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.