15 May 2015
Reorganise your company to improve efficiency
We have all been at those meetings where a group’s legal entity structure chart is tabled, only to be greeted with what looks like a small book, with page upon page of entity diagrams, or, if you are lucky, a one pager that is nigh on impossible to read. Trying to make sense of it all, for the group, its advisors and other stakeholders, can often be a time consuming and expensive process.
Many of today’s company entity structures have evolved over time, often as a result of mergers and acquisitions or tax planning opportunities, and in many cases, are no longer fit for purpose. Groups often fail to recognise the annual costs of maintaining these structures and the associated problems they can bring, for example when it comes to raising finance or seeking to dispose of part of the business.
As more groups embark on general cost reduction exercises, the penny has finally dropped that significant financial savings can be made, and a group’s overall risk profile reduced, by undertaking a Legal Entity Rationalisation (LER) programme. The elimination of surplus or redundant legal entities is however the final phase of any LER project. At the outset, groups will need to think about what their end-state structure should look like.
Company secretaries are at the heart of an LER programme and can carry significant influence when instigating them and ensuring their effective delivery. They are able to add value and expertise as they often have the widest lens on the group structure, an appreciation of the current activities of each company within the group, and an understanding of the burden of statutory compliance to maintain the structure and the personal risks for the respective company directors.
Unfortunately, there is never a ‘one size fits all’ approach when it comes to designing a legal entity structure. There are a variety of issues that will inevitably help shape discussions around it, but the first and most important question that should be asked when embarking on any such process should always be if the existence of every company in the group can be justified.
It is not uncommon for a group to be operating in one particular industry sector or market, yet have several legal entities all performing the same activity. In extreme cases, we have even seen instances where subsidiaries of the same group have actively, albeit unknowingly, competed with each other for contracts – not a scenario any group wishes to find itself in.
Including all the relevant functions is also key to the planning process. This usually means seeking counsel from representatives in tax departments, finance, legal, human resources, operations, regulatory and IT.
Although there is no prescriptive template, when designing their preferred end-state structures groups should consider the following:
Fundamentally, any entity should serve a useful purpose to the group which adds value to its activities. Although this might sound like a no-brainer, it is remarkable how many entities are created and then retained when their purpose and activities could or should be undertaken elsewhere in the group.
One of the common purposes of undertaking an LER is to end up with a leaner, more agile structure, which will empower groups to seize opportunities more quickly.
The structure should be aligned with the future growth strategy of the group, which may, for example, include raising external finance, disposing of non-core businesses and transforming existing finance operations.
It is worth remembering that a leaner structure is typically more attractive to possible acquirers, in the case of discussions around exit strategies.
As tax has historically been one of the main drivers for the evolution of existing structures, it is not surprising that the same considerations are often at the forefront of redesign.
It is essential however that care is taken to ensure that existing tax benefits are not lost while exploring future tax structuring benefits. The involvement of in-house and external tax expertise is critical when designing the end-state structure.
Having fewer entities undoubtedly reduces the overall risk profile of the group, allowing for more effective governance. However, it is important to note that directors can also reduce their own personal risk profile by having fewer appointments, particularly over entities where they may not have the relevant corporate knowledge or background.
In certain circumstances, it may be desirable to ringfence a specific trade or other issue within a legal entity to benefit from limited liability and avoid potential contagion to the rest of the group.
The regulatory regime of the group’s particular industry sector (or sectors) can have a significant impact on the design of the entity structure. For example, if an entity is registered to undertake investment business with the FCA, regulatory approval may be required before entities are eliminated or trading activities transferred elsewhere in the group.
Many groups today are multinational, operating in a number of jurisdictions and utilising a number of different entity structures depending on the geography. Most organisations would aim to have
one entity per jurisdiction, but this is not always possible or even desirable. Specialist advice should therefore always be sought when dealing with overseas jurisdictions.
After the LER programme, it is not quite job done. Having invested time and effort to get the structure in order, it is of paramount importance to then ensure you have tight control over its future evolution.
Ideally, there should be somebody (or a committee) responsible for controlling the number of entities formed, and whose job is to undertake periodic reviews of the structure. Where there are acquisitions being made or in the pipeline, the integration of any acquired businesses should also include a strategy for dealing with any redundant entities.
What looks good for one organisation will not necessarily work for another, but fundamentally, the legal entity structure should support the groups’ goals, be cost effective to manage and promote good corporate governance. Having advisors on board who are experienced in LER should help ensure you do not end up with the same unwieldy structure you started with.
John Milsom is Restructuring Partner at KPMG and Jacqueline Edwards is Restructuring Manager at KPMG