Perspectives

Your business entity needs periodic health checks, too

Entity compliance and governance checks help reduce risks

People aren’t the only things that need periodic health checks. With managing entity compliance and governance risk top of mind, entity health checks have become vital. Let’s explore the value of a health check, the issues it can address, and the challenges standing in the way.

The value of an entity health check

Annual physical exams. Having our cars serviced at regular intervals. Testing our smoke and carbon monoxide alarms. The list of things we are supposed to periodically check may not be endless, but it’s pretty long. These periodic checks are not ends in themselves; rather, they are diagnostic and preventive—designed to determine whether there are any problems and, if so, to find them early and treat them before they become or cause bigger problems.

Businesses also need to undergo periodic checks of their own, and more specifically, of their entity data. It’s vital to assess, reconcile, and remediate potential inconsistencies and problems that can jeopardize everything from day-to-day operations to the very survival of the business. Determining the existence of these problems and addressing them early could potentially be lifesaving for businesses of all sizes and types, in every industry.

The challenges

What can go wrong? If a business entity is not in good standing in the jurisdictions in which it operates, or if it fails to maintain a required license, it may not be able to engage in its intended activities or avail itself of certain protections that the applicable laws or regulations permit for entities in good standing or properly licensed. Some common examples may include maintaining business operations in a specific jurisdiction or taking certain actions, such as prosecuting and defending against lawsuits.

If an entity does not have the required officers or directors or similar officials, contracts and other corporate documents may not be validly executed or enforceable. A failure to file annual reports with secretaries of state and to pay any related franchise taxes can result in the accumulation of interest and penalties. And these consequences may have further repercussions, such as reputational damage when a potential supplier or customer notes that the company is no longer in good standing.

What are the key areas that a periodic checkup can address?

  • Existence in good standing: Whether your business is organized as a corporation, a partnership, a limited liability company, or otherwise, the parent entity must remain in existence and good standing in order to stay in business.
  • State annual report filings: Has your business filed all required annual reports in the state in which it is organized or qualified to do business (including making the necessary filings with the secretary of state)? If these reports have been filed, have the required annual franchise or similar taxes been paid? Are any back taxes due?
  • Directors and officers: Does your business have the required directors and officers or comparable officials? Are the records maintained by the business up to date to reflect the officers and directors serving the organization?
  • Operating licenses: Is your business authorized to do the things it needs to do? Aside from “merely” remaining in existence in good standing, many types of businesses (e.g., banks, restaurants, and educational institutions) must also obtain and maintain licenses relating to their specific operations. Even nonprofits must maintain state registrations permitting them to solicit contributions within a given state.
  • Processes, procedures, and records: Are there clear controls indicating which members of your team are authorized to approve expenses, execute agreements and other documents, and take other actions on behalf of your business? How about procedures to be followed in these and other areas? And, does your business maintain comprehensive records of these and the other matters referred to above? The absence of an entity database containing up-to-date records can create or exacerbate problems when the business needs to, but cannot, substantiate compliance with governmental requirements or even your own policies.

Operating in multiple jurisdictions

Having subsidiaries in several jurisdictions, including those outside the United States, can create additional challenges:

Assessment, reconciliation, and remediation (ARR)

How do assessment, reconciliation, and remediation work? First, a business should assess the data relating to the above and other matters, to determine whether it is accurate and complete and, where possible, to correct inaccuracies and provide missing data. If, as is often the case, information is stored in different databases or other repositories, the ARR process will consolidate data maintained in-house and will seek to reconcile any inconsistent information to avoid confusion about which information is “right.”

The next part of the ARR process is to review books and records, from the parent company through all subsidiary levels, and compare the information they contain to the information maintained in public records and with other third parties. As noted above, the differences across states and international boundaries can make this task daunting. Finally, where compliance issues, failures to comply with internal processes and procedures, or other deficiencies are found to exist, the ARR process involves the remediation of these anomalies and to set the business on a path of compliance. Importantly, the remediation process also entails establishing processes for continuous monitoring of emerging entity-related data issues, risks, and opportunities across the enterprise.

Next steps

A periodic health check, whether of a person or a business, does not provide any guarantees; a person who undergoes rigorous annual physical exams can still become gravely ill or worse. A technological disruption can cause a business to fail. However, a periodic entity health check can avoid or significantly reduce the risk that a preventable problem will cause harm. For your business, an assessment, reconciliation, and remediation process will serve this purpose and should be considered on a regular basis.

The Deloitte US firms do not practice law or provide legal advice.

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