Bringing order to chaos – entity simplification
Updated: Oct 30
Complex corporate structures should be simplified to reduce costs, mitigate risks and remove superfluous legal entities. Eddie Bines, managing director, restructuring at Kroll explains the key steps to take
Eddie Bines, Managing director restructuring advisory, Kroll
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 Leonardo da Vinci quote 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 make things complicated by creating more legal entities than they know what to do with.
Corporations tend to form these entities to meet specific operational or financial objectives, optimise their tax position, or are inherited through mergers and acquisitions (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
That means adopting 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 aren’t just reducing the number of entities; 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 things that really matter, 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 is 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. Left un-simplified, these roots 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 are questioning why the structure is the way it is;
when the foundations of your business (eg, finance, legal, HR) encounter challenges doing their day job that result from structural complexity;
before a spark is lit, not after! Before an unexpected liability crystallises in the lower tiers of the entity structure that has a contagion effect on the group; and
when undertaking material changes to the operating model of your business.
Why simplification should be on the corporate agenda?
Risk mitigation - 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 organisation must increase its monitoring and entity management to mitigate risks such as forgotten filings, missed new regulation and unexpected liabilities.
Cost reduction – reduced direct and indirect costs associated with the maintenance of the legal entity structure, as well as related administrative, regulatory and compliance savings.
Operational excellence – improved transparency and governance in relation to operations and financial reporting, refocus upon activities that create value, the chance to assess each entity’s utility within the group and understand legacy assets and liabilities and whether the tax structuring remains fit for purpose.
Entity rationalisation 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
set up – 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?; and
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; and
secure necessary approvals to proceed with elimination.
implement the steps plan;
put in place the necessary corporate documentation;
deal with ad hoc issues; and
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 organisations 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, the sooner you start the sooner the cost, risk and operational rewards can start rolling in.