Structuring your business 101 – Part One
When a business or enterprise is being established, one should consult with their accountant and lawyer to determine the tax and structuring options available to the enterprise. This article provides an overview of a common structure to be considered when establishing an enterprise.
Similarly, there may be a new opportunity or possible threat on the horizon to justify a restructure of your existing structure. Part 2 of this series will further consider issues and options around a restructure.
Common Asset Structure:
Many enterprises will have the following structure in play:
- Holding Company that will own shares in its subsidiaries (e.g. Trading Company and Asset Companies).
- Trading Company that will trade.
- Labour Company that will employ the staff and provide to the Trading Company.
- Asset Entities (where applicable):
- P&E Company that will acquire plant and equipment and hire out the P&E to the Trading Company.
- Land Company that will acquire land or lease land from third parties and then hire/on-hire to the Trading Company.
- IP Company that will own the intellectual property of the group and then licence it to the Trading Company.
See diagram below for a visual representation of how these entities interact.
The Holding Company will:
(a) Obtain funding or capital from third parties or its shareholders. Such funding will then be on-lent in part to the Trading Company to cover its expenses. The terms of the loan should be documented to reflect the terms of interest and repayment – consultation with the accountant and lawyer is necessary to ensure they are enforceable. The Trading Company should provide security over all its assets in favour of the Holding Company and this should be done by the parties executing a General Security Agreement and registration on the Personal Property Securities Register (“PPS Register”).
(b) Obtain funding or capital from third parties or its shareholders. Such funding will then be on-lent in part to the relevant Asset Entity to purchase assets. The terms of the loan should be documented to reflect the terms of interest and repayment – consultation with the accountant and lawyer is necessary to ensure they are enforceable. The Asset Entity should provide security over all its assets in favour of the Holding Company and this should be done by the parties executing a General Security Agreement and registration on the Personal Property Securities Register (“PPS Register”), and a mortgage over any interest in land and register such mortgage with the Titles Office.
The Asset Entity will:
(a) Hire the plant and equipment (“P&E”) to the Trading Company. The hire of the P&E must be documented and registered on PPS Register to ensure the P&E is not lost to a secured creditor or liquidator of the Trading Company. The easiest way to do this is a Master Hire Agreement between the parties to cover all P&E provided from time to time. The rent payable and the items of P&E hired out can be determined by the parties and the accountant (on a monthly, quarterly or annual basis) to enable certainty and flexibility.
(b) Where the Asset Entity owns the Land, it will lease or licence the land to the Trading Company. Such lease or licence should be documented and on commercial terms. However, the term of the arrangement should be month-to-month to provide flexibility for either entity to end the lease/licence on short notice, to facilitate the property being used by another entity, if required. If it is a lease, then this lease should not be registered with Titles.
It is not ideal for an Asset Entity to be a tenant under a lease to a third party. Whilst it will control the site, it is exposing itself to liability in favour of the landlord which may then take action to recover its debt from other assets owned by the Asset Entity.
Ideally you would have a special purpose company owned by the Holding Company to become the tenant (“Leasing Entity”) and such entity would sub-lease to the Trading Company. The head lease should be documented and registered with Titles to ensure the Lease will stay with the land regardless of owner changes. The sub-lease should be month-to-month to provide flexibility for either entity to end the sub-lease on short notice to facilitate the property being used by another entity, if required. This sub-lease should not be registered with Titles and you will likely need to obtain consent from the landlord for such a sub-lease not to be an event of default under the head lease.
(c) Licence the intellectual property (“IP”) to the Trading Company. The licence should be month-to-month to provide flexibility for either entity to end the licence on short notice, and contain non-exclusive use and ownership provisions that make it clear that any adaptation or creation relating to the IP solely vests in the Asset Entity.
The Trading Company will:
(a) Enter into the above agreements (if applicable); and
(b) Enter into a labour hire contract with the Labour Company for the provision of people and services on a month-to-month basis. This will enable such company to then put in place the relevant HR management, policies and employment or contractor contracts for the benefit of the Trading Company. If the Labour Company provides such labour hire services to third parties then it will need to comply and register itself as a labour hire provider.
All the terms of loan, security, hire, lease/sub-lease and licences detailed above must be on commercial terms. If they are uncommercial or unfair then they can be challenged and set aside in whole or part by the aggrieved party or their liquidator.
It is suggested all documents signed by the Trading Party in favour of another Group Entity consider inserting a general charge clause where the Trading Party offers up its assets as security for any obligations and monies it owes to the other contracting Group Entity.
This charge would need to be registered on the PPS Register. This then elevates the Group Entity to secured party status which will outrank unsecured creditors of the Trading Company if it goes into liquidation. Furthermore, having a perfected charge over all assets of the Trading Company enables you to repossess assets of the Trading Company and/or appoint a receiver to take control over the assets, books and business of the Trading Company in priority to the Liquidator of the Trading Company.
An important note to remember is anything established with the primary intent to defeat creditors will be subject to challenge and prosecution. However, if done correctly, it will leave the risk in the trading entity and preserve the assets and income/rewards flowing through to the entities that have limited trading or liability exposure. This then enables the group greater flexibility to quarantine risk, facilitate growth and innovation, close down non-performing operations, tax, funding, income distributions and/or the sale of all or part of the empire.
Shareholding in the Holding Company
The shareholders of the Holding Company are usually discretionary trusts which enables flexibility for tax and dividend distributions from the Holding Company, and provides protection for the Holding Company.
An example of such protection is setting up the Holding Company and the subsidiaries to minimise or quarantine risk from one enterprise affecting the other companies and their assets. However, this may all unravel if a major shareholder of the Holding Company goes into liquidation, receivership or bankruptcy. Such shareholder’s controller will then take over the shares in the Holding Company and then run and/or realise the company and all subsidiaries you have established. Therefore, it is preferred to have a shareholder of the Holding Company as a special purpose discretionary trust with no or limited exposure to creditors (e.g. not a guarantor, borrower or trading entity, etc…).
You do not have to do all of the above but you should at least consider the risks and benefits of all of the above and then establish the correct structure, documents and registrations.
A similar analysis can be conducted for existing structures to determine if a restructure is warranted. Our next article will touch on some key points to consider when restructuring.
If you have any questions about this article please get in touch with an author or a member of our Restructuring, Turnaround & Insolvency team.
This article is general commentary on a topical issue and does not constitute legal advice. If you are concerned about any topics covered in this article, we recommend that you seek legal advice.