Structuring for smart businesses

By Scott Moran, Partner

First published in The Dominion Post & Waikato Times, 25 February 2008

Businesses often perceive the need for a restructure is limited to circumstances where a company needs to recover from financial difficulties. They also perceive that the costs of a restructure can outweigh the benefits. Often, however, a delay in reviewing its structure will result in it not keeping pace with its size and operations.

Legal restructuring can take many forms and we discuss a common form of company restructure for a growing business in this article.

Vesting the underlying value of the business in a holding company is a common tool to separate the accrued value and goodwill in a business from its operational components that are held through subsidiary companies. Subsidiary companies are companies that are 100% owned by the holding company.

This structure can have a number of benefits.

Separating out parts of a business into separate companies allow joint venture partners to be introduced seamlessly into parts of the business without the business owners having to be concerned with such impacting on the core ownership of the business.

Separation of components of a business allows a business to limit exposure to creditors, landlords and financiers to the particular part of the business trading, leasing or borrowing respectively.

Separating out parts of a business into separate entities can also allow parts of the business to be sold with ease.

Intellectual property assets, such as trade marks, patents and copyright works, are often held by either the holding company or a separate intellectual property company. This entity may then licence the intellectual property to the various operating entities in the structure that require use of the intellectual property. This again means that if one of the operating entities was to be at risk for any reason the holder of the intellectual property can cancel the licence, thereby protecting the value in the intellectual property. A dedicated intellectual property entity is often used as it may be able to commence its own activities outside the core business by otherwise exploiting the intellectual property, for example, overseas.

As an example, ABC Consulting, after establishing itself in Wellington, expands its operations over time to establish businesses in Hamilton, Christchurch and Melbourne. It incorporated a limited liability company when it established Wellington and has continued to use the original company to establish and operate all 4 businesses and the ABC Consulting brand.

Upon receiving advice it restructures into 5 companies, 4 companies to operate each of the consulting businesses, a holding company to hold the shares in each consulting company and to hold the intellectual property.

Over time it transpires Melbourne is trading at a loss and underperforming, Hamilton’s management team want to acquire the local consulting business or they will leave to start their own, and the owners, based in Wellington, are finding servicing the Christchurch market difficult and have been speaking to an established Christchurch based consulting firm that are keen on a 50/50 joint venture.

If the companies had not been restructured the underperforming Melbourne operation would have the potential to be a drain on, or even fatal to, the global business. However, because it is a separate company the holding company can if it elects place the Melbourne subsidiary into liquidation with the creditors only having recourse to the assets of the Melbourne company.

In Hamilton, the business owners can easily negotiate a management buy-out of the Hamilton company rather than having to go through an exercise of selling a specific part of a global company (and possibly its intellectual property).

In the meantime the Christchurch subsidiary can enter into its joint venture. The joint venture is with the Christchurch subsidiary only, not the entire business.

Throughout these events the holding company also retains ownership in the intellectual property and so can control the right to use that at any time, and indeed expand its operations again.

It should be noted that it is not unusual for third party creditors to seek guarantees from holding companies, although such guarantees can often be negotiated.

While the above example may be prudent from a risk perspective, every case will need to be considered on its own facts. Other factors that will be taken into account on reviewing a structure will include tax efficiencies and the additional compliance costs created by additional entities. Structures should be reviewed regularly.

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