In this Jnet series, we introduce current topics in the field of corporate M&A, revitalization and restructuring that are relevant to Japanese companies operating in the United States. In this issue, we discuss how focusing on existing corporate structures of both the target and acquirer can lower costs and aid the integration process.
Experienced buyers pay careful attention to the corporate structures of entities they acquire to both help secure tax-efficient movement of assets at close and to implement tax efficiency for ongoing operations. Focusing solely on tax, however, can lead to unexpected operational inefficiencies if structuring decisions inadvertently create overly complex business processes between entities.
Both before and during the integration process, a buyer may find a target has tens or hundreds of entities transacting among themselves in a manner that may have tax benefits, but which can make operations and reporting inefficient. Evaluating what to do with existing entities becomes even more complex when considering if, when, and how the acquirer may want to consolidate the target’s structures into their own.
The process of implementing a new structure can also have far-reaching impacts on legal, HR, IT, supply chain, and other business processes that can create risk if not properly identified and managed as part of the broader integration plan. It is critical to employ an enterprise-wide approach that engages all functions potentially impacted by entity decisions.
This type of holistic approach enables a buyer to fully consider business impacts and costs alongside tax savings prior to execution. It also allows functional leaders with the best understanding of key risks to identify and implement mitigating tasks as part of a smooth transition.
Depending on potential tax savings, the depth and urgency of the operational integration, and other considerations, some buyers may feel they have some flexibility when to perform the consolidation (if at all) and whether to include a material reduction in the total number of entities as a key goal of their integration program.
Experienced buyers typically search out deal-specific tax savings such as releasing trapped Net Operating Losses (NOLs) to the extent allowed by merging unprofitable and profitable entities and including those projected tax savings as a core component of their overall synergy plan and valuation. They also recognize that there may be a material cost involved in administering tax, financial, and other statutory reporting obligations covering a large number of entities. Eliminating some of these entities and creating a simpler, but still tax-efficient, structure reduces costs and creates a more transparent corporate structure.
Many acquirers implement the entity consolidation as soon as possible after taking control and may even encourage sellers to make key changes before close to help “pre-package” the structure for sale. Other buyers may plan limited integration, or just delay changes to the underlying entity structure that they believe they will have time to address in the future.
Without sound operational rationale, delaying the consolidation can slow synergy realization and contribute to overall entity proliferation, especially for serial acquirers.
Over time, a number of factors tend to increase an organization’s total number of entities. Some of this is simple inertia, such as an acquisitive company taking the safe route of leaving structures in place around risks they could not fully evaluate before close. In other cases, however, there may not have been a sound reason to delay a consolidation— or original justifications fade as tax management changes.
Regardless of the original rationale, structures that have been allowed to grow unchecked over time can become expensive to maintain, decrease operating efficiency, and generally reduce the value of the acquired assets. Experienced buyers evaluate the size and complexity of a target’s stand-alone structure during the pre-acquisition due diligence phase. Where inefficient structures are found, the consolidation program typically includes a parallel goal of significantly reducing the total number of entities during the consolidation.
When integrating larger acquisitions with a material amount of operational overlap, buyers also may want to place a critical eye on the size and efficiency of their own structures.
If a buyer has also allowed its entities to grow unchecked, it may be worthwhile to further expand the consolidation program to include a rationalization of the buyer’s global structure. Buyers should be thoughtful not to extend beyond their ability to implement a full-scale entity rationalization program during the already challenging integration process. However, pursuing both goals simultaneously can deliver additional value by taking advantage of the fact that certain operational inefficiencies are already being addressed.
Consolidating entity structures while also rationalizing entity count can provide numerous benefits, including reducing tax and regulatory compliance costs, decreasing transfer pricing complexity and risk, and making tax attributes (e.g. losses) easier to control in ongoing combined operations.
It is important to note, though, that potentially significant cost savings are unlikely to be achieved merely by eliminating dormant or almost dormant companies. Major benefits typically follow mainly from combining active operating entities, which means assets and liabilities may need to be redistributed. It is essential that such transfers are properly structured and controlled from a tax, accounting, and legal perspective.
It is also critical to consider the potential operational impacts of moving, combining, or dissolving entities. Examples of typical legal, tax, regulatory, and general operating issues arising in an entity consolidation and rationalization project can include:
- Ability to assign contracts, licenses, leases, and obligations
- Reconfiguring entity reconciliations and other system changes
- Transferability of regulatory permits, licenses, contractual rights, and remediation obligations
- Headcount reductions linked to realization of efficiency savings
- Transfer of employment contracts
- Lender arrangements over collateral pools, negative covenants, etc.
- Exposure of valuable asset pools and/or income streams to operational liabilities of affiliate entities
- Cash trapped overseas or within inefficient cross-border structures
- Preservation of NOLs, tax credits, and other material tax attributes
- Entity name changes
Entity consolidation and rationalization programs are highly cross-functional. Dependencies need to be identified and managed by department leaders and specialists who know them best.
A well-run integration management program will already have many of the tools and project management
methodologies in place to run an entity consolidation process. Additional specialized tools may be required, however, to help assess existing entity operating characteristics so they can be properly considered in both the design of the new entity structure and its implementation.
Whether to execute a consolidation at close or whether to also include rationalization as a key planning goal requires deal-specific analysis and recognition of the cost of allowing entities to proliferate over time.
For all programs, however, it is important to take a cross-functional approach that helps determine a broad set of multidisciplinary issues are being adequately identified and managed.
This text was reprinted, with permission, from M&A Spotlight: Consumer Legal Entity Structuring Can Enhance Integration Results (PDF)
For more information regarding this article or KPMG’s services in the area of mergers and acquisitions, please contact a member of your KPMG engagement team or Hideharu Kojima at email@example.com or 213-955-8511.