Should You Create a Management Company?
For roughly twelve years, I worked directly or indirectly for an amazing family-owned business in Missouri. For about eight of those years, I was paid by Orscheln Management Company, ORMANCO for short.
ORMANCO was not a holding company. Instead, it was a management company with common ownership of the various entities it served, including retail, manufacturing, real estate, and entertainment.
ORMANCO’s services included senior-level accounting, tax, payroll, HR, risk management, legal, travel, finance, and administration. In return, they received a monthly management fee across the divisions they served.
Coincidentally, I’ve served a few businesses that own a management company. The only issue we’ve dealt with is minor–intercompany transfers. Otherwise, it’s a great mechanism for splitting out management costs that benefit more than one company owned by the owner or stakeholders.
What Are The Benefits of a Management Company?
Let’s start with a simple quiz:
- Do you own more than one business?
- Are these businesses related, or are some unrelated?
- Are the various businesses lending money back and forth to each other?
- In addition to yourself, do you have administrative staff on your team?
- Do you periodically split out costs to these different businesses?
If you answered ‘yes’ to four or more questions, a separate management company could alleviate some administration frustration in your business.
If you answered ‘yes’ to three of the questions, there’s still a strong possibility to consider setting up a management entity in your portfolio of businesses.
Oddly, I’ve never met resistance when I bring this up with an entrepreneur owning multiple businesses. That’s because they like the idea of being paid by just one entity, not five or six if that’s how many businesses they own.
While there is the minor hassle of additional administration costs of a new entity, the biggest benefit is that all costs that benefit all of the businesses as a whole can be charged to one entity–the management company.
Are there tax and legal benefits? If they exist, they are insignificant. Again, the upside is having all corporate costs charged to one entity whose mission is to serve the other businesses owned by the founder.
The Downside of a Management Company
I’ve shared the benefits of setting up a management company, but what are the downsides? Here is my shortlist:
- Cost to set up in legal fees (and minor tax fees from your CPA firm)
- The ongoing annual tax cost
- Extra cost for daily and monthly accounting
- The extra cost of bureaucracy
Let’s knock each of the cons out one by one.
The legal fees should be minimal. I already know what you are thinking–let’s use LegalZoom because it’s cheap. Please don’t do that. Use your current attorney and CPA firm. Plus, the total out-of-pocket cost will be minimal because I’ll show you all the paperwork you need to complete if you are already working with G3CFO. Additionally, the work to be performed by the attorney and CPA firm will be minimal.
The ongoing tax cost is minimal too. The annual cost will be less than $1,000 annually. That’s especially true if you follow annual tax schedules based on your financial operating system.
Probably the biggest cost to maintaining a management company is the cost of bookkeeping and accounting, whether you do your accounting in-house or you outsource that service. In both cases, the cost can be contained by following the same daily, weekly, monthly, and quarterly checklists you follow in your other operating entities.
The cost of bureaucracy is real, but it’s also immeasurable. If you are worried about this new layer of bureaucracy, don’t move forward. The management entity is primarily geared for 10x or scaleup CEOs who see the value of separating their management arm from the operating businesses he or she owns.
The Benefit I Hate Talking About
Most CEOs I serve are self-directed, decisive, confident, and love saying ‘yes’ to great ideas. That’s why I’m a bit reluctant to mention this benefit for fear that the idea will be acted on swiftly.
The other beauty of a management company is that it can periodically conduct soft due diligence on potential new businesses to acquire. It already owns a handful. More will undoubtedly be on the way.
If you currently don’t have a management company, then one of the existing operating entities is eating that cost, and that’s misleading on the financials. With a separate entity, costs such as these will never show up on the operating company’s P&L.
While this is a fascinating benefit of having a management company, it’s not the primary reason. The primary reason is to simplify corporate administration while not charging these costs to the entities you currently own, which muddies their financials.
Should a Management Company Make Money?
No, no, and no. Let me explain.
The purpose of the management company is to serve its sister businesses and to ease the administrative complexity of the owner. There is no profit motive. The management company has to be reimbursed for its monthly outlay, but that doesn’t mean it has to generate a profit.
Stepping back in time, ORMANCO charged its sister companies a management fee. My old boss at Orscheln Farm & Home hated this cost. He reasoned he didn’t need 75% of the costs he was billed for. I agreed with Dennis K., the president, but this former accountant had to understand ORMANCO had to be financed. I knew the right answer, but my idea was never implemented.
For every company I serve with a management company, we require an equity transfer from the operating companies each month. For instance, if the retail arm has to pay $10,000 a month to fund the management company, its cash is decreased along with its equity. That is, it’s an equity distribution for the operating company.
For the management company, in this case, cash is increased, and paid-in capital is also increased. In both cases, the P&L is not touched.
That’s not always true. Let’s assume the management company has hired a consultant for general marketing purposes, and it pays for these costs. Let’s assume this project ends up benefiting just one of the operating businesses. In this case, the management company will bill the operating entity as though it’s a pass-through cost. I would not increase revenue at the management company. Instead, it would be a reduction of the consulting cost originally charged.
In summary, whether the management company books revenue for its management fee or treats its receipt from its sister companies as paid-in capital, there is no tax difference. The only thing that matters is that equity does not drop below zero at the end of the year–we don’t want to trigger a capital gain for tax purposes (I’ve overly simplified this part of the discussion, but book equity and the tax basis of the management company should be about the same).
What Are the Next Steps?
If you believe setting up a management company makes sense in your situation, my suggestion is to initiate a 30-minute discussion with your attorney and tax partner explaining your desire for this new entity and why. If you have a part-time CFO, please invite that person to the meeting too.
I doubt this will happen, but it’s possible you could be talked out of this idea. Use the points above to convey your reasoning along with the associated benefits you perceive. Unless these are small firms, they will have already seen this structure before.
Be prepared for the tax partner to school you on tax basis, but you’ll be prepared to address this based on the comments above.
If everybody agrees to move forward, please have someone internally play the quarterback role. Don’t let the attorney do this. CPAs are better at project management, but I’d still set up a simple project plan in SmartSuite, Trello, Airtable, or whatever project management tool you use.
Plan on getting this project done in 45 days with the following milestones to be included:
For each step above, include a due date and owner, just like you would for any other project.
Two months after this project is completed, I promise you’ll find the new structure simple to use and maintain. I’m certain you’ll ask, “Why didn’t I do this sooner?
