expenses;
- exit provisions. Each family may have different needs when an investment is realised particularly as to the tax efficient distribution of proceeds;
- managing potential conflicts. An arbitration procedure agreed at the outset can prove beneficial in the event that disputes arise between the co-investing families;
- exit provisions. The joint venture agreement can include provisions for the realisation of the co-investment.
Quite often with co-ownership structures there is a lead family which promotes the investment opportunity to other families. In most jurisdictions when the investment opportunity is a security like a share or a fund, the promotion is regulated and will need to be issued or approved by a regulated entity.
There are normally exemptions for promotion to high net worth or sophisticated persons but great care needs to be taken to comply.
The problem is that families do fall out and if an investment turns sour and there is an unlawful promotion in the chain, the investment might be set aside by a court and families to whom the unlawful promotion was made would be entitled to the return of their investment.
The optimum structure from a tax perspective will depend on the tax position of the different family members in their local jurisdictions. Often, family members will be located in a variety of jurisdictions, which may not necessarily characterise and tax the arrangements in the same way. Therefore it will be important to obtain coordinated tax advice for the applicable jurisdctions, in order to optimise the structure and avoid any problems down the line eg on exit.
Regulatory requirements where the co-ownership vehicle constitutes a collective investment scheme
Where the co-ownership vehicle is a collective investment scheme, there is a risk that it may be regarded as an alternative investment fund for the purposes of the Alternative Investment Fund Managers Directive. This would not be ideal as the co-ownership vehicle would need, under the provisions of the Directive, to appoint a regulated manager and be subject to operational and reporting obligations.
Under the Directive, alternative Investment funds are defined very widely as collective investment undertakings which:
- raise capital from a number of investors with a view to investing it in accordance with a defined investment policy for the benefit of those investors; and,
- are not a UCITS scheme.
There is an exclusion for family office vehicles which invest the private wealth of investors without raising external capital. However, family offices for these purposes are defined very narrowly as circumstances when capital is invested in an undertaking by a member of a pre-existing group of family members for the investment of whose private wealth the undertaking has been exclusively established.
The choice of co-ownership vehicle is driven by a combination of tax, commercial and regulatory considerations. Getting the vehicle right at the outset and incorporating effective corporate governance procedures is vital.
It is important to bear in mind that the exemption is unlikely to be of use to co-ownership structures constituted as collective investment undertakings as the contributions of multiple families is likely to constitute the raising of external capital.