Bill Gates was once asked what he thought was the most significant invention in business in the last hundred years. Everyone expected him to say the desktop PC or the internet or something related to his world and career. He said the Limited Liability Company (LLC). He felt that the limited liability company was the biggest step forward in the business world in the last hundred years. Why? Because it gave protection of capital for people to invest and take risks. Before the limited liability company, if an investment didn’t work out, you lost everything. And if you lost everything, you went to jail (at the time they still had debtors’ prisons, literally).
After the implementation of the limited liability company, which then made it possible for people to take ring-fenced, isolated risks, there’s been a huge boom in economic activity. This has probably done more to improve global living standards than anything else in history.
There is huge power in the use of a limited liability company. The companies we’re acquiring are limited liability companies, and we will always acquire them by using another limited liability company, which is what we call a Special Purpose Vehicle (SPV).
When I talk about buying a company for $1, what actually happens is an SPV buys the shares in the target company for $1.
What is an SPV?
An SPV is simply a registered limited liability company sitting and waiting to do a deal. Just a normal, run-of-the-mill limited liability company, nothing different or special about it. You can give it any name, have any number of directors or shareholders—it doesn’t matter, but it’s always easier with one director and shareholder when it comes to filling out paperwork. Generally speaking, the SPV should be registered in the country where you are doing the deal. You can register companies quickly and cheaply, so I recommend having one set up and ready-to-go, just waiting to do a transaction.
The key component of an LLC is its limited liability. Rather than personally buying the company and risking yourself as a contracting party, being held liable for something in the future, just putting an SPV in between creates a little more security. The contracting party (the one that enters into the agreements and therefore can be sued for any breach) is a company, not you.
If you have an existing business and you are looking to acquire another business, you should still use an SPV. Create one that can be standalone or a subsidiary of your current business. Use it to do the deal. Accountants sometimes advise against this because you have to consolidate the accounts, making a little extra accounting work, but it is vitally important that the deal you do uses an empty limited company. As the contracting party, if you buy directly, you open yourself up to litigation risk, and when dealing with distressed businesses, this is a higher than usual risk. Use an SPV, and it is largely mitigated.
Here’s are two interesting cases where an SPV wasn’t used, and how it cost the buyer.
- YouTube managed to have a huge amount of illegal content on its site for years without ever being sued. As soon as Google bought them, MGM, Fox, and others, whose material had been published illegally, issued a multi-billion-dollar lawsuit, knowing that YouTube could now afford it!
- I also dealt with a telecom company that bought a customer of theirs (another telco) and spent nearly $500,000 on due diligence. As soon as the deal was closed, they were sued by a staff member who had left six months before they had even started looking to buy the The staff member hadn’t bothered suing before because he didn’t believe the company had the money to pay out, but now it did!
It’s important not to throw a rotten apple into your nice clean barrel of shiny ones.
A Side Note to SPVs: Empire-Building
When I first started doing deals, I went through what I call my “empire-building phase.” I just wanted to buy everything and build it into this giant holding company. I had the holding company at the top, and I just kept adding more companies underneath it. It created a very pretty organizational structure.
But a few things happen when you build an empire:
- You are treated as a group for taxation, and in some countries, taxes are higher for larger companies. None of my businesses were individually large companies, but my group now paid the higher rate of tax.
- Some of the businesses were so small they would not have met the sales tax threshold! However, as a group, you have to register for sales tax for all group
- As a large company, you are required to have a full audit. Small companies are generally exempt. A full audit can be a huge cost, not just to the external provider, but also in terms of internal
So, while a group structure looks pretty and feels right, it is really an ego thing. You don’t need a group: you can just as easily have silos—separate companies that can inter-trade, share resources and office space, and garner all the benefits of a group without the penalties.
So, if you are building an empire, ask yourself if there’s a good reason. Don’t get me wrong—there are good reasons (e.g., if you want to go public or pitch for bigger contracts), but make sure you have a good reason before you empire-build.
Next time, I’d like to share more on structuring a deal so that you can acquire a really decent business. I look forward to connecting with you then.
This article was originally published at: https://www.jeremyharbour.com/be-sure-to-use-this-when-you-acquire-your-next-business/