Steve Carpenter oversees business operations, sales, P&L, product and data. With an impressive 16-year tenure at Creditsafe, Steve has played an integral role in the company's international expansion efforts, spearheading global data acquisition and fostering global partnerships.
There’s opportunity in groups. This was the opinion of W.L. Gore, the founder of American manufacturing powerhouse W.L. Gore and Associates. He’s known for developing the lattice model, a kind of organizational structure inspired by the lattice concept found in architecture.
In Gore’s lattice, there are no employees. There are associates who work autonomously and have a share of company profits through an Associates’ Stock Ownership Plan - an ASOP without any fables, according to the people who work there. There are no bosses. There are only sponsors who collaborate with the associates for greater productivity.
This kind of organizational model has similarities with a group structure. Group Structures refer to when one limited company owns another limited company and a hierarchy is created. At the top is the holding or parent organization and the other companies in the lattice are subsidiaries. Through this structure, collaboration can be encouraged. But there are other reasons why corporate group structures are created.
Depending on motivations and setup, group structures can be exposed to a variety of risks. We know first-hand how confusing it can be to understand group structures, especially if you deal with thousands of customers with complicated group structures.
Chapter 1
What are some examples of corporate group structures?
Vertical: This type is a hierarchical form that features multiple levels of management. The pros of this approach are more oversight and improved decision-making. The cons include a lack of communication between employees and a lack of accountability.
Horizontal: This type involves a flat structure and decentralized decision-making. Employees are often more empowered and this model has more in common with Gore’s lattice. But this structure can lead to inefficiencies and confusion because there is no chain of command.
There are alternatives like a separate standalone company or companies being owned by the same non-corporate shareholder(s). In this example, the associated businesses are called sister companies and are under the control of an individual, but don’t form a group.
But it can often be better to set up a group structure instead of sister companies. Why? Well, if certain conditions are met, groups of companies have access to different tax exemptions and relief between the members. This means they have the potential for better cash flow and greater profitability.
Make sense of corporate group structures
Chapter 1
What are the benefits of corporate group structures?
Asset protection
A major benefit of group structures is that a subsidiary acts as a ringfence for the assets and liabilities of the parent company. The business at the top isn’t exposed to the commercial risks of running a new venture or an established organization.
As an example, assets like cash and property could be placed into one subsidiary. Meanwhile, vehicles and equipment are put into another subsidiary so in essence you aren’t putting all your eggs in one basket.
Let’s say you’ve purchased an office to run your main operations from and it’s been done through your holding business. So long as there’s enough retained reserves in the existing limited business, you could set up a group structure so that asset is moved as needed.
Tax incentives
To dig deeper into tax and group structures, there are several advantages. Firstly, you don’t have to pay tax on moving assets around e.g. shuffling machinery from one company to another. Secondly, if you make a loss in one of the subsidiaries then it can be offset against other profits in the group.
Of course, you have to make sure you’re adhering to the right tax regulations. We’ve covered this in our corporate group risk mitigation strategies section further down the page.
Regulatory and centralized functionality
A third benefit is that group structures offer regulatory and centralized protection (i.e. holding specific assets like intellectual property). These assets may be extended to cover other group members and certain products if there’s a need for copyright protection.
Another aspect of this comes with the leasing of assets. Let’s say one business owns several properties. The group structure holds all those property assets and they can then be licensed for other revenue streams.
Plus, with this centralization comes the opportunity to divest a particular product or division straightforwardly and cost-effectively.
Chapter 1
What are the risks of corporate group structures?
Difficulty with decision-making
On the other side of the coin, a group structure can make it harder for decisions to be reached. For one thing, nothing might be able to be signed off until all the subsidiaries have given the green light to the parent company. This could slow down key processes like vetting the credit risk of new customers or getting permission to follow through with approving a credit decision.
An outcome of this is frustration from shareholders and investors in the parent company. Because that parent doesn’t have full control of the subsidiaries, the lack of flexibility can become a cause for concern among investors. They may choose to withdraw their funds, cutting off an important cash flow channel and opening the entire group to further risk.
As part of the decision-making process, a corporate group structure can also lead to a conflict of interest. This is when the parent organization puts their own interests ahead of the subsidiaries or vice versa. This puts profit, business operations and even trade secrets in danger. Trust issues build up and legal action is taken among the group, destroying employee morale and further impacting day-to-day operations.
Lack of insight and financial losses
Scott Garger, Enterprise Accounts Manager at Creditsafe, shared his thoughts on what a lack of insight can do within group structures.
“Let’s say there’s a company with 1,000 customers and they’ve checked all their information by using accountancy software. What they may not know is that 10 customers belong to the same company and goods or services are being sold at $1,000 each. So, in this scenario, your risk exposure isn’t $1,000 for one company, it’s $10,000 in risk value for a group of companies.
If the parent company suddenly goes bankrupt, then you’re potentially going to lose money across those 10 ‘companies you’ve been dealing with. This is a serious issue because we’ve seen that bankruptcies are going up every year.”
Acquisition and branding issues
Another risk Scott Garger has seen in his experience is the complexity that comes from acquiring multiple subsidiaries and deciding how to brand them under one name.
“Look at Google. For the past 20 years, they’ve taken a merger approach of buying up all these companies like Android and decided not to integrate them into Google. The decision there could be based on this type of thinking: ‘Okay, we’re going to spend $10 billion on the next big tech company because it’s going to help our AI advancements. Now, that company is in the news but we’re still going to keep them separate.’
Scott continues, “There’s risk here that comes from deciding to buy a company without evaluating it and there’s only so much information you can find on it. Then you introduce the complexity of deciding whether to roll a new company into a single brand or call it a division of the parent company.”
Chapter 1
Practical corporate group risk mitigation strategies
Gather the right data
Now that we’ve looked at the pros and cons of setting up a group structure, the first thing to do for your risk assessment is to pull the right data together. This is information that will help you make an informed decision about whether you’re acquiring a subsidiary or planning to structure horizontally or vertically.
A simple way to do this is to check a company’s credit report and look at data like:
Credit scores and credit limits
DBT over a 12-month period
Average industry DBT over a 12-month period
Number of past due bills over a 12-month period
Total value of past due bills over a 12-month period
Legal filings (i.e. tax liens, bankruptcy filings, UCCs, lawsuits)
Compliance alerts or violations
Scott Garger explains, “To avoid risk, you have to go deep down the rabbit hole. Just imagine if you were vetting a company and you first found out they were owned by a company in Germany. But then you go to the next layer and the company is owned by another business in Cyprus. The next level after that is realizing the true ownership of the company is in the Cayman Islands and there’s actually a Russian oligarch who’s a shareholder.”
In the above example, being in a group structure with this kind of business is going to expose you to massive risk because of the potential to violate sanctions placed on Russia. Remember, data is always your best friend when managing risk in group structure setups.
Understand tax regulations
The next step for evaluating risk within group structures is tax. What exemptions are you eligible for? What aren’t you eligible for? PwC has a useful list of US corporate group structure taxation rules.
Some are as follows:
An associated group of American ‘includible’ corporations, making up a parent and subsidiaries, directly or indirectly 80% owned, generally can offset the profits of one associate against the losses of another associate.
A foreign-incorporated subsidiary can’t be consolidated into an American group, except for certain Mexican and Canadian-incorporated entities.
In the case of transfer pricing adjustment, a multinational conglomerate may face double tax, paying tax twice on the same income in two countries. Multinationals can request competent authority relief from double taxation in a tax treaty.
Manage risk with the right technology
Pulling together all the group structure risk data we’ve talked about isn’t easy - especially if you’re doing it manually. You don’t want to be adding further complications to a setup that has a lot of moving parts already. So, the pragmatic way to deal with risk is through technology designed to address it.
Credit risk and business intelligence software specializes in managing this kind of risk. You can deep dive into every detail of a company’s ownership and financial history. No matter where a company is in the world, you’ll be able to leave no stone unturned and decide whether they pose a low, moderate or high risk to your company.
Build a structure where everyone’s on the same page
Good communication between parent companies and subsidiaries should also be factored into your group structure risk assessment. The classic example to follow is Warren Buffet and Berkshire Hathaway. Berkshire started in textiles and is now the holding company of multiple businesses in various industries, including insurance, publishing, paint, jewelry, footwear and air compressors.
The way Buffet and his former vice chairman Charlie Munger built their enterprise was by investing in businesses with incredible economic characteristics and run by exemplary managers. They took a ‘double-barreled approach’ of buying on the open market less than 100% of businesses they were interested in at a pro-rata price well below what it took to buy 100%.
Based on this approach, the per share basis of Berkshire’s portfolio increased from $4 in 1965 to nearly $50,000 in 2000, at a 25% increase. As of recent figures, Berkshire’s total portfolio value has been calculated as $347,358,074,461.
The takeaway lesson is that a parent company should empower its subsidiaries to act autonomously and vice versa.
About the Author
Steve Carpenter, Country Director, North America, Creditsafe