When starting a new business, a fundamental question becomes how should it be structured? Then as the business grows and evolves, its structure evolves along with it, sometimes in a haphazard way. What started as a simple family owned business can turn into a complicated maze of entities.
Whether at inception, periodically or during uncertain times, it is a good idea to consider whether the business structure is fit for purpose, efficient and in alignment with long term goals.
Various types of entities can be ‘created’; trusts, companies, look through companies (LTCs), partnerships and limited partnerships. Each have their own attributes, pros and cons. They should be well understood to enable the right type of entity to be used for the right purpose, and if multiple entities are being created they should work together.
One objective should be the limitation of liability and risk, but pursuit of this objective can give rise to a proliferation of entities, hence there is a cost versus benefit aspect to be considered. The effectiveness of a well thought out structure that does limit risk could be negated if guarantees are given that put wider assets at risk. Particularly the family home. Hence, it is also important to structure debt in such a way that reduces the need for guarantees. One approach is to aim for a balance sheet, by individual entity, that allows it to stand on its own two feet.
Think ahead to how the business might be sold. All at once or in stages? If held within a company will the shares be sold to a third party? Is the company ready for sale? Or will you retain the company and sell its assets. Or will the business be transferred to the next generation and how? Do your kids want it?
Tax legislation invariably needs to be taken into account. For example, tax benefits exist when multiple entities are held under a single point of ownership. But this can be contrary to maintaining separation which reduces risk.
In some cases, splitting a business into different entities occurs so that performance of an individual entity can be tracked. However, this could be achieved through an effective accounting system.
A good place to start is to:
- Map each entity (business and personal), whether few or many, including the ultimate owner.
- Outline the nature of each entity’s operations, what does it do and what is its purpose?
- Outline the types of assets held by each entity and distinguish between business assets and personal assets.
- Review existing debt arrangements for each entity and understand the risks associated with any guarantees.
- Finally, review how decisions are made for each entity and the group overall.
A material factor to take into account is personal preference and what is important to you. If you stand back and look at your structure after completing the above exercise and it does not appear logical, taking into account how you plan to exit the business, it may be time to make some changes.