Unlike a licensing arrangement, the parent company of a wholly owned business:

Structuring cross-border transactions

Acquisition vehicles, forms of payment and acquisition, and tax strategies are discussed in detail elsewhere in this book. This section discusses those aspects of deal structuring most pertinent to cross-border transactions.

Limited Liability Company

LLC is one of the common legal forms used in running a business. A company is incorporated to form an entity that has a separate legal personality, and this implies that an organization can engage in a business and form contracts on its own. Upon incorporation, a company is required to have two major constitutional documents. These include the following:

Articles of association, which represent a contract between the members and the company and they set a legal binding rules for the company and this is inclusive of ownership, control, and decisions. The Company Act of 2006 allows significant flexibility to draw the articles so as to suit the specific needs of the company as long as it is within the law.

Memorandum that records the fact that the initial subscribers agree and wish to form a company and consequently become its members. It is impossible to amend a memorandum.

A limited company is normally owned by its members who invest in the business and enjoy limited liability. This implies that the company’s money is separate from individual money. As a general rule, the creditors of the company can only pursue the assets of the company to settle a debt rather than the personal assets of the owners. Two main mechanisms for company membership include company limited by shares and company limited by guarantee members.

Company limited by shares has each of the members having some shares in the company, hence become shareholders. The limited liability by shareholding implies that the members stand to lose whatever had already been committed to be invested (unpaid amounts on shares) or has already been invested.

Company limited by the guarantee members: A company limited by shares has a voting right attached to each share meaning that the members can vote on important decisions that affect the company. One share is normally equivalent to one vote though this is not the standards. Companies may choose their own class of share and voting rights. The company limited by guarantee has its one-member equivalent to one vote.

Finance for a company limited by guarantee member comes from the loans, members’ contribution or retained profits. A company limited by share can raise funds from shareholders in exchange for increased stake in business and any profits are distributed inform of dividends. Limited companies have a higher capacity to finance the business than most of unincorporated companies since they can use the assets held as security for obtaining loans and this gives them charge over their assets.

The limited companies are subjected to stricter regulatory requirements than the unincorporated firms, hence, greater transparency and accountability are vital for members to benefit from the company. Also, accountability is required both from the people dealing with the company and also the shareholders. The company is supposed to comply with the taxation stipulations of the country such as value-added tax, income tax, withholding tax, and many others.

A company that is limited by shares can either be a public limited company (Plc.) or private limited company (Ltd.). The main difference is that a Plc. is allowed to sell shares to the public. Nevertheless, a private limited company forms the most common legal incorporated form of company. Private limited companies may upgrade to Plcs. to take advantage of raining funds. A Plc. is exposed to stricter regulation than their private counterparts so as to ensure protection and transparency of the public investors who are in most cases not included in management decisions of the company.

A Plc. may become a listed company after it floats its shares on a recognized stock exchange. This creates a wider market for its shares. A listed company is subjected to even greater regulations in the form of listing rules as well as the requirements of information disclosure to ensure maintenance of integrity and proper functioning of the market.

Choosing the Appropriate Postclosing Organization

The postclosing organization refers to the legal or organizational framework used to operate the acquired firm following closing, so it can be the same as that chosen for the acquisition vehicle: corporate, general partnership, limited partnership, and the limited liability company. Common organizational business structures include divisional and holding company arrangements. The choice will depend on the objectives of the acquirer.

A division generally is not a separate legal entity but rather an organizational unit, while a holding company can take on many alternative legal forms. An operating division is distinguishable from a legal subsidiary in that it typically will not have its own stock or board of directors that meets on a regular basis. However, divisions as organizational units may have managers with some of the titles normally associated with separate legal entities, such as a president or chief operating officer. Because a division is not a separate legal entity, its liabilities are the responsibility of the parent firm.

The acquiring firm may have a variety of objectives for operating the target firm after closing, including facilitating postclosing integration, minimizing risk to owners from the target's known and unknown liabilities, minimizing taxes, passing through losses to shelter the owners' tax liabilities, preserving unique target attributes, maintaining target independence during the duration of an earn-out, and preserving the tax-free status of the deal. If the acquirer is interested in integrating the target business immediately following closing, the corporate or divisional structure may be most desirable because it may make it possible for the acquirer to gain the greatest control. In other structures, such as JVs and partnerships, the dispersed ownership may render decision making slower or more contentious, since it is more likely to depend on close cooperation and consensus building that may slow efforts at rapid integration of the acquired company.

In contrast, a holding company structure in which the acquired company is managed as a wholly- or partially owned subsidiary may be preferable when the target has significant known or unknown liabilities, an earn-out is involved, the target is a foreign firm, or the acquirer is a financial investor. By maintaining the target as a subsidiary, the parent firm may be able to isolate significant liabilities within the subsidiary. Moreover, if need be, the subsidiary could be placed under the protection of the U.S. Bankruptcy Court without jeopardizing the existence of the parent.

In an earn-out agreement, the acquired firm must be operated largely independently from other operations of the acquiring firm to minimize the potential for lawsuits. If the acquired firm fails to achieve the goals required to receive the earn-out payment, the acquirer may be sued for allegedly taking actions that prevented the acquired firm from reaching the necessary goals. When the target is a foreign firm, it is often appropriate to operate it separately from the rest of the acquirer's operations because of the potential disruption from significant cultural differences. Finally, a financial buyer may use a holding company structure because they have no interest in operating the target firm for any length of time.

A partnership or JV structure may be appropriate if the risk associated with the target firm is believed to be high. Consequently, partners or JV owners can limit their financial exposure to the amount they have invested. The acquired firm may benefit from being owned by a partnership or JV because of the expertise that the different partners or owners might provide.

A partnership or LLC may be most appropriate for eliminating double taxation and passing through current operating losses, tax credits, and loss carryforwards and carrybacks to owners.3 Cerberus Capital Management's conversion of its purchase of General Motors Acceptance Corporation (GMAC) from General Motors in 2006 from a C corporation to a limited liability company at closing reflected its desire to eliminate double taxation of income while continuing to limit shareholder liability. Similarly, when investor Sam Zell masterminded a leveraged buyout of media company Tribune Corporation in 2007, an ESOP was used as the acquisition vehicle and a Subchapter-S corporation as the postclosing organization. The change in legal structure enabled the firm to save an estimated $348 million in taxes, because S corporation profits are not taxed if distributed to shareholders—which in this case included the tax-exempt ESOP as the primary shareholder.

Limited Liability Company

Like a corporation, the LLC limits the liability of its owners (called members) to the extent of their investment. Like a limited partnership, the LLC passes through all of the profits and losses of the entity to its owners without itself being taxed. To obtain this favorable tax status, the IRS generally requires that the LLC adopt an organization agreement that eliminates the characteristics of a C corporation: management autonomy, continuity of ownership or life, and free transferability of shares. Management autonomy is limited by expressly placing decisions about major issues pertaining to the management of the LLC (e.g., mergers or asset sales) in the hands of all its members. LLC organization agreements require that they be dissolved in case of the death, retirement, or resignation of any member, thereby eliminating continuity of ownership or life. Free transferability is limited by making a transfer of ownership subject to the approval of all members.

Unlike S-type corporations, LLCs can own more than 80% of another corporation and have an unlimited number of members. Also, corporations as well as non-U.S. residents can own LLC shares. Equity capital is obtained through offerings to owners or members. Capital is sometimes referred to as interests rather than shares, since the latter denotes something that may be freely traded. The LLC can sell shares or interests to members without completing the costly and time-consuming process of registering them with SEC, which is required for corporations that sell their securities to the public. However, LLC shares are not traded on public exchanges. This arrangement works well for corporate JVs or projects developed through a subsidiary or affiliate. The parent corporation can separate a JV's risk from its other businesses while getting favorable tax treatment and greater flexibility in the allocation of revenues and losses among owners. Finally, LLCs can incorporate before an initial public offering tax-free. This is necessary because they must register such issues with the SEC. The life of the LLC is determined by the owners and is generally set for a fixed number of years in contrast to the typical unlimited life for a corporation.

The LLC's management structure may be determined in whatever manner the members desire. Members may manage the LLC directly or provide for the election of a manager, officer, or board to conduct the LLC's activities. Members hold final authority in the LLC, having the right to approve extraordinary actions such as mergers or asset sales.

The LLC's drawbacks are evident if one owner decides to leave. All other owners must formally agree to continue the firm. Also, all the LLC's owners must take active roles in managing the firm. LLC interests are often illiquid, since transfer of ownership is subject to the approval of other members. LLCs must be set for a limited time, typically 30 years. Each state has different laws about LLC formation and governance, so an LLC that does business in several states might not meet the requirements in every state. LLCs are formed when two or more “persons” (i.e., individuals, LLPs, corporations, etc.) agree to file articles of organization with the secretary of state's office. The most common types of firms to form LLCs are family-owned businesses, professional services firms such as lawyers, and companies with foreign investors.

Discussion Questions

15.1

What is a limited liability company? What are its advantages and disadvantages?

Why is defining the scope of a business alliance important?

Discuss ways of valuing tangible and intangible contributions to a JV.

What are the advantages and disadvantages of the various organizational structures that could be used to manage a business alliance?

What are the common reasons for the termination of a business alliance?

Google invested $1 billion for a 5% stake in America Online as part of a partnership that expands the firm’s existing search engine deal to include collaboration on advertising, instant messaging, and video. Under the deal, Google would have the customary rights afforded a minority investor. What rights or terms do you believe Google would have negotiated in this transaction? What rights do you believe AOL might want?

ConocoPhillips (Conoco) announced the purchase of 7.6% of Lukoil’s (a largely government-owned Russian oil and gas company) stock for $2.36 billion during a government auction of Lukoil’s stock. Conoco would have one seat on Lukoil’s board. As a minority investor, how could Conoco protect its interests?

Johnson & Johnson sued Amgen over their 14-year alliance to sell a blood-enhancing treatment called erythropoietin. The partners ended up squabbling over sales rights and a spin-off drug and could not agree on future products for the JV. Amgen won the right in arbitration to sell a chemically similar medicine that can be taken weekly rather than daily. What could these companies have done before forming the alliance to have mitigated the problems that arose after the alliance was formed? Why do you believe they may have avoided addressing these issues at the outset?

General Motors, the world’s largest auto manufacturer, agreed to purchase 20% of Japan’s Fuji Heavy Industries, Ltd., the manufacturer of Subaru vehicles, for $1.4 billion. Why do you believe that General Motors initially may have wanted to limit its investment to 20%?

Through its alliance with Best Buy, Microsoft is selling its products—including Microsoft Network (MSN) Internet access services and handheld devices, such as digital telephones, handheld organizers, and WebTV, that connect to the web—through kiosks in Best Buy’s 354 stores nationwide. In exchange, Microsoft has invested $200 million in Best Buy. What do you believe were the motivations for this strategic alliance?

Answers to these Discussion Questions are available in the Online Instructor’s Manual for instructors using this book.

27.3.4.1 Roles of the sponsor and the trustee

Math-Based Asset Services LLC is a limited liability company formed in 2013 in Delaware and is wholly owned by Winklevoss Capital Management LLC. Under Delaware corporate law and the Math-Based Asset Services LLC’s governing documents, Winklevoss Capital Management LLC is not responsible for the debts, obligations, and liabilities of the sponsor solely by reason of being the sole member of the sponsor. The trust was to be administered using a proprietary system owned by Winklevoss IP LLC, exclusively licensed to the sponsor for the purposes of operating an ETF.

The sponsor, Math-Based Asset Services LLC, was to arrange for the creation of the trust, the registration of the shares for their public offering in the United States, and the listing of the shares on the NASDAQ. It would assume certain administrative and marketing expenses incurred by the WBT: the trustee’s monthly fee and expenses reimbursable under the trust agreement, exchange listing fees, US Securities and Exchange Commission registration fees, printing and mailing costs, audit fees, marketing and legal expenses subject to a per annum cap, and the costs of the WBT’s organization and the initial sale of the shares. The sponsor had the discretion to waive its fee. The fee is calculated by the trustee and to be paid by transfer of bitcoins from the trust custody to the sponsor custody accounts on a monthly basis, calculated at the WinkDex spot price at the time.

The trustee is yet to be appointed. In its capacity as trustee of the trust, the trustee is generally responsible for the day-to-day administration of the trust. The trustee would receive and process orders to create and redeem baskets in coordination with the Depository Trust Company (DTC) and calculate the net asset value of the trust and per share. It was to transfer the bitcoins it held out of the trust custody account in certain circumstances: paying the sponsor’s fee and any extraordinary trust expenses not assumed by the sponsor out of WBT’s bitcoins and selling WBT’s bitcoins at termination of WBT and distributing the cash proceeds to the shareholders of record. The trustee could sell bitcoins in the trust expense account to cover WBT’s expenses and liabilities not assumed by the sponsor or as required by law or regulation. Every delivery, transfer, or sale of bitcoins by the trust to pay any trust expense was to be a taxable event to shareholders.

The trust’s custodian is also the trustee. Although the trust’s bitcoins are not stored in a physical sense, the transaction records included in the blockchain assign a location for each of the trust’s bitcoins to digital wallets established by the trustee using the trust’s proprietary security system, which wallets digitally hold the bitcoins and permit the trust to move its bitcoins. Access to those digital wallets, and the bitcoins they hold, is restricted through the public-private key pair relating to each digital wallet. As custodian, the trustee is responsible for the safekeeping of the trust’s private keys used to access the digital wallets. The trustee also facilitates the transfer of bitcoins into and out of the trust custody account through the bitcoin custody accounts it will maintain for authorized participants and the sponsor. In accordance with the procedures of the security system and the provisions of the trust agreement, the trustee will store all of the trust’s digital wallet private keys in US vaulting premises on a segregated basis and will deliver such private keys to the trustee’s authorized administrative operations to permit access to the digital wallets on an as-needed basis.

Advantages of Creating a Limited Company

There are a number of advantages in trading as a private limited company which can be summarised as follows:

The liability of the members is limited to the value of their shares.

The company has a legal personality of its own separate from its members.

The name of the company is prevented from being used by other companies.

There are certain advantages in borrowing money (see below).

The interests and responsibilities of the persons engaged in the business are clearly defined, including the management responsibilities of the firm.

The company has a continuing existence of its own, independent of its members.

In some circumstances there are taxation advantages.

The appointment, retirement or removal of directors is carried out in the prescribed manner.

Employees may gain the opportunity of acquiring shares in the company, and outside investors may become shareholders.

Profile of a small Irish Moss producer: Benjo Seamoss Agro Processing Limited

Benjo Seamoss and Agro Processing Limited (Benjo) is a limited liability company that was located at Ravine Coque in Roseau in the Commonwealth of Dominica in 1999, at the time of the initial intervention described as part of this case study. The firm produced a variety of traditional beverages using Irish moss (also more commonly called seamoss in that region of the world). The company manufactured the products from marine algae, particularly the agar-rich variety G. debilis, previously sourced from St. Lucia but supplies of which were then (at the time) being obtained from Grenada, both nearby Organization of Eastern Caribbean States (OECS) countries. The Irish moss used was a completely natural product which was not cultivated but harvested from the wild. The company was marketing its product locally in Dominica,a in several English speaking Caribbean countries and in other Caribbean countries such as St. Maarten at the time. The product had met with reasonable success and had great potential for increased volumes, particularly since beverage products in this category had shown consistent growth globally over many years. In addition, there was a growing market for seaweed products which was estimated to be expanding at a rate of 10% per annum.b As a result, the firm’s production and exports to the OECS region was expected to increase by over 250% over the next 6 years (to 2005), with exports into EU and US territories and other countries in the wider region being targeted, thereafter.

The company manufactured its products on a single production line on which it produced different variants of seamoss drinks, including seamoss with Bois Bande,c plain seamoss (natural, nothing added), and seamoss with milk. Sixty percent of consumers in the regional market for its product prefer seamoss with milk, 20% the natural product, and 8% the seamoss with Bois Bande. Benjo operated from a small facility (Fig. 3.1) with rudimentary equipment using its existing manufacturing protocols. The company, however, had plans for expansion to take advantage of opportunities identified in the market place, as outlined later and had, in addition, realized that as its volumes grew, so did the cost of any quality problems that arose from time to time or noncompliance with market requirements.

In 1999, Benjo was in the second year of implementing a strategic marketing plan which was a critical part of its business plan and which called for a significant increase in sales to its targeted markets over the next few years. Local sales were expected to grow by an average of 10% per annum for the next 3 years, after which the annual increase was targeted at 5%. Regionally, the plan called for expansion in the volumes of its sales by 20% over the next 2 years, then 45% per annum over the following 6 years. Internationally, a 50% per annum growth was expected over the next 5 years, followed by a 35% per annum growth in the succeeding 6 years. All of this would require substantial improvements in production capacity, logistics and sales and marketing capabilities and, critically, effective technical support to facilitate the increases in production, compliance with requirements and access to markets that were being targeted under its business plan. In essence then, the firm could only achieve these objectives if it had strong, effective technical support to address its quality systems, food safety, and food science needs. This upfront recognition of the role that food science and quality systems play in the successful growth and expansion of food production enterprises formed the basis for this case in which support was provided to help the firm successfully implement its business and market expansion plan. It also highlights the importance of considering the technical aspects of a business in developing successful business plans for food production and handling businesses.

Benjo was desirous of modernizing its facilities, addressing existing constraints to production and growth and implementing a recognized Good Manufacturing Practice (GMP) program that would allow its products access into regional and extraregional markets. To make its plans a reality, Benjo realized that it would need technical support. At the time (in 1999), HACCPd-based food safety systems were becoming in vogue in Canada and the Australasia regione in the dairy and meat processing industries, were mandatory for some categories of products in the European Union, and were required for meats and seafood in the United States of America. However, the HACCP concept had not yet become the norm in the food industry, GMPs being regarded as a good and more practical starting point for most food and beverage production firms trading in developed country markets, hence the interest of Benjo in GMP systems implementation. Benjo’s management, advised by its supporting network of partners therefore sought the assistance of a firm that specialized in providing technical assistance in food safety and quality systems with knowledge of the nuances of the Caribbean region, which could assist them in achieving compliance with the requirements for certification to a recognized GMP standard for export to North America and Europe.f This formed the basis of a series of technical assistance interventions which were maintained, as required, over an extended period of time.

Products and production processes

At the time of the initial intervention in 1999, Benjo had a total staff compliment of 12, including the owner and manager of the business. The firm operated with the most basic, but scale-appropriate equipment that it used to successfully manufacture products at its then current level of production. This was done according to manufacturing protocols and procedures that had been developed by the owners, as for many other start-up food businesses, largely through trial and error. The beverages were bottled in 5-oz. bottles such as the one shown in the middle in Fig. 3.2, then normally used for carbonated beverages which were quite popular in the region. While initially manufacturing only three variants, Benjo subsequently expanded its range between 2002 and 2006 to include other variants that were also associated with various positive health outcomes, including Seamoss with Oats and Barley and Seamoss with Linseed (Table 3.1).

Figure 3.2. Some of Benjo’s products in the early 2000s in the original and newer bottles.

Table 3.1. Selected products made at Benjo Seamoss over the period 1999–2010

Product type (original)List of ingredientsNatural SeamossSeamoss, sugar, citric acid, sodium citrate, stabilizer, cinnamon, nutmeg, natural flavorsSeamoss with milkSeamoss, sugar, milk, citric acid, sodium citrate, stabilizer, spices, natural flavorsSeamoss with Bois BandeSeamoss, sugar, Bois Bande, citric acid, sodium citrate, stabilizer, spices, natural flavorsProduct type (new flavors)List of ingredientsSeamoss with oats and barleySeamoss, sugar, milk, oats, barley, citric acid, sodium citrate, stabilizer, spices, natural flavorsSeamoss with linseedSeamoss, sugar, milk, linseed oil,a citric acid, sodium citrate, stabilizer, spices, natural flavors

aLinseed oil is the oil expressed from flax plant (Linum usitatissimum). It is thought to have health promoting properties, being rich in the Ω3 fatty acid, α-linolenic acid, which creates a demand for products containing the oil in the Latin American region and elsewhere.

The original process of manufacturing Benjo seamoss beverages was discontinuous and is outlined in Fig. 3.3 and also shown (selected stages) in Figs. 3.4 and 3.5. The product was made as outlined in the following:

Figure 3.3. Process flow for making Seamoss (Irish Moss) at Benjo in 1999.

Figure 3.4. Original process for making Irish (Sea) Moss at Benjo in 1999.

Figure 3.5. Cooling bottles of Benjo Seamoss using fans.

1.

The seamoss was selected, examined and physically washed 3 times (Fig. 3.4A).

2.

It was then placed in a steam-jacketed kettle and heated for 30 min or until it softened.

3.

The product was then mixed, acidified, and homogenized.

4.

The homogenate was held overnight and then water and other ingredients were added.

5.

The homogenate was blended (20 min) while being heated and other ingredients being added (Fig. 3.4B).

6.

The finished product was then strained and decanted into spouted jugs, which were used to fill the bottles (Fig. 3.4C).

7.

The bottles were capped (Fig. 3.4D) and placed in small “retorts” (pressure cooker units) and heated on gas stoves for about 30 min (Fig. 3.4F) before the pressure cookers were allowed to cool.

8.

The pressure cookers were opened and the bottles cooled in the retorts for 5–10 min, then removed and put to cool under fans, washed to remove excess product from the bottles, before being dried, placed into soft drink trays for warehousing and subsequent delivery to market (Fig. 3.5).

This process and production system was the one based on which Benjo had built its business and with which it sought assistance to improve its operations as it sought to successfully pursue its business plan and expand production and sales in third country markets.

Which of the following is a similarity between licensing and franchising group of answer choices?

Which of the following is a similarity between licensing and franchising? Both are types of cooperative contracts.

What are the two kinds of cooperative contracts in global business?

The two kinds of cooperative contracts in global business are: licensing and franchising.

Which of the following is a regional trade agreement between most European countries quizlet?

The most advanced regional trade agreement in terms of fostering political and economic integration is the European Union.

What entry strategy gives a firm the right to manufacture another firm's product or use its trademark for a royalty fee?

Licensing is a business arrangement in which one company gives another company permission to manufacture its product for a specified payment. Licensing generally involves allowing another company to use patents, trademarks, copyrights, designs, and other intellectual in exchange for a percentage of revenue or a fee.