Our economy has seen better days. We've all heard the talk of "unprecedented circumstances" and "tough economic headwinds." We are finding that businesses are using these circumstances as an opportunity to review their operations and proactively looking for ways to simplify their businesses.
Entities Upon Entities
"Simplicity is the ultimate sophistication" is a famous quote by Leonardo da Vinci that I came across recently. It made me think that I'm not sure that many large corporates abide by this tenet. There's a tendency to complicate things by creating more legal entities even when they are not needed.
Corporations tend to form these entities to meet specific operational or financial objectives or to optimize their tax position, or they are inherited through M&A activity. While they don't set out to make things complicated, these entities can proliferate like knotweed and, like with knotweed, elimination requires determination. The longer you leave it, the more daunting removal becomes.
Some global groups have more than a thousand companies. Even when the vehicle outlives its usefulness, groups prop them up or abandon them in place. Maintaining these entities can be expensive and risky and lead to an adverse financial impact. If companies are to navigate through the jumble of entities, they need to tackle the problem head on.
Simplifying The Problem
It is important to adopt a disciplined approach to simplification. For companies that succeed in disposing of their unnecessary entities, the payoff is immediate. By bringing order to the chaos, they are not only reducing the number of entities but they're also improving their planning and risk management.
Once all that knotweed has been cut away, management, employees and systems are freed to spend their time on other important matters, adding value to the business.
In our experience, a major factor of increased corporate complexity is growth through acquisition. Although key performance indicators for acquisitions often involve cost cutting targets and synergies, it's rare for companies to look back at the consequences of having acquired a large and complex structure. The fact is that, once the deal closes, they move on to the next transaction.
Before you know it, there are three times as many entities, and it takes time and energy, both limited resources, to reduce that back to the original number. Groups are always growing and becoming more complicated often adding additional jurisdictions. If left un-simplified, these roots can disrupt the foundations of the corporate and choke future growth.
When To Simplify?
- When you can't describe your corporate structure to your stakeholders, including employees, shareholders and finance providers
- When your non-executive directors or audit committee is questioning why the structure is the way it is
- When the foundations of your business (e.g., finance, legal, HR) encounter challenges doing their day job that result from structural complexity
- Before an unexpected liability crystallizes in the lower tiers of the entity structure that has a contagion effect on the group
- When undertaking material changes to the operating model of your business
Why Simplification Should Be on The Corporate Agenda?
As a group's structure grows, it takes on increasing risk. Each new legal entity brings with it a unique set of challenges and risks. With each new market and each new vehicle, an organization must increase its monitoring and entity management to mitigate risks such as forgotten filings, missed new regulation and unexpected liabilities.
Simplifying the legal entity structure reduces direct and indirect maintenance, administrative and regulatory and compliance costs.
Transparency and governance in relation to operations and financial reporting can be improved when surplus entities are eliminated; this is because it allows the group to refocus upon activities that create value, and assess each entity's utility within the group and understand legacy assets and liabilities and whether the tax structuring remains fit for purpose.
Entity rationalization projects require leadership. As the benefits are tangible and significant but hard to measure, it is important to have a vision of "end state" from the outset and embed a process that captures the benefits on the path to get there.
How Can I Get It Done?
We typically see the following lifecycle:
Kick-Off and Feasibility
- Setup—cost/benefit, project team formation (including external advisors), governance and reporting protocols
- Validation of existing legal entity structure taking into account all acquisitions
- Compilation of entity specific data, including role of each entity
- Classification of entities—is it a target for elimination?
- Questioning entity retention rationale
Due Diligence and Planning
- Complete entity reviews to identify elimination risks
- Compose elimination steps plans and timelines
- Where possible, group entities to secure economies of scale
- Where necessary, seek professional advice on bespoke entity matters pertaining to the elimination
- Secure necessary approvals to proceed with elimination
- Implement the steps plan
- Put in place the necessary corporate documentation
- Deal with ad hoc issues
- Execute the appropriate elimination process to achieve entity dissolution
Most CFOs, general counsels and heads of tax are well aware of the benefits of corporate simplification and will likely have been involved in such projects at some point in their career. As organizations continue to grow and transform their operations following the pandemic and other macro-economic factors, corporate simplification remains an important action to consider. My advice to any C-suite executive in a mid to large enterprise is to look at corporate simplification, and the sooner you start the sooner the cost, risk and operational rewards can start rolling in.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.