Structuring Ownership Of Multiple Companies
Part 1-Corporate Division
You already own a company called ABC, LLC and you’re thinking of starting another one, or you are going to buy another company. How should you structure the ownership of these two entities? There are a lot of options, and each one has its own advantages and disadvantages. This is Part 1 of a multi-part series on business ownership structure where we help you think through those options so you can choose the structure that is best for your situation at each stage of the business venture. The later parts are at Part 2 and Part 3.
Corporate Division-New Venture Inside Your Existing Company
In many cases we counsel our clients who want to dabble in a new line of business to consider creating a division within their existing business, because there is literally zero legal effort to do that. This is the simplest structure because a division is not a legally separate entity, it’s just part of your existing company. With your new division you can advertise and do business under a name (XYX) that is distinct from your existing company (ABC, LLC). A word of caution, since the division XYZ is NOT a registered LLC, you cannot name it XYZ, LLC or present that name to the world.
You don’t register a new division with the State as a distinct LLC or corporation. But since you are presenting XYZ to the world as if this is a distinct company with its own name and apparent separate identity, you have to register that name with your State. XYZ is called a fictitious name, or trade name, or many people call it a “DBA” meaning “doing business as.” This legal requirement of registering the trade name alerts people you do business with that name XYZ actually points to a real company that is permitted to do business within your State. When you sign contracts with customers or suppliers that want to do business with XYZ, your contract would say that the party is ABC, LLC, doing business as XYZ.
One of the most attractive aspects of having XYZ be a division within ABC, LLC is that you can easily share resources between the “companies.” You might want to operate XYZ as a division, because you want the profits from ABC, LLC to finance XYZ’s startup costs, or you want to share employees and other expenses between the operations of ABC, LLC and XYZ. For example, the receptionist for ABC, LLC can also answer the phones for XYZ. XYZ may be housed in the same leased space as ABC, LLC at least at the begining. And because the tools used by ABC, LLC people are all around that space, XYZ people can use those tools without paying for its own set (such as software licenses, computers, furniture, etc.). You are also allowed to have a single bank account that mingles the funds of the operations of XYZ and ABC, LLC. It’s easy to co-mingle all of this because in fact to the outside world there is no difference between ABC, LLC and XYZ. Even the IRS treats them as one entity.
But is it wise to continue such resource sharing as XYZ begins to establish its own business value?
Thinking ahead, what if someone wants to buy the division XYZ, but not the whole company ABC, LLC? Or what if you decide to spin this division out as a separate LLC of its own—for various reasons that we’ll explore later? To be prepared for those scenarios at some point you should start keeping separate internal accounting records for the activities of the main company ABC, LLC and the division XYZ. While this is not a LEGAL requirement, keeping separate accounting records helps you and potential buyers understand whether that division is making a profit and can stand on its own. Will it need to hire its own (part time) receptionist? How integral to XYZ’s business is the developer that XYZ borrowed frequently from ABC, LLC? All these things can be answered only when you have fully separated the financial records of ABC, LLC and XYZ.
One more thing about record keeping: Who owns that name, XYZ? Certainly you have registered a federal trademark on the name XYZ for its particular business line. A trademark is essential to protection of all the investment you put into developing a brand identity. But what entity owns that trademark? This is no small question, because the value of a brand can be the largest single asset of a company. Well, when you register a trademark at the US Patent & Trademark office, the application asks for the name of the owner, AND it asks for the trade name, or the “DBA.” Be sure that you tell your trademark attorney that you want the DIVISION to own the name. This is a small technicality, but it can make a difference in perception when people are doing business with XYZ, or when someone wants to buy the assets of the division XYZ.
Disadvantages of the Corporate Division Structure
Opportunity: XYZ does really well, and one or more of the employees that work exclusively in XYZ are expressing interest in stock options—they want to be compensated well if that “company” is bought out. What is even more interesting is that an angel investor has told you he wants to invest $100,000 in XYZ return for 5% of the “company.” But XYZ doesn’t have its own stock, and you are not willing to give stock in ABC, LLC to either the employees or the angel investor.
Disaster: The risks associated with XYZ’s products are much higher than the risks associated with the operating of ABC, LLC. Suddenly someone sues XYZ over a product-related injury, and it looks like you might lose the lawsuit! What happens to ABC, LLC? As you probably realize, since XYZ IS ABC, LLC, all of the assets of ABC, LLC are at risk to pay the judgment against XYZ. This cannot be avoided with the structure of XYZ as a division of ABC, LLC.
You need a way to protect the assets of ABC, LLC from both the interests of new investors/employees in XYZ and the potential liabilities of XYZ. You need to spin XYZ out as a separate LLC of its own.
But who should own the new entity? Now there are other options available to you for the structure of separate entities, which will be the next topic in this series, Part 2.
Entrepreneurs are going to save the world, and Argent Place Law wants to help. That’s why we are a team of entrepreneur-lawyers serving Entrepreneurs just like you. Think how great it will be to have a legal team with entrepreneurial experience on your speed dial so you can call us up and say, “I’m starting a new business line, should I put that into a separate LLC?” Call Argent Place Law to find out at 703-539-2518 or set an appointment today; your first 30 minutes are free!