The Legal Viewpoint: How To Structure Your Startup For Success
One of the most critical questions in startup decision-making is probably: “What is the best legal structure for my business?” The entity you eventually select will have legal, operational, and financial implications, so choosing the right fit for your business is a crucial step.
There is no doubt that a lot of blood, sweat, and tears, along with a little bit of luck here and there, will pave the way for success. However, giving proper attention to choosing the right business structure will provide the foundation for this success as you move forward.
So, why is it important to choose the correct structure for my business?
Selecting the right structure is vitally important, not only in terms of legal and operational risk, tax obligations, asset protection, legal costs, and your clientele, but also in terms of accommodating future growth. Changing the legal structure down the line is possible, but it can be extremely complex, so making the right decision in the early days will save you a whole lot of stress.
The choice of corporate structure may seem overwhelming and each with their own pros and cons. Here, we are going to explore the options of dual company structures (comprising both holding company and operating company), special purpose vehicles (SPV), and offshore.
Source: Suraya Turk
What is a holding company, and why would you need it?
The core purpose of a holding company is to control another company rather than engage in business endeavors. In doing so, holding companies own the important business assets on behalf of the operating company, so they can keep your golden nest egg safe and secure.
Because the operating company deals with all aspects of contract management, employee hiring, and client relations, they bear the burden of liability. While this structure may be a costlier option, the benefits of minimizing shareholder risk as well as protecting business assets and interests tips the balance in terms of negatives and positives.
Clearly, certain types of business will benefit from this structure over others:
- Intellectual Property (IP) Your business may own extremely valuable IP (trademarks, patents, branding, or copyright), so it makes sense to protect this via an IP holding company.
- Trade Risk Asset protection is a major concern when operating in a high-risk sector, such as a heavily regulated industry, which is addressed by establishing a holding company.
- External Investment A dual company structure is a very attractive proposition for external investors due to the separation of their investment from the operating company’s trading risk.
Do special purpose vehicles (SPVs) offer a better solution for your business?
SPVs are passive holding companies that offer an extremely flexible solution to structuring your asset holding and investments. The ability to isolate financial and legal risk by ring-fencing specific assets and liabilities is an attractive proposition for many business types, uses, and industries. Further, as SPVs are corporate vehicles, they can be used to establish subsidiaries, projects, or joint venture (JV) vehicles.
The benefits of an SPV are clear in terms of minimizing financial risk, direct asset ownership, tax savings (dependent on where the vehicle is created), and a straightforward process in terms of setting it up. Looking ahead to the future, be mindful of potential regulatory changes that may impact your operations if you select this structure.
What do I need to consider in terms of ownership structure?
Founders should have a clear vision of their ownership structure at business inception, and they should look at how this will be regulated going forward. Establishing the right shareholdings for your business in the early days will help avoid potential issues down the line. If you are intending to use equity to raise funds, beware of over-promising or over-issuing shares, and setting overly generous investor terms- also, remember that shareholders may come and go.
Business governance is another key factor. How the business is run, who makes the big decisions, and how disputes are dealt with should be defined and documented. This is usually done via a shareholders’ agreement, supplemented by the memorandum and articles of association. From a shareholder/investor viewpoint, it’s important to lay out how and when they can exit, and establish an appropriate ownership structure if the goal is to go for an initial public offering (IPO) or sell the company.
Which jurisdiction is the best home for my business?
Choosing the best jurisdiction very much depends on where you plan to conduct your core business activities, the location of your investors and where the company will be managed from. In this article, we are focusing on the UAE, British Virgin Islands (BVI), and Cayman Islands, which are popular jurisdictions for startups, but many other options are available too, such as Cyprus, Belize, Singapore and the Bahamas.
Before you select your holding company jurisdiction, consider:
- Taxation Explore tax obligations, particularly if there any double taxation agreements (DTAs) impacting the holding company and any subsidiaries or operating entities.
- Economic substance Address any compliance matters with economic substance regulations, which require a company to have both economic and commercial substance in the jurisdiction.
- Nature and location of underlying assets Choosing the most appropriate jurisdiction will depend on the nature of your underlying assets, i.e., equity holding, IP, leasing, or financing.
- Access to professional/financial services Assess whether the geographical location is accessible to shareholders and directors, if robust legal systems are in place, as well as any cost or governance requirements you need to meet.
When it comes to the UAE, the country is politically stable, well-positioned globally, and has a strong economy. With its offering of tax benefits, asset protection, 100% ownership, flexible corporate laws, and robust support services, it almost seems like a no-brainer!
Holding companies in the UAE are typically set up in free zones -primarily Abu Dhabi General Market (ADGM), Dubai International Financial Center (DIFC), Dubai Multi Commodities Centre (DMCC), Ras Al Khaimah Economic Zone (RAKEZ), or Jebel Ali Free Zone (JAFZA)- but, following changes to commercial company ownership, you can also opt to launch on the mainland in Dubai, Abu Dhabi, or one of the remaining Emirates.
If you decide to go down the SPV route via ADGM, you will find a flexible, straightforward option that is attractive to a broad range of businesses and individuals. Bear in mind that there is a requirement for SPVs to show a connection or “nexus” to ADGM, the UAE and/or the GCC region, in addition to no option to conduct operations or appoint staff members with this vehicle.
If you are looking to launch offshore, then the BVI and Cayman Islands offer similar advantages in terms of tax neutrality, flexible and modern corporate laws, sophisticated service providers, and well-respected judiciaries. The core differences between the two are that BVI can be more cost-effective and flexible, whereas Cayman Islands is well-known to private equity investors due to the high volume of publicly listed companies it attracts.
Can I use my holding company to operate my business?
Holding companies are not allowed to engage in any standalone commercial activities, so you would not be authorized to produce or sell any goods or services with this structure. Therefore, you would need to incorporate an additional “operating” company. Consequently, it is costlier to implement and maintain, but an operating company provides the ability to trade, secure contracts, hire staff, and engage with clients as a subsidiary of the holding company.
At the end of the day, here are the three key points you need to keep in mind when structuring your startup:
1. Structuring your business correctly at the outset is one of the most important things you can do to help prevent issues down the line, and it is -truly- the foundation for success.
2. Do your research- consider whether a dual company structure, SPV, or an offshore solution would be the best fit for your startup and its future operations.
3. Secure professional legal advice to make sure you make the best choice for your business, and relieve the pressure of navigating the tricker aspects of your startup’s inception.