Changing business conditions as well as new research on corporate structures has prompted us to consider a major change of business strategy for our consultancy and other business operations.
In the past, and in line with the General / Limited Partnership structure of our firm, we have been developing a classic root-and-branch structure for our business group which features:
One holding company or “mothership”;
Single-purpose subsidiaries established to cater to specific partners or business functions.
Figure 1 indicates the current idealized operating structure of our group:
Figure 1: Classic Holding Company Structure
Costs in the Business Environment
This structure creates a tremendous duplication of effort at a time when growing regulation and growing inflation costs cannot be passed on to customers. Let’s take a look at some recent tax and banking changes in Cyprus (and the European Union as a whole), and how this has affected us:
In the European Union, the last 10 years have seen a veritable landslide of new regulations which have the net effect of making companies guilty until they prove themselves innocent. Regulations such as the EU General Data Protection Regulation (GDPR), the Ultimate Beneficial Owner (UBO) register, new banking reporting rules, and new rules for international financial transfers as well as inter-group financial transfers mean that for the average SME, achieving true compliance costs at least € 10,000 – 15,000 per year in added direct costs. The rate of EU policy-making is set to rise, with new mandatory rules on Environmental, Social and Governance (ESG) reporting; a stricter ePrivacy Act; gender equality and reporting guidelines and more.
While Cyprus has long advertised itself as a tax haven, there has been creeping taxation in every sector of the economy. Our companies were recently assessed with a “professional tax” from the Municipality of Limassol, which for some enterprises in the group were recently increase from € 270 to € 770 for the unexplained purposes of green dot recycling. No explanation or redress were forthcoming. Cyprus has also implemented a General Health System, which is now levying taxes on annuity income, rental income and other income streams which are totally unreasonable for taxation. The fact that the system is loss-making every year implies that direct or indirect taxation will continue to rise.
High domestic inflation costs are wrecking the traditional middle class economics of the country, while the nature of our customers means that we cannot pass on price increases. There have been no daily rate increases to our customers in Cyprus or to European Commission customers in the past 20-25 years, despite the fact that real inflation in this time has easily surpassed 150%.
Costs at the Enterprise Level
In addition to business environment costs, costs at the enterprise level are rising. The costs of accounting compliance, banking costs, IT services and other related costs continue to rise, while the quality of services continues to drop.
Let’s look at the replicable costs for each enterprise. Please bear in mind that we are talking about micro-enterprises in each case, i.e. enterprises with a total of 1-10 staff.
Table 1 shows the direct operating costs (not including shared rental costs, electricity, telecom, etc.) of € 6,796 per year. Experience shows us that this is on the low end.
Table 1: Direct Operating Costs
Item | Amount € |
Accounting & Audit (External) | 3,380 |
Banking | 1,566 |
Professional Taxes | 650 |
Software Licenses | 1,200 |
Total | 6,796 |
On top of this, however, is the now tremendous management cost of compliance. This includes accounting and audit; addressing requests from the banks for documentation; complying with GDPR and other policies; and troubleshooting.
Speaking as an owner / manager, I believe that I am working at least one day a month on operating issues of this type, not taking into account the added costs additional staff in the company are dedicating to this. The break-even cost is 12 days is at least € 6,000 for this.
This, each company registered and operating in our group costs a minimum of € 13,000 per year. This cost is certainly an understatement, and continues to grow as regulatory requirements and bureaucracy grows as well.
Just the cost of maintaining a separate website, social media ecosystem, newsletter and advertising and other content marketing content for separate enterprises is massive.
A business group comprising four legal entities and two separate startups therefore cost at least € 78,000 per year. We are confident that the real cost is far higher.
The Costs of Silos / The Potentials of Synergy
Beyond the purely financial costs are the costs of the “silo approach”: of restricting the creativity, vision and talent of highly quality knowledge workers into single companies.
McKinsey Consulting recently published an article entitled “Capturing the Value of “One Firm” (McKinsey Quarterly, 9 May 2023), which expressed this challenge extremely well:
The value of working together is intuitive to most leaders. Capturing the full value of operating as one firm, however, is elusive for most. Those who drive integration and standardization from the top down often stifle business-level innovation, entrepreneurship, and client responsiveness, which can further create talent attraction and retention issues. Those who emphasize local autonomy, however, often create massive inefficiencies, competing priorities, and inconsistent client service. This often leaves organizations both competitively vulnerable and held hostage to rainmakers, as the client relationship is largely owned individually rather than institutionally.
The challenge we set ourselves at Navigator Consulting moving forward is:
Can we innovate within a Single Enterprise structure to ensure greater synergies, greater cross-sales and customer satisfaction, greater service quality and a great use of shared internal services? This is the organisational challenge.
Can we achieve this while substituting the General / Limited Partnership structure with something equally effective?
Challenge 1: The Organisational Challenge
Of these two challenges, the organizational challenge is the easier of the two to accomplish. This is done by re-imagining the role of what was previously independent companies into internal business practices, similar to a strategic business unit or business practice in an enterprise. Some definitions are in order:
Business Practise: In the context of a professional services organisation, a business practice is a cluster of services that is coherent in terms of client applicability and can be managed on a clearly-defined stand-alone basis.
Strategic Business Unit: This is the same principle, but typically adapted for manufacturing or larger organisations. The strategic business units of an automotive manufacturer, for example, might be based around brand families of cars, such as SUVs, sedans, crossovers and microvehicles.
Figure 2: One Enterprise Strategy – Organisational Structure
A business practice, in the services context, is an internal organizational entity that offers a cluster of coherent and non-competitive services. Examples of business practices at Navigator Consulting include:
Consulting
Training and Development
Technology
Investment Advisory
Each business practice can be managed independently and coherently. This means that the direct revenue and direct expenditure of a business practice can be easily monitored, and whether there is only one limited partner or multiple limited partners, their share of financial performance can easily be calculated and dividends allocated.
To provide coherence, we can refer to these business practices as “limited virtual partnerships”, making the link between the traditional limited partnership and the same relationship in the context of a One Enterprise Strategy.
The same can serve startup requirements. Unless there is a pressing external need for a startup to have its own structure, it can function as an internal business practice until it reaches the scale needed to “leave the fold” and register itself as an independent entity. Such moves are typically related to bringing new investors into the share capital of the organisation.
On the right side of the organizational structure are the traditional overhead service units of the enterprise: the accounting function, the marketing and sales function, etc. Rather than looking at these as self-funded entities, however, we should look at these as shared services.
Each entity will provide billable services to each business practice based on (a) the minimum statutory requirement, and (b) the internal agreements between the business practices and the share service units.
Let’s take accounting and finance, for example. If a group of 5 business practices hires a full-time accountant, then the share of time of that accountant can be billed to each business practice in proportion of the time worked per entity.
If this is too difficult to calculate, then there are three simple alternatives:
Each business practice splits the accountant costs by 20%;
Each business practice splits the accountant costs by share of expenditure;
Each business practice splits the accountant costs by share of transactions recorded.
Since every transaction (i.e. recording an expenditure amount; recording a sales invoice) represents time, the easiest proxy for time worked per business practice is probably the share of transactions per business practice.
The internal billing can also include a “cost plus” arrangement as a performance incentive.
The Management Team, in this context, takes on a much different role: the management of the former “enterprise” remains at the level of the business partnership.
The management of the business group includes a much wider and more synergistic approach to business:
Exploring external synergies, including cross-sales to customers between practices;
Ensuring common reporting, development and quality standards;
Ensuring internal cooperation and synergies based on tangible management tools, cost accounting, marketing activities, client relationship management, database management, etc.
The greatest requirement of the management team is that it maximises the potential of the entire group, both in terms of external revenue and sales, as well as in terms of internal cooperation and synergy.
Challenge 2: The Dividend Challenge
The second challenge can more appropriately be termed the Dividend Challenge. How can different business practices, with different profitability allocations each year, allocate dividends to limited partners?
Remember that a General Partner in the firm is responsible for the functioning of the entire time, and in good times earns dividends from profit distribution in proportion to his or her shareholding in the firm.
In bad times, the General Partner must make up costs that are not covered by revenue from his or her own resources.
A Limited Partner, in contrast, does not have responsibility for the entire firm: only for that element of the firm that the LP is directly involved in: the Business Practise, in other words).
In a One Enterprise Firm, an adequate system for dividend distribution must be developed. There are three potential methods for this.
Method 1: General Partnership adjusted based on Earnings
In the first method, the company converts to a mandatory general partnership. Each limited partner has shares in the enterprise based on their annual revenue and net profit contribution. This implies annual changes in the firm’s statutes and shareholdings, which can be problematic in some jurisdictions due to bureaucratic complexity.
Method 2: Irregular Dividends and Bonus Payouts
In the second method, the limited virtual partners would receive an “anchor stock” in the firm (e.g. 5%), with dividends distributed when the business practice is profitable; when the entire company has a sufficient cash reserve to maintain operations, and where variations between the shareholding level and the dividend level are bridged through irregular dividends and bonus payouts.
Method 3: Separate Incorporation of Limited Partners
In the third method, each limited partner would be responsible for invoicing their dividend amount as a form of service fee. This implies that for tax efficiency, each limited partner would have either a corporate entity or a trust. While this does increase the level of potential indirect costs and bureaucracy which led to the “One Enterprise” system in the first place, many individual shareholder would benefit from a trust system for their wider assets and revenues. Some countries also have favourable tax systems for “independent entrepreneurs” which include simplified tax filings and taxation. (Not Cyprus, alas).
Conclusions
My personal observation is that from a certain financial point and upwards, the level of dividend and overall revenue sharing comes second place to the advantages and benefits of working with a powerful team of like-minded entrepreneurs and business partners.
When one factors in all the uncertainties and risks of today’s business environment, it is clear that there is strength in numbers, and more importantly, strength in like-minded individuals with a set of shared, collective values.
My personal aspiration in converting to the “One Enterprise” system is that these synergies and collective growth aspects will prove more interesting to our partners than the present system, where resources are clearly lost to galloping bureaucracy and over-regulation.
I look forward to sharing my experience moving forward. I would also be grateful for any practical advice or sharing of similar experience. Please feel free to contact me for more information.
Philip Ammerman
Managing Partner