Why & How to Set Up a Holding Company
Holding companies have been used throughout the corporate world with great success by businesses both big and small. Some of the most well-known holding companies include the likes of Berkshire Hathaway Inc, Alphabet Inc, and Metlife Inc. However, this type of corporate structure does not only benefit large multi-national holding groups like the ones mentioned.
Holding companies can be utilised by many different types of businesses to help mitigate risk, limit liability, reduce taxes, and provide various other benefits.
In this article, we give an overview of what a holding company is, why you should consider setting up a holding company, and how to practically do so.
Table of Contents:
- What Is A Holding Company?
- Difference Between A Holding Company And A Traditional LLC
- Difference Between A Holding Company And A Parent Company
- Why Set Up A Holding Company?
- Advantages Of A Holding Company
- Disadvantages Of A Holding Company
- How Do You Set Up A Holding Company?
- Should You Set Up A Holding Company?
What Is a Holding Company?
A holding company is a type of business entity with the single purpose of owning and controlling one or more “subsidiary companies”, without conducting any of its own business operations. Holding companies either hold 100% ownership of their subsidiaries, or just the controlling stakes. They can also be used to own business assets such as real estate, buildings, equipment, and even intellectual property.
While a holding company oversees and controls the companies it owns in its group, it does not actively take part in the day-to-day operations and management. Holding companies are protected from losses incurred by any one of the companies that it owns.
So, if a single company in the group goes bankrupt or faces a litigation, the obligations are not passed on to the holding company or to other subsidiary companies in the group under ordinary circumstances.
Difference between a Holding Company and a Traditional LLC
A holding company can itself be formed as a Limited Liability Company (LLC), but it doesn’t have to be. The primary difference between a holding company and a traditional LLC is that, unlike the LLC, a holding company does not perform any of its own business operations such as buying and selling goods, or providing services. It exists purely to own stakes in other companies or to hold assets.
Difference between a Holding Company and a Parent Company
The terms “holding company” and “parent company” are often used interchangeably; however, there is a slight difference between the two. Like a holding company, a parent company also owns subsidiary companies which form a group or “umbrella”. However, a parent company may also conduct its own day-to-day business operations such as trading goods and services, whereas a pure holding company does not.
It is important to understand the subtle difference between these terms to know that when a “parent company” is mentioned, it may or may not also be a holding company depending on whether it conducts its own business activities.
Why Set Up a Holding Company?
Purpose of a Holding Company
The primary purpose of a holding company is to allow single ownership of a number of businesses while minimising risk and liability. Holding companies can own a number of smaller businesses as well as their valuable business assets. This shields the assets, the subsidiary companies, and the owner from losses if any of the individual businesses face bankruptcy or court proceedings.
Because holding companies do not engage in their own day-to-day business operations, the risk of being sued or facing other risks is greatly reduced. Therefore, transferring valuable assets from the operating companies in the group to the holding company shields them from risk and liabilities.
Holding companies also provide a way to operate in different sectors/areas and separate the risk of each of these. Instead of owning one company with multiple divisions, you can instead separate these into individual subsidiary companies. This effectively insulates your risk in each individual area to that specific subsidiary company, and therefore avoids the risk of cascading losses arising from only one area of your business.
Other reasons to form a holding company include:
- As a way to optimise taxes.
- To create a central point of control for a large group of companies.
- To streamline the management and operations process.
- To hold other assets such as real estate, intellectual property, capital, etc.
Advantages of a Holding Company
The advantages of using a holding company structure to organise your business include:
- Centralised control: holding company structures provide a means for the owner to maintain centralised control over all the subsidiary companies. This is often more streamlined, efficient, and cost effective. The owner need only appoint a single board of directors, along with an executive management team for each of the subsidiary companies.
- Targeted investment opportunities: a holding company structure allows equity investors and shareholders to choose which of the subsidiary companies they want to invest in. If all the subsidiary companies were instead joined into one large corporation, investors would be forced to invest in all the divisions of the business. With a holding company, they can focus their investments to the specific segments that they are interested in.
- Limits liability and risk: The primary benefit of a holding company is that it greatly reduces risk by limiting the liability that the holding company and its individual subsidiaries are exposed to. By segregating the business group into individual subsidiary companies, risks and liabilities are insulated. This can actually enable the holding company to enter riskier and more experimental markets without having to worry about exposing the rest of their business to the same risks.
- Sharing skillsets and resources: Certain skills and resources can be shared across different subsidiary companies in a holding group. Some employees and managers may be employed to work across more than one subsidiary, resulting in wider expertise and lower costs. In addition, business assets owned by the holding company may be utilised by multiple subsidiaries in the group.
- Better borrowing rates: due to a holding company’s larger size and the fact that it owns a range of different types of businesses, it can often access loans with better borrowing rates from financial institutions. It can then in turn loan the capital to its individual subsidiaries at a better rate than what they would otherwise be able to get. This lowers the cost of operating capital and leads to greater profitability and ability to repay debt.
- Tax optimisation: A holding company structure may result in reduced overall taxes if structured effectively. The holding company can be incorporated in a state or jurisdiction with favourable tax rates, as it has none of its own operating requirements and therefore no physical need to be based in a specific jurisdiction.
Disadvantages of a Holding Company
A holding company also comes with some disadvantages, which include:
- More arduous reporting and operational requirements: as each subsidiary is its own separate business, they must each adhere to all the formalities and requirements of a distinct business entity, such as:
- Keeping a separate business bank account
- Maintaining and filing their own financial statements
- Holding and recording annual meetings
- Having their own separate employees, managers, and executive managers
This creates additional administration work and costs compared to having all subsidiaries operate as one larger business entity.
- May not be able to claim lost profits from IP infringement: An Intellectual Property Holding Company (IPHC) is a useful tool that is designed to hold and manage intellectual property such as patents, trademarks, and copyrights. The IPHC will be the legal owner of the IP and in turn create a license arrangement with its subsidiaries for them to “use” the IP in exchange for a royalty fee. This creates a layer of protection for the valuable IP. However, in the event that there is a malicious IP infringement, the holding company may not sue for so-called lost profits as they are not directly profiting from the IP other than via royalties. They will therefore only receive a royalty that is deemed appropriate, which may actually be much less than the profits the subsidiary lost as a result of the IP infringement.
- Protection is not guaranteed: while a holding company provides some degree of risk mitigation, it does not guarantee protection against all losses. There are many instances where a holding company can indeed be liable for the debts of its subsidiaries. One example is if one of the subsidiary companies it owns commits financial fraud or another crime, in which case the holding company can almost always be held responsible.
How Do You Set Up a Holding Company?
Starting a holding company is a relatively straightforward process that is not much different from setting up a regular LLC or corporation. However, in order to structure it in the most effective way and to ensure that all business assets of subsidiary companies have been fully transferred to the parent holding company, you should seek expert legal guidance.
The usual steps required to set up a holding company are as follows:
- Assess your business needs and objectives: before starting a holding company, you should conduct a comprehensive needs analysis to determine whether a holding company is in fact the ideal structure to accomplish your objectives. It may help to consult with an expert tax and/or asset protection attorney to help you make this decision.
- Select an appropriate business structure and jurisdiction: Holding companies are not limited to one specific type of business structure. You may opt to form your holding company as an LLC, corporation, partnership, etc. Smaller business owners generally opt to use an LLC holding company structure, as it is more cost effective and simpler to set up. Larger business groups such as multi-national companies usually need to register their holding company as a corporation. During this stage you will also have to select the best jurisdiction in which to register the holding company.
- Register the company: Once you have decided upon the type of business structure and where it will be formed, you can proceed with the actual registration process. Follow the relevant procedures in your jurisdiction and submit all the required documents to successfully register your holding company. This will generally include the name of the company, the names of the owners and registered agent, and the articles of incorporation or similar document depending on the structure you have chosen.
- Open a separate business bank account for the holding company: it is important that the holding company keeps its own separate bank account and financial records from each of its individual subsidiaries so as to maintain independence and protect the assets from individual risk. You will need to acquire a company tax ID (EIN) in order to open the business bank account.
- Fund the company: in order to start acquiring ownership stakes in subsidiary companies, the holding company needs sufficient funding. This can be obtained directly from the individual owner/members in the case of an LLC or from equity investors and shareholders (by issuing shares) in the case of a corporation. You should also transfer ownership of valuable assets from the operating companies to the holding company. The main wealth and assets of the holding group should be stored (and therefore protected) by the holding company. The individual operating companies can then take loans from the holding company as needed to fund operations.
- Maintain proper accounting records: ensure that accurate accounting records are kept for the holding company and each of the individual operating companies. It is important to meticulously record all transactions between the different individual business entities in the holding group so as to maintain legal distinction and therefore continued protection from individual risks and liabilities.
Should You Set Up a Holding Company?
A holding company is undoubtedly a useful and versatile entity that can help to protect you and your business from risk, create a more streamlined corporate structure, and reduce taxes and other costs.
Ultimately, the decision about whether to set up a holding company depends on many factors unique to your own personal and financial circumstances.
You need to consider what exactly it is you are looking to achieve by setting up a holding company, and weigh that against the costs and potential shortfalls of a holding company structure compared to other financial structures. Consulting with a legal expert who can guide you through the complexities of setting up a holding company is a must before you begin the process.
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