One question I get asked on a regular basis is how a business should be structured. Not necessarily business entity and what type should be chosen, but if one has a “complicated” business model, how should it be structured. The question of subsidiaries (should I or shouldn’t I) is often the subject of discussion.
Since I am an attorney, my answer is usually complicated and full of ifs, ands, or buts; here are a couple of client scenarios that led me to advise my client to use subsidiaries or not.
Disclaimer: Although inspired in part by a true incident, the following story is fictional and does not depict any actual person or event. #LawAndOrder
Same Business Different Liability
It’s Not Me Company is an online streaming business that decided to add a brick and mortar retail business. The streaming company had little or limited liability in the type of work that it conducted. Expenses were mostly tied to human resources and the purchase of equipment. It’s Not Me, decided to “merge” with a startup company that was a brick and mortar gaming company. Instead of housing both companies as one, we decided to create a parent and subsidiary relationship.
Rational: It’s Not Me had a lot to lose if the start-up when bust. Separating its assets from the start-up allowed it to limit its own liability. If the start-up goes belly up, then the only thing It’s Not Me loses is its investment. If the start-up does well, It’s not me increases its value by having a profitable subsidiary, not to mention potential dividends.
Different Business Different Liability
Janet Jacobson owns multiple businesses. She has an adult day care, an assisted living facility and a home health care agency. On the surface, they seem like the same or similar businesses. But the liability and regulations are very different. Licensing requirements mean that ownership is closely monitored. Therefore, we decided to have three separate companies with no connection with one another.
Rational: Each company, though service the same or similar community, has a different set of legal requirements and reporting. Having three separately owned entities by Janet created the ability to adjust to the varying requirements of governmental oversight. In addition, we were able to create service contracts between the entities to allow them to work with one another and receive payment for services.
Different Business Same Liability
Same liability is a misnomer here, I simply mean that the liability risk is no greater or less than the other businesses. In this case Barbara Bennett and her husband want to invest in various companies. Instead of having multiple businesses in their name, they have decided to create a company that “houses” the various investments. In this case, we decided to go with a “step-parent” company that owned percentages of other companies.
Rational: Barbara and her husband did not want all the business ventures tied to their name and assets. To give them another layer of protection, we created an entity that could sufficiently invest and own other companies. These companies would not be wholly owned by the investment company. In most cases, the company may decide to fund other ventures or partner with certain companies. This will allow all passive income to flow into the investment company.
Shahara Wright is an experienced and highly sought after business law attorney and business strategist. She is the author of From Entrepreneur to CEO and host of the CEO Collaboration Circle. Shahara founded The CEO Effect, LLC to work with small business owners who want to implement strategy to build capacity.