Leveraging Different Classes of Shares in Japanese SMEs: Customizing Rights for Succession and Stability?

Japanese corporate law, under the Companies Act (会社法 - Kaishahō), provides a framework that allows companies, particularly Small and Medium-sized Enterprises (SMEs), to issue different classes of shares (種類株式 - shurui kabushiki). This capability serves as a significant exception to the fundamental principle of shareholder equality, enabling businesses to tailor shareholder rights related to economic benefits and corporate control to meet diverse strategic needs. This article explores how these various classes of shares can be strategically leveraged by Japanese SMEs for purposes such as business succession planning, ensuring management stability, and consolidating shareholder structures.

Understanding Classes of Shares in Japan (Companies Act, Art. 108)

The Companies Act permits companies to define in their articles of incorporation (定款 - teikan) shares with varying rights concerning:

1. Dividends (剰余金の配当 - jōyo-kin no haitō): Shares can be designed to have preferential rights to dividends (優先株式 - yūsen kabushiki), meaning they receive dividends before common shareholders or receive a higher fixed dividend. Conversely, shares can have subordinated rights (劣後株式 - retsugo kabushiki). Dividend rights can also be cumulative (if a preferential dividend is not paid in one period, the entitlement carries over) or non-cumulative, and participating (allowing holders to receive further dividends alongside common shareholders after their preference is met) or non-participating.
2. Distribution of Residual Assets (残余財産の分配 - zan'yo zaisan no bunpai): Upon liquidation, certain classes of shares can have preferential rights to the company's residual assets over other classes.
3. Voting Rights at Shareholder Meetings (株主総会における議決権 - kabunushi sōkai ni okeru giketsuken): This is a crucial area for customization. Companies can issue:
   • Non-voting shares (無議決権株式 - mu-giketsuken kabushiki): Shares that carry no voting rights on most or all matters.
   • Limited voting shares (議決権制限株式 - giketsuken seigen kabushiki): Shares that have voting rights only on specific matters defined in the articles.
   • Shares with veto rights ("Golden Shares" - 黄金株 - kogane-kabu / 拒否権付株式 - kyohiken-tsuki kabushiki): Shares (often just a single share or a small block) that grant the holder veto power over specific resolutions passed by the general shareholder meeting or the board of directors (Companies Act, Art. 108(1)(viii)).
   • Shares with director appointment rights (役員選任権付株式 - yakuin senninken-tsuki kabushiki): Shares that entitle holders of a particular class to elect a certain number of directors at a class shareholder meeting (Companies Act, Art. 108(1)(ix)).
4. Transfer Restrictions (譲渡制限 - jōto seigen): While not a "class" in itself, all shares of a non-public company are typically subject to transfer restrictions requiring company approval. Specific classes can have tailored transfer conditions if needed.
5. Acquisition by the Company:
   • Shares with shareholder acquisition request rights (取得請求権付株式 - shutoku seikyūken-tsuki kabushiki): Holders of this class can demand the company buy back their shares under predefined conditions (Companies Act, Art. 108(1)(v)).
   • Shares with a company call option (取得条項付株式 - shutoku jōkō-tsuki kabushiki): The company has the right to acquire these shares from shareholders upon the occurrence of certain predefined events (Companies Act, Art. 108(1)(vi)).
   • Shares with a call option for all shares of the class (全部取得条項付種類株式 - zenbu shutoku jōkō-tsuki shurui kabushiki): The company can, by a shareholder resolution, acquire all shares of this class. This is a powerful tool often used in squeeze-outs or emergency restructurings (Companies Act, Art. 108(1)(vii)).

The Companies Act also allows non-public companies to stipulate in their articles of incorporation for different treatment of specific shareholders regarding dividends, residual asset distribution, and voting rights, without necessarily creating formal "classes" of shares (属人的株式 - zokujin-teki kabushiki or "personal shares") (Companies Act, Art. 109(2)). This offers even greater flexibility for tailoring rights to individuals in closely-held SMEs.

The essence is that these features can be combined to create "custom-made" shares that precisely fit a company's strategic objectives for succession, control, and shareholder relations.

Strategic Application 1: Business Succession Planning

Business succession in Japanese SMEs often involves navigating complex challenges such as identifying and preparing successors, determining the timing and method of transferring control, providing for non-succeeding family members, and managing inheritance tax burdens. Class shares, often in conjunction with other legal structures like General Incorporated Associations (GIAs), can offer potent solutions.

Illustrative Scenario & The GIA Model with "Personal Shares":

Consider a typical SME founder (A) who is aging and concerned about succession. A has potential successors (e.g., Eldest Son C, capable non-family Director H) and other family members (spouse, other children not involved in the business) who need to be provided for. A wishes to ensure capable management continues, wants flexibility in the final choice of successor, and desires to prevent outside interference while providing some income to the broader family.

A common sophisticated strategy involves:

1. Establishment of a General Incorporated Association (GIA - 一般社団法人): Key family members involved in the business (founder, potential successors) establish a GIA. Other family members may also become members (shain) of the GIA.
2. Transfer of a Control Block (Minimal Shares with Super-Voting Rights): The founder (A) transfers a very small number of the operating company's common shares (e.g., just one share) to the GIA.
3. Creation of "Personal Shares" with Multiple Votes: The operating company's articles of incorporation are amended (requiring a special super-majority vote under Companies Act Art. 309(4) for such "personal clauses") to grant the GIA, as a specific shareholder, significantly enhanced voting rights for the share(s) it holds (e.g., 1 share = 100 votes). This is permissible for non-public companies under Article 109(2).
4. Conversion of Other Shares: The operating company further amends its articles (by special resolution) to become a "class share issuing company." All other common shares (held by the founder and other family members) are then converted into a new class of shares, typically dividend-preference, voting-rights-restricted shares (配当優先議決権制限株式). This conversion requires the consent of all affected shareholders.

Outcomes of this GIA/Personal Share Model:

• Concentrated Control: The GIA, holding perhaps only one share but with massively multiplied voting rights, effectively controls the operating company. The governance of the GIA (whose members are family) dictates the operating company's direction, including the appointment of its president (who could initially be Director H, and later Son C).
• Flexibility in Leadership: The GIA structure allows the family members, through their collective governance of the GIA, to adapt to changing circumstances and select the most suitable leader for the operating company over time.
• Economic Provision for Non-Successors: Family members holding the dividend-preference, voting-rights-restricted shares receive economic benefits (preferential dividends) without having control rights that could interfere with management.
• Inheritance Planning: The founder's remaining shares (now preference shares without significant voting control) can be distributed more equitably among all heirs for inheritance tax purposes, potentially reducing conflicts over control and minimizing iryūbun (statutory forced heirship) claims against the core control structure maintained by the GIA. These preference shares could also be designed with an acquisition request right (put option) to provide liquidity for heirs needing to pay inheritance tax.
• Why a GIA for "Personal Shares"?: A GIA, as a legal entity, offers permanence for the super-voting rights, as it doesn't "die" like an individual shareholder (whose personal rights would typically extinguish upon death or share transfer). It also allows for collective family governance of the control block.
• Tax Valuation of "Personal Shares": While there's no explicit National Tax Agency (NTA) guidance on shares with such personal, super-voting rights, a common view is that the underlying share itself might be valued similarly to common stock for transfer or inheritance tax purposes, as the special voting rights are tied to the specific shareholder (the GIA) and not intrinsically to the share if transferred to another party without the "personal clause" applying. The NTA's 2007 response to a METI inquiry on valuing various class shares for inheritance tax provides some analogous principles (e.g., non-voting shares often valued like common shares, with a potential minor discount under specific conditions).

Strategic Application 2: Ensuring Management Stability and Shareholder Management

Class shares can also be deployed to manage shareholder relations, ensure stability, and address specific financial or control objectives.

1. Debenture-Like Shares (社債類似株式 - Shasai Ruiji Kabushiki)
These are a specific type of preference share designed to have characteristics similar to debt instruments.

• Key Features (based on METI/NTA 2007 guidance): Fixed preferential (and often cumulative) dividends, no participation in further profits, liquidation preference typically capped at the issue price, mandatory redemption by the company at the issue price on a fixed future date, no voting rights, and no right for the shareholder to request conversion into other shares.
• Valuation for Inheritance Tax: Due to their debt-like nature, these shares are generally valued at their issue price for inheritance tax purposes, which can be highly beneficial if the company's overall value is appreciating. This "fixes" their value for estate planning.
• Use Cases:
  • Providing a stable, fixed-income return to passive shareholders (e.g., retiring founders, non-active family members).
  • Facilitating temporary shareholding by an interim manager or a non-family "stable shareholder," with the assurance that the shares will be redeemed by the company (the "boomerang function").
  • Managing inheritance tax exposure for parts of a founder's shareholding.

2. Shares with Veto Rights ("Golden Shares" - 拒否権付株式 - Kyohiken-tsuki Kabushiki)
These grant the holder of even a single share (or a small class) the power to veto specific corporate decisions.

• Mechanism: The articles of incorporation specify which corporate actions (e.g., election/dismissal of directors, mergers, major asset sales, new share issuances, approval of share transfers by the board) require the additional approval of a class meeting of these veto shareholders (or the sole veto shareholder if only one exists).
• Use Cases:
  • Phased Succession ("Reigning from Behind" - 院政型事業承継 - inseigata jigyō shōkei): A founder can transfer operational leadership to a successor but retain veto shares to oversee critical decisions during a transition period.
  • Protecting Minority Interests or Strategic Alliances: A key investor or strategic partner might hold such shares to protect their interests.
  • Anti-Takeover Defense (less common in SMEs for this specific share type alone).
• Considerations:
  • Public Disclosure: The existence and terms of veto shares are part of the articles and thus publicly accessible through the corporate registry. This can signal the extent of the veto holder's influence.
  • Incapacity of Veto Holder: If the individual holding the veto share becomes incapacitated, it can create a governance deadlock. Therefore, this strategy should be combined with other mechanisms like conditional transfer agreements for the veto share or provisions within a trust.
  • A similar veto effect can sometimes be achieved contractually through shareholder agreements, but this lacks the corporate-level binding power of veto shares embedded in the articles.

3. Shares with Acquisition Request Rights (Put Options) or Company Call Options

• Acquisition Request Rights (取得請求権付株式): Give shareholders the right to demand the company buy back their shares at a predetermined price or based on a formula. Useful for providing liquidity to minority shareholders, employees under ESOPs, or family members wishing to exit.
• Call Options (取得条項付株式): Give the company the right to buy back shares under specified conditions. Useful for consolidating ownership, removing shares from departing employees, or as part of a planned buy-sell arrangement.

Key Considerations When Implementing Class Share Strategies

• Shareholder Approvals: Creating new classes of shares or converting existing shares into different classes invariably requires amending the company's articles of incorporation. This demands special shareholder resolutions (typically a two-thirds supermajority). If the rights of an existing class of shareholders are adversely affected, a separate resolution of that class is also required.
• Valuation and Tax Implications: The valuation of different classes of shares for issuance, transfer, conversion, or inheritance/gift tax purposes can be complex. While the NTA/METI guidance from 2007 provides a framework for common types like preference shares and debenture-like shares, bespoke classes or "personal shares" with unique voting rights may require careful analysis and potentially expert valuation. Tax consequences of conversions, redemptions, and dividend payments for each class must be thoroughly reviewed.
• Drafting Articles of Incorporation: Precision in drafting the articles to define the specific rights, preferences, limitations, and conditions for each class of shares is paramount to avoid ambiguity and future disputes.
• Integration with Other Legal Tools: Class share strategies are often most effective when integrated with other legal instruments, such as trusts (e.g., a GIA holding control shares), shareholder agreements (to govern relations among holders of different classes or within a class), and comprehensive estate plans.
• The Principle of Shareholder Equality: While class shares are a permitted exception to strict equality, the overall design should not be arbitrarily discriminatory or abusive towards any group of shareholders, particularly those in a minority position not benefiting from special class rights, unless clearly agreed and structured within the bounds of law.

Conclusion

Different classes of shares, including the highly flexible "personal shares" available to non-public companies in Japan, offer a powerful and versatile toolkit for SMEs. They enable businesses to strategically structure ownership to achieve specific objectives related to business succession, long-term management stability, shareholder incentives, and the balancing of diverse stakeholder interests. From concentrating control with minimal share transfers using super-voting personal shares held by a GIA, to providing fixed income with eventual redemption through debenture-like shares, or allowing founders to retain oversight via veto shares, the possibilities are extensive. However, the design and implementation of such structures demand a sophisticated understanding of the Companies Act, tax law, and potential valuation challenges. For Japanese SMEs looking to leverage these tools, careful planning and expert legal and tax advice are essential to navigate the complexities and achieve their desired outcomes effectively and lawfully.