The Pros and Cons of Creating a New Entity for a Business Acquisition
Business acquisitions can be transformative opportunities, allowing companies to expand their market presence, diversify their offerings, achieve growth at an accelerated pace, and retain jobs. One of the key decisions that arises during an acquisition is whether to integrate the acquired business into the existing structure or create a new entity. Here we discuss the advantages and disadvantages to consider when choosing to create a new entity or retain the existing one.
Benefits of Creating a New Entity
Liability Mitigation: By creating a new entity, you can isolate potential liabilities and risks associated with the acquired business from the existing operations of your company.
Business Type Flexibility: Creating a new entity offers the flexibility to choose a corporate structure that aligns with your management, ownership, and tax preferences. You will be able to decide whether an LLC, S-Corp, Sole Proprietorship, or other is the best fit for you.
Simplified Accounting: Separating financial records of the new entity from the seller company's financials simplifies reporting, analysis, and compliance.
Branding and Positioning: A new entity allows you to strategically position and brand the acquired business in a way that resonates with your target market and strategic focus.
Competitive Advantage: A new entity can be positioned as a unique player in the market, combining the strengths and capabilities of both businesses. This can create a competitive advantage by offering customers a differentiated product or service.
Disadvantages
Name Recognition: If the acquired business has a strong brand identity, forming a new entity could be a detriment to existing name recognition, but there are ways to retain trade names while still forming a new entity. This can be particularly useful when maintaining customer loyalty and trust.
Regulatory Hurdles: Forming a new entity requires compliance with various regulatory and legal requirements, such as obtaining licenses, contract assignments, and approvals. This can vary by jurisdiction and industry, adding a layer of complexity to the process. Engage legal experts who are well-versed in the local laws and regulations.
Resource Allocation: Creating a new entity requires time, money, and human resources. You will need to allocate resources to avoid impacting day-to-day operations.
Integration Delays: Creating a new entity can extend the timeline for integration. This delay could impact your ability to capitalize on synergies and realize anticipated benefits from the acquisition in a timely manner.
Disruption to Operations: The process of creating a new entity can disrupt the normal operations of both the acquiring and acquired companies. This disruption might impact productivity, customer service, and overall business performance.
Steps to Create a New Entity
Due Diligence: Thoroughly assess the acquired business's financials, legal contracts, assets, and liabilities. This helps identify potential challenges and opportunities early on.
Legal Structure: Decide on the legal structure for the new entity. Common options include forming a subsidiary, joint venture, or wholly-owned separate entity.
Name and Branding: Choose a name that reflects the entity's purpose and aligns with your company's values. Design a branding strategy that harmonizes the acquired business's identity with your own.
Legal Formalities: Register the new entity with the appropriate government authorities, adhering to local regulations. Obtain any required licenses and permits.
Governance Structure: Define the organizational hierarchy, roles, and responsibilities within the new entity. Establish a board of directors or governing body, if necessary.
Intellectual Property: Address intellectual property rights, trademarks, patents, and copyrights to ensure a smooth transition and protection of existing assets.
Employee Transition: Plan for employee onboarding, training, and retention. Communicate the changes transparently and ensure a smooth cultural integration.
Financial Integration: Establish separate financial accounts for the new entity. Implement accounting and reporting systems that align with your company's standards.
Contracts and Agreements: Draft new contracts or amend existing agreements as needed. This includes supplier contracts, customer agreements, partnerships, and leases.
Communication Strategy: Develop a communication plan for stakeholders, including customers, suppliers, employees, and investors. Address concerns and highlight the benefits of the new entity.
Creating a new entity for a business acquisition is a strategic decision that requires careful planning, due diligence, and thoughtful execution. While creating a new entity can offer advantages, it's essential to be aware of the potential downsides and challenges that come with this approach. Ultimately, the decision to create a new entity should align with your long-term business strategy and be made after a comprehensive evaluation of both the benefits and drawbacks. If you are still deciding whether or not to acquire a business, check out on blog Unlocking Opportunity: The Path to Wealth Creation through Business Acquisition.
Thinking about purchasing a business with a SBA 7(a) loan? Contact our lending experts to learn more.
Want to receive more content like this?
Sign up for our small business updates.