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From Paul Spencer of Second Nature Solutions, a conversation about the complexities and nuances of building resilient family enterprises, especially in the face of economic and political uncertainties that loom on the horizon. See more at secondnature.solutions.
Welcome to Resilience Talk hosted by
Paul Spencer of Second Nature Solutions.
Let's dive in.
Paul Spencer: Next up in the ownership
series is corporate structure.
So this one, I would say out of the
eight, um, this is my least knowledgeable
area, so we'll go through it.
Um, of course, at a high level
we can understand the pieces and
the parts and how they play out.
Um, this one though has a lot of
nuance to it because we talk about.
We're talking about corporate
structure, like entity types, S corp,
C corp, um, lots of different ones.
We'll talk about those.
Um, but it also affects
different tax strategies as well.
And so this is perfect for, uh, your
CPA, um, any kind of a business advisor.
You have financial advisor, um,
somebody who may be working with your
estate planning or trust planning.
These are, this is the area you
wanna have conversations with them.
You wanna make sure that you bring in.
So we're in the middle
of the ownership series.
And just to review, we have financial
performance, growth, potential key
dependencies, recurring revenue, right
to win corporate structure, which is
what we're gonna talk about today.
Key management and leadership.
Then lastly, owner involvement.
So I've mentioned this caveat for all
of them so far, is that these are the
ones that I've gathered from different
friends and people in my network.
This is how they tend to think about it.
Again, if you go out to chat GPT,
Google, you'll find variations of these.
Uh, you'll find a lot of them.
Like financial performance
will probably always come up.
And right to win will probably always come
up because those are the ones that rise
to the top as far as, um, key valuations.
But in the end, they're gonna
overlap, they're gonna be different.
We're just trying to get the gist so
that my aim for you is that you take all
of these ideas, which are just kind of.
Spread out onto the board and then
you can be strategic about where you
wanna go, where you wanna be, um,
focused on where you want to target
and where you wanna go to work on.
And so that's the point of all of this.
So if we think about corporate structure,
like I always, I already mentioned
there's the entity, essentially the
legal registration of your organization.
So, uh, we tend to think of those as LLCs.
Um.
The big ones are at this point
are S Corps, and then you've
got your C Corps, right?
And so I don't know the
history of this very well.
At one time, C Corp were the best ones
to have because of, uh, the tax advantage
and how those things were set up.
And then there were changes.
I, I think, and I could be completely
wrong on this, but there were things
changed around how the S Corp was
structured and it became more friendly.
So I would imagine most of you are
scorp, um, but they're probably a good
handful of, of C Corps as well, so.
It's a, but it's also a good reminder
that just because the registration of your
company today is the best one, given your
situation and given your tax implications
and your, your ownership structure that,
uh, we recommend you use the C corp.
Well, you may have different
regulatory, either state or federal.
Changes or even, um, into the, the
tax codes for state or, um, federal or
just how the entities work themselves.
And so, uh, those things can shift.
What's, what's good for today for
the C corp may make this S corp
better for you 10 years from now.
Right.
So it's just, just to be aware of that.
So there's the, there's
the C corp, the scorp.
I'm not gonna get into the nuances
of all of those and, and why
one is better than the other.
That's, um, things we can talk about.
But, um, there are, there are experts
in that can, that can give you infinite
amount of more detail than I can.
So, um, just know that the, the, uh, tax
filing and the ownership structure legally
is different between the two C Corp.
S Corp, right?
S corp is a pass through.
C Corp has different, uh, tax filings.
So there are other ones that you can
have, which is a more of a partnership.
Um, you can have an esop, which is an
employee, um, owned organization, 100%
owned by the company or by the employees.
Uh, you can have B Corp, which
are, they're not non-profits,
but they're very focused on.
Uh, soc, social aspects or environment
aspects, and they operate similar.
To a, um, a nonprofit in that, in
its vision, uh, the, the organization
is focused on a social cause.
So you could have a traditional
technology business that is a B Corp.
And what that means is that,
um, maybe some of the profits.
Some of the things that we do within
our culture are focused on a certain,
um, aspect within the community.
Um, you could have
different holding companies.
You could have a holding company with, um,
different types of entities underneath it.
And what that does is that gives you the
ability to have different carve outs.
So I could sell a subsidiary.
Of my, uh, holding company
and still hold onto the rest.
Right?
Um, there's a new thing called Series
LLC, which is a similar concept where
I could have a series of LLCs that are
separate but also enjoined and, uh,
you can do a similar thing, meaning I
could, I could, uh, sell this product off
because it's a separate, um, series LLC.
So anyway, those are the different
entities that we register within our
own state or maybe outside of our state.
Um, and, uh, those are important
because as you know, as an owner, they
affect your accounting process and they
affect your, um, tax process, right?
So how often are you paying taxes?
What are the rules on distributions?
Um, at the end of the year or
during the year, all of those things
come into play depending on, um,
the, the entity that you have.
So when we're thinking about as a
buyer, that is important because that
that corporate structure that you have.
Um, will be part of the
sale transaction, right?
Which could include, which would mean
maybe that I have to, as a buyer, add
more cash or maybe, um, just based
on the, the holdings themselves.
Um, it will reduce or increase
the amount of value that I get
cash from the purchase itself.
So anyway, those are, those are
nuanced, those are, there's lots of.
Industries, businesses that handle that,
they'll know that way better than I do.
Those are my quote unquote
Baker Banker friends.
So when we're thinking about what's
the best for your situation, you're,
you're really trying to understand,
getting advice and having a good
sense of what is your estate planning.
So what's your personal family wealth?
What are the members of your family?
What's your, um, what's
your, uh, beneficiaries?
Look like, who are they?
How old are they?
How many are, are they?
All of those kind of play into
your estate planning, obviously.
Uh, but they may also feed into as
an input in the type of business,
the corporate structure that
you choose for your business.
Um, there's also, obviously what we
already talked about is the tax planning.
You may have, um,
executive planning as well.
So, um, as I, um, onboard new leadership,
new executives, uh, my corporate
structure may give me more options on,
maybe I give them some more equity.
Maybe I have, um, kind of
a, um, a profit share or a.
An opportunity to claim options, right?
All of those things fit into the type
of corporate structure that you have.
And then obviously
there's employee planning.
So, um, with, if I have hundreds of
employees, thousands of employees, I may
have a different entity, um, just based
on the size and how I want to, uh, do
compensation plans and things like that.
What kind of flexibility do I want?
So, um, when we think about
corporate structure and the eight,
um, evaluators that we, that we're
looking at, the valuations that
we're talking about, corporate
structure is pretty low on the list.
Um, meaning that the most important
thing is financial performance, and
then likely we get into right to win.
Where are you in the market?
Um, and then they, they kind of, they're
kind of, there's those middle ones that.
Each buyer is gonna move
some of those around.
But those, those are really the top two.
Um, recurring revenue
could be up there as well.
Um, but corporate structure
is pretty far down the bottom.
If you, uh, they're not gonna look
at corporate structure first and say,
Hmm, C Corp probably not gonna buy you.
I don't even care what
your financials are.
Right?
That's not gonna happen.
So they're gonna go through
their due diligence as normal.
And they may be aware of your
corporate structure at the beginning,
but that doesn't really come into
play much until the end where
we're gonna make a deal, right?
And now we have to figure out what
that transaction's gonna look like
based on the entity that you have.
So I think that's important to know that,
um, and we'll talk about this a little bit
later, is, uh, out of all of these, the
ones that are gonna give you a big bang
for your buck on if I'm going to sell.
Or if I'm just looking to increase the
value of my asset, it's most likely the
other ones that I'm gonna be focused on.
Those ones take more time to
establish, um, mature processes, right?
All the things, uh, uh, getting
reputation within your market.
Corporate structure, we have, we
do have the ability to change.
Our corporate structure.
Is it painful?
Yes.
Is it complicated sometimes?
Um, can it take a long time?
Yeah.
But in relative terms to the other ones,
uh, it's not, it's, it's manageable.
Right.
All right.
So, um, but where we do get into deal
breakers, and I wanted to highlight
this 'cause I think it's important is.
When we do get to that part where, okay,
I'm interested, I wanna buy, let's look at
your entity and your corporate structure.
Things that can break the deal
is a complicated ownership web.
So the complicated ownership web
is basically, we've got cousins,
we've got, um, nieces, nephews.
Just over time, we've allowed, um,
um, I would call them micro shares,
entity shares to be equity shares to
be distributed a across our family.
And all it does is it complicate and
complicates the, the structure, the
deal, because now, um, depending on your
entity and the roles that you have within
shareholders, some of them have to.
Um, approve or, uh, they have to,
there has to be a sell and then
you have to agree to a price, and
then you have to pay everybody out.
And then it just adds
so much complication.
And if that's not well, um, documented
and you don't have a nice clean
cap x table, a cap table around
that, then uh, it can, it can.
The deal can break because of that.
The buyer gets skittish.
It's a lot of work.
I don't wanna do that.
Right.
And that can get very complicated.
So another one could be
embedded tax liabilities.
So you, um, some of you actually done
this recently, um, is you've, were a long
time C Corp and you've converted to an
S-corp and there's a timeframe with that.
I think it's, I think it's five
years, but I could be wrong.
Um, for that whole conversion to complete.
Um, because there may be some embedded
tax liabilities that you have to
basically wear off, um, over time for
you to be, um, for you, for you able
to get out from under some of the C
Corp tax liabilities that you have.
And then you become able to, to
have the S corp and then operate
as S corp in order to sell.
So those could be some of
the, um, deal breakers.
There could be, um, regulatory issues.
So if you're a, uh, a lawyer firm,
a legal firm, or a medical practice,
right, you're called a professional
service and, um, and you're not
gonna be able to transfer those over.
Those are really difficult.
They're just non-transferable.
Um, loss of current contracts, um, which
basically means that, um, as a license.
Issuer, right?
I, there may be when we transfer the sale
of ownership, that, um, in the contract it
says that, um, when we change ownership,
then maybe, um, we have the right to,
uh, go shopping for another, um, vendor
or to cancel our, our contract outright.
Um, and that could happen
with vendors, our customers.
So that's something to be aware of.
Um, all of that fits, does fit
into the entity registration.
Um, things that we wanna think
about though for, um, how
important these things are.
You have to be aware.
So be aware of these things.
Um.
Talk with your CPA, with
your business advisors.
Your financial advisors, to make
sure again, that you are aware of
any changes in the, in the law or
changes in the IRS regulations.
Um, but know that this is not always,
unless, and this is not always where
you wanna spend a lot of your time,
unless you have one of those deal
breaker scenarios, then it's worth.
Jumping in and trying to simplify
your ownership structure, right?
Your equity table, um, your cap table,
um, maybe understanding, looking
through your, your current contracts
and looking at some of those things.
Um, so anyway, most of the time the buyer
is just gonna see the, your corporate
structure as, um, like if we wanted
to use a, a buying a home analogy,
we might say the home's not real.
Clean and well kept, but
it's not really gonna keep me
from buying the house, right?
It's, it's a dirty home and, uh, maybe it
will over the long haul, it will reduce
the number of offers you get and maybe
slow down the process, but it's rarely
gonna be the deal breaker all by itself.
Um, and, uh, so, so that's,
that's important to know.
One other thing before
we wrap it up is that.
Um, you do have options.
So I kinda mentioned this at
the beginning, is the other
ones kind of take longer, right?
So to get your, um, growth
potential, your revenue, uh,
recurring revenue, that takes time.
It takes some maturity.
Um, you can make a decision that
you're gonna sell your company or
you're gonna put it out on market.
If, if you wanna call it that,
and in five years or in 10 years.
And you can give yourself kind of
a, a three year-ish window, even
18 to 24 months prior to when you
wanna put thing, put the shingle
out for sale and you can make your
entity conversion if you wanted to.
So I wanna go from an a c corp to a
S corp because of whatever reasons.
And so you don't need to do that
right now, um, if you're only doing
it for the sale or for a potential
sale to make it better for the buyer.
Um.
You can do that with, with,
with some good planning of about
a year and a half, two years.
Um, and then that's typically
just some paperwork.
Um, doesn't make mean it's easy and,
and it's not always clean, um, but you
go through the process and you're done.
Right.
As opposed to when I want to sell.
Um, I don't have a good sales pipeline.
My recurring revenue is a
little, um, stop and go.
And if I'm wanting to sell, sell, say
in the next two or three years, that's
gonna be, um, a big headwind for me.
I'm gonna have to really, really
pump it out and, um, make sure that
I can make those things clear up.
But that's also gonna, that
those forensics are gonna
be left in my financial.
Performance.
Right?
And the customer's gonna be able
to look backwards and say, geez,
for a long time you didn't have any
recurring revenue, and for the last
18 months, 24 months, you've improved.
But what's going on there?
Right?
And you may say, well, we weren't good
at it, but then we did get good at it.
But they still, it's still a risk for them
because you don't have the track record
necessarily over the long haul that has
proven the longevity of your business.
So anyway, um, you guys get it.
It's, again, fun conversations, I think,
uh, to be thinking about the divergent
thinking, all these different aspects.
It doesn't have to be overwhelming, it
just has to be aware and then we can
figure out where we wanna go to work.