The purpose of this article is to consider some of the principal issues which major shareholders and senior management responsible for the direction and supervision of a group of businesses ought to take into account whenever that group is set to grow either organically or by the strategic acquisition of new businesses.
Taxation
In most jurisdictions around the world, taxation, with considerations of corporate revenue taxes, capital gains taxes, withholding tax, rolled-over accrued gains, the existence or lack of international double taxation treaties etc., bears heavily on how flexible one can be in attempting to implement a group structure that might appear ideal in light of other determining factors. However, in the UAE (and to an extent in its neighbouring countries) questions of taxation will not necessarily be the determining factor in defining a group structure. Nevertheless, where a corporate group has assets or operations spanning a number of jurisdictions, then tax planning will certainly have implications for the structure of such a group.
Use of holding companies
Where shares in operating companies within a group of companies are held by individuals, if those individuals seek or are forced by death or incapacity (physical or legal) to transfer their shares to third parties, the group risks becoming fragmented and the underlying businesses may also be adversely affected.
However, if companies within a corporate group are wholly owned directly or indirectly by an ultimate holding company, then there is greater likelihood that theintegrity of the group's structure will be preserved.
For example, where a group comprises of three operating companies and a shareholder dies or desires to transfer his shares to someone else, the disruption to the group's ongoing affairs can be reduced and the transfer process will be simpler and less costly by utilising the structure at B below rather than that at A.
Intermediate holding companies
An intermediate holding company is a company within a group, which holds shares in two or more operating companies whose businesses together form a discrete business division. By way of example, there may be some companies within a group that specialise in operating hotels and catering, whereas others specialise in transportation.
The hotel and catering companies could be owned by one intermediate holding company and the transportation companies could be owned by another intermediate holding company. Holding companies themselves are often dormant in that they do not carry on an active business of their own and merely function like a basket to hold shares in other operating companies.
The management of the group may decide at some point in the future that a particular division of the group should be sold off, so that the group can focus all its efforts on other core businesses. If there is a rational ownership structure in place such that the relevant division can simply and easily be divorced from the remainder of the group, this will facilitate the sale and avoid the need for a possibly more complex pre-sale reorganisation at a later date.
Additionally, a business division (comprising of a number of companies engaged in related businesses and/ or inter-dependent businesses) will be more attractive and more valuable to a potential purchaser if it already has a sensible and manageable structure in place. Otherwise, the purchaser may have to carry out the reorganisation following the sale and all the disruption and loss of management time involved, whilst possibly at the same time attempting to integrate the new division into its own group. The transaction costs incurred in selling a business division will be significantly reduced if a business division (comprising of a number of related companies) exists under a single intermediate holding company. Simply transferring the intermediate holding company to the purchaser will result in the entire division being transferred to the purchaser.
Accordingly, the shape of a corporate group should ideally resemble a pyramid.
Limited liability companies
It is generally prudent practice for business activities to be carried on within the framework of a limited liability company (insofar as possible). This is to protect the ultimate owners from claims that may be made by third parties in respect of the business. With a limited liability company, unless the shareholders have given personal guarantees to third parties, the shareholders will not generally be liable for commercial claims made against the company and stand only to lose the amount they have subscribed for their shares in that company.
Accordingly, in a group structure claims by customers, suppliers or other third parties are contained within individual companies and cannot work their way up the chain of ownership to the owners of the group. This allows risks and liabilities to be ring-fenced and serves to preserve shareholders' personal assets.
In certain countries, including the UAE, there are restrictions on particular types of businesses such that they cannot be carried on through the medium of a limited liability company. Professional services businesses, in particular, tend to fall into this category. However, with careful planning, it may nevertheless be possible to achieve a significant level of protection against creditors for individual participants in such businesses.
Appropriate level of shareholder control
Individual or corporate shareholders may initially feel that they have a greater level of control over the affairs of a business if they directly own a business or shares in a company that runs a business.
However it is possible for them following a reorganisation to maintain efficient and effective control over operating companies within a structured group by imposing particular checks and controls.
For example, shareholders can procure:
(i)that provisions are included in the memoranda and articles of association of operating companies stipulating that such companies and their subsidiaries shall not undertake particular actions without the consent of all or a prescribed majority of the shareholders,
(ii) that particular business operating policies are imposed on management throughout the group,
(iii) that reporting requirements are imposed on key management personnel throughout the group, and so on.
Examples of the sort of matters over which the ultimate shareholders may wish to retain control may include any of the following:
approval of appointment of general managers
appointment of bankers and auditors
bank borrowings (no borrowing beyond prescribed limits)
other bank facilities (including guarantees)
increase/decrease of share or loan capital
change of company names
change of core business, opening new business streams, abandoning any business stream
appointment / dismissal of senior personnel
award of commercial contracts of certain types or to particular organisations
appointment of agents and representatives in particular circumstances
purchase / sale of certain assets (defined by value or type e.g. any real estate)
approval of accounts or business plans and budgets
declaration of dividends (and allocations to reserves)
opening of new branches or formation of further subsidiaries
institution / settlement of legal proceedings
Additionally, a corporate structure organised with different divisions under an ultimate holding company will enable the more senior management to devote their time to higher level issues and so to formulate policy that will then apply group wide, rather than sitting on the board of each and every operating company. Also, where a group is divided into different divisions, particular managers can be assigned responsibility for their own divisions whilst at the same time falling under the authority and direction of the holding company's board. In general, it is considered simpler and more effective to allocate management responsibilities within an organisation with a divisional, multi-tiered structure. This allocation is reinforced by the fact that companies within the higher tiers of a group own and ultimately control those in the lower tiers.
Asset protection
A corporate group should aim to ensure that the assets of the group are protected where possible and practicable. For example, it would be prudent for expensive or unique assets to be owned by different companies. By these means, if a claim is brought by a third party against any one of the asset holding companies, then only the assets of that particular company are likely to be susceptible to attachment if court proceedings brought by the third party are successful. But those assets held by other companies in the same group can be protected from attachment.
Shipping companies in particular avail of this structure by ensuring that each individual vessel is owned by a separate owning company. If accidents occur, ships can give rise to huge liabilities for their immediate owners if damage is caused to other vessels, ports, coastlines etc. Accordingly, to safeguard other ships within the same commercial fleet from potential creditor claims, each ship will be owned by a separate owning company.
Similarly, it is generally prudent for companies carrying on a trade, which exposes them to a greater degree of risk from third party claims, not to have a significant asset base. Where a business necessarily involves the provision of services or trading activities and the use of significant assets (e.g. real estate, plant and equipment or intellectual property rights), then that business may be carried on by two or more companies working together within a contractual relationship. One holds the assets (thereby shielding them from creditor claims behind the corporate veil) and the other trading or service company deals with third parties and can make use of the relevant assets by way of a lease, licence or similar arrangement with its sister concern.
Exits and listing on a securities exchange
As previously mentioned, there are advantages in having a rational, pyramidal structure when selling business divisions.
The same considerations are applicable when the ultimate owners of a group comprising a number of divisions elect to exit and realise their investment.
Equally, a corporate group may at some point require additional funding. Other than debt funding or capital injections from exiting shareholders, a means of raising funds is to list the share capital of a company (or more usually a holding company of a group of companies) on an appropriate stock exchange. By these means, the shares in the ultimate holding company are made available for public subscription (by way of an initial public offering, commonly termed an 'IPO'). The more sizable and profitable a group of companies intending to list on a stock exchange is, the greater the likelihood of it attracting significant outside funding from new institutional and retail shareholders. Having shares listed on a stock exchange also creates a new market for the group's founders' shares so that they have a new means of realising some of the value of their stake in the group or ultimately disposing of it entirely.
Counter-considerations
Naturally, there will be legal and accounting costs to be borne in carrying out any form of reorganisation.
Management will need to devote some of their time to planning and implementing the changes. This may involve talking to employees, customers, suppliers and bankers to assure them that the changes are to be implemented for the benefit of the group and are not indicative of insolvency or otherwise likely adversely to affect employees, customers and suppliers.
However, most successful corporate groups will go through one or more reorganisations from time to time and once a rational structure has bedded down, it should serve to boost the morale of management and other employees within the group as they are more likely to consider themselves as part of a cohesive commercial enterprise.
Final comments
Whenever a business is considered likely to expand or to be the subject of a sale, partial sale or IPO, the management of the group should consider the points raised above.
In essence, the key projects of focus of a corporate group reorganisation are likely to be: simplicity, consolidating business streams into saleable modules, ringfencing key assets and ensuring overall tax efficiency. The issues highlighted above are merely a foretaste of what is a complex set of considerations.
Managers of groups of companies will need to consult carefully with their legal and accounting advisers to best protect and develop value within their groups.
By James MacCallum
© Al Tamimi & Company 2007
