For fast-growing and ambitious tech companies, the right business structure is key. The wrong structure can make it harder to reach strategic objectives: the business becomes more difficult to manage and ultimately incurs higher tax and compliance costs.
Before raising capital for growth, businesses must ensure their business structure is fit for purpose. While a deal can always be done, a streamlined structure can help attract investor interest and allow businesses to maximise value.
There are other events that should also cause management to re-look at their business structure. Here we look at the key triggers.
1. To secure third party investment
When raising capital for growth, simplicity is almost always the best strategy. Third party investors and funders frequently back businesses with more streamlined structures. A sprawling company with a large number of subsidiaries may be seen as a riskier proposition.
Updating a business structure can take time, so streamlining activity must start several years before attempting to raise capital. Where possible, dormant or rarely used entities should be closed down. It is also important to consider whether the group’s intermediate parent undertakings are required.
Similarly, group structures can be streamlined by identifying whether different trading activities could be concentrated amongst a fewer number of subsidiaries.
2. When adding new services or business lines
When starting a new venture, a business can de-risk its position by setting up a trading subsidiary. In the media world, for example, publishing houses often create separate trading vehicles for each magazine. If one fails, it won’t drag the rest of the group down with it.
This approach can also be used by tech companies. But businesses must find the right balance. Each subsidiary that’s added creates another mouth to feed: another set of accounts, another tax return, another set of compliance costs. When the family becomes too big, associated costs can quickly undermine any potential advantages.
3. To incentivise old and new employees
Recruiting and retaining top talent is a major challenge across the sector. The right business structure can help tackle the problem, providing new opportunities to incentivise existing staff and create a more attractive proposition for new employees.
For example, share schemes set up in the appropriate entity can help lock in and incentivise key staff, as can shadow bonus or equity schemes. It may also be appropriate to give small amounts of equity directly to key employees to ensure that they are properly motivated.
4. When expanding internationally
When expanding internationally, a corporate entity must typically choose between setting up a branch or a subsidiary in the overseas territory. Each has its own benefits and drawbacks. The right structure will always depend on individual business circumstances.
An informal branch structure incurs lower launch costs and can therefore be a useful route for businesses that want to test the water in an overseas territory.
A branch is essentially an extra arm of a UK company. It can be a less attractive option for local businesses in the new jurisdiction as they often prefer to trade with other local companies.
In some jurisdictions, a branch structure can also have legal implications. In the US, for example, a branch would expose the parent UK-based company to US liabilities. For IP-heavy companies, this can lead to major risks.
Entering an overseas market is inherently challenging and new ventures are likely to create losses in the first year at least. As a standalone entity, a subsidiary allows a business to ring-fence risk in the new jurisdiction, and potentially ring fence losses that may have a detrimental impact on the appearance of the parent balance sheet.
However, with their higher set-up costs, subsidiaries typically only benefit businesses that are confident about their overseas expansion plans. Each new subsidiary creates new compliance costs. If the international venture fails, it can also prove costly to wind down. Businesses should not underestimate the costs of withdrawal.