Growth is great! With it, however, comes much to contemplate. When an accounting firm acquires or merges with another firm to expand its capabilities and market reach, its owners must consider how that will affect the legal, financial, and other facets of their business.
Pros, cons, opportunities and challenges exist no matter how you decide to structure your expanding company.
1. Maintaining separate legal entities
In some instances, business owners may decide to keep their practice and the one they're acquiring as independent legal entities.
Advantages:
- Enables leveraging each firm's strong name recognition and reputation with its existing client base and geographic market.
- Limits liability for each firm because they are separate entities and are responsible only for their own debts, not each other's.
- Provides a smooth transition with minimal disruption as there are fairly minimal changes to be made to business compliance documentation.
- May avoid excessive sales and marketing-related expenses to update advertising collateral because each retains its own brand identity.
Disadvantages:
- Managing multiple entities means higher administrative costs and more paperwork (separate tax filings, more compliance responsibilities).
- May result in unnecessary software costs and other expenses due to a lack of uniform systems and processes across the companies.
- Difficulties in forging a cohesive company culture if the combined companies (and their team members) operate in silos without integration.
- Potential inefficiencies in resource sharing.
2. Merging or consolidating firms
A merger typically involves one of the combining companies surviving and the other company dissolving their legal entity; essentially one company absorbs the other. A consolidation typically involves dissolving the existing firms' legal entities and forming a new entity that combines them. Both a merger and a consolidation operate as one entity, sharing all legal, tax, and compliance responsibilities.
Advantages:
- Consolidating financials, compliance and tax filings under a single entity simplifies management.
- Streamlining operations and administrative processes reduces costs and saves time.
- Enables a foundation for building a unified company culture.
- Makes it easier to present a consistent brand across locations.
- Under strict circumstances, the transaction may fall under IRC Section 368 as a reorganization (statutory merger or consolidation), which is a tax-free transaction for federal purposes.
Disadvantages:
- Dissolving one or both entities and forming a brand new one can become time-consuming and costly.
- May create brand recognition and awareness problems depending on the choices made regarding the business name, logo and other aspects of the brand identity.
- All debts and liabilities are shared in the combined company, so if either merging or consolidating firm has unresolved issues, the new company may be exposed to legal or financial risks.
- May negatively affect relationships with the firms' employees or clients if they aren't well informed about the merger and its impact on them.
3. One firm acquiring another as a subsidiary
When a firm acquires another, the acquired company might either be dissolved and fully absorbed into the acquiring firm, or it might become a subsidiary of the acquiring business. Another possibility is that a new entity is formed as the parent company, and both the acquiring company and the acquired company become subsidiaries. Here are some of the upsides and downsides of establishing a subsidiary.
Advantages:
- Limits the parent company's exposure to legal and financial risks because the subsidiary is its own legal entity.
- May provide some financial flexibility because in some jurisdictions the transfer of assets between companies is tax-free.
- Enables each firm to maintain its brand identity and manage its operations with some independence.
- Allows the company to diversify its client base and expand its areas of expertise while maintaining its tried-and-true services and approaches to serving its incumbent customer base.
Disadvantages:
- Complicates financial reporting and tax filings as the parent company must aggregate its subsidiaries into its statements.
- May negatively affect relationships with the acquired firm's employees and clients if they are fiercely loyal to the way things were before.
- Increases legal, accounting and business compliance costs.
- Makes it challenging to gain operational efficiencies and unified brand awareness if the subsidiary company is operating in a silo, rather than as an integrated part of the company.
Business formation and compliance: Food for thought
As you're welcoming another firm into your business, realize there will be various formation and compliance filings and updates to complete. The requirements will depend on which option you've chosen for bringing the other business into your firm and the business entity types involved. Here are a few of the filings and applications a firm might be responsible for:
- Certificate of merger or acquisition. This is to officially combine entities and update public records.
- Articles of dissolution. This must be filed with the state when dissolving a business entity.
- Articles of incorporation, articles of organization, certificate of limited partnership (or other business registration form). These are required when forming a new business entity.
- Certificate of conversion. This is required when converting from one business entity type to another (e.g., changing from a limited partnership to a professional corporation).
- DBA filing. This is for registering a fictitious business name (e.g., if a post-merger entity files the acquiring firm's name as its legal name and also wants to do business under the acquired firm's name).
- IRS Form SS-4. This is for obtaining an Employer Identification Number for a newly formed entity.
- Business licenses and permits. These need to be updated or reissued to reflect the new ownership information and entity type.
- Articles of amendment. These are required if an existing entity's name, registered agent information, director or member information, number of authorized shares, or business activities change.
Because of the legal implications when structuring multiple firms, it's wise to seek advice from an attorney for guidance. And of course, you'll want to tap your own expertise and thoroughly consider the tax-related impacts of your options.
