This article appears in the November issue of our International Corporate Structures Newsletter.
It’s well known that Lexcorp, Lex Luthor’s vast business empire, includes thousands of companies all over the world. You might wonder why he doesn’t simplify it, and reduce what must be a huge administrative burden. No doubt a profusion of companies may be helpful in money laundering and disguising the proceeds of crime. But of course Lex has a very carefully cultivated public image, and the advent of Country-by-Country reporting is not something he wants to be seen to ignore.
For other corporate groups, sometimes it’s obvious that the number of legal entities may need to be cut down. The group may have 128 dormant companies, each of which have done nothing for 15 years. There may be a global policy at head office level which instructs local management to implement a policy of legal entity reduction. Or a key regulator may decide that the group’s haphazard corporate structure represents an unacceptable risk, and needs to be addressed. In these situations, you just go ahead and do it. (“You” being the CFO, FD, Company Secretary or whoever has responsibility for the legal structure of the group globally or in the relevant region.)
In other cases, removing unnecessary legal entities might seem like a tempting idea. But, like Lex, you will want to evaluate it first. Here are some of the key hurdles which can sometimes prevent a much-needed simplification project:
Corporate simplification projects require resource. It might seem like it’s just a matter of signing a few forms to strike the relevant companies off, but that’s not the case. You will need to involve each of the key functions in the group, from legal and tax to HR and insurance. You’ll need a methodology to establish that removing the companies will not trigger material liabilities or the loss of material assets. You may need to appoint liquidators. And you may need to take specific corporate actions to deal with issues that emerge.
- The financial benefit is uncertain and is deferred
Although removing companies should produce ongoing cost savings – such as audit and company secretarial charges – it is notoriously difficult to quantify them. So you’re talking about incurring a significant upfront cost to produce an uncertain, deferred benefit. In our experience, if the possibility of cost savings is expected to be the main driver, then the project probably won’t go ahead.
- Corporate memory issues
This one can be a killer. For directors to approve the removal of a company, they need to be reasonably satisfied that there are no outstanding liabilities or assets which need to be dealt with. Proving a negative can be challenging, especially if key members of staff have moved on, and there’s little information about why the company exists and what it has done. Addressing this issue properly takes a consistent, systematic approach.
- You don’t have enough time
Keeping a major corporate simplification project on track requires a big investment of time. Setting up the core team. Agreeing the parameters. Setting budgets. Creating standard approaches. Setting deadlines. Monitoring progress and troubleshooting. Perhaps you can’t spare that time, and perhaps the project just isn’t important enough for you to prioritise.
- Your colleagues don’t have enough time
Legal entity reduction projects usually involve issuing due diligence questionnaires to a variety of people within the group. This means asking people to take time out of their schedules to focus on something else. Overcoming the ‘too busy’ factor takes focus and determination.
- Your directors don’t actively support it
This is another critical reason why corporate simplification projects can grind to a halt. You need serious support from heavy-hitters to overcome blockages – such as dealing with the ‘too busy’ phenomenon, or taking a view on the materiality of potential issues.
- You could mess it up
By ‘mess it up’ we mean: you could incur costs which are disproportionate to the perceived benefits, the project might never get off the ground, removing a company could trigger a significant, unexpected liability, or some other mishap could befall the project. These outcomes should be very unlikely with careful planning, but they’re still possible. Much safer to do nothing, and to leave your successor with the potential task.
All of these reasons are perfectly legitimate reasons why Lex Luthor might say to himself “OK, let’s forget it.”
However, there is another way – which is not to start with a major corporate simplification project at all. Lex could just choose a small number of companies to remove, maybe 5 or 6. Go with the easy ones. Give himself a reasonable time to deal with them. And take it from there.