Using a Holding Company to Reduce Business Risk

Business owners are always looking for ways to protect their business’ assets from risks and claims. One tactic is to divide the business into several business entities all owned and controlled by a single holding company.

What is a holding company?

A holding company is a business entity—usually a corporation or LLC—that does not have customer-related operations such as selling products or delivering services. Its primary purpose, as the name implies, is to hold (i.e. own) the controlling stock or membership interests in other companies. The companies owned by the holding company are often called “subsidiary companies”. The business operations are typically conducted through the subsidiary companies.

The holding company can own 100% of the subsidiary, or it can own just enough stock or membership interests to control the subsidiary. Having control means it has enough stock or membership interests to ensure that shareholder or member votes will go its way. This can be 51%, or where there are many owners, it can be a lower percentage.

Not just for large businesses

You do not need to be Microsoft or Berkshire Hathaway to use a Holding company. Holding companies can also be used by much smaller businesses—even by single entrepreneurs. Risk mitigation and control of your company are issues important to businesses of every size.

How are holding companies used?

There are different reasons why holding companies are used. Below are a few:

1. Mitigate Risks. Placing operating companies and the assets they use in separate entities provides a liability shield. The debts of each subsidiary belong to that subsidiary. A creditor of the subsidiary cannot reach the assets of the holding company or another subsidiary. An example is a traditional restaurant that also operates food trucks. The risks inherent in running a traditional restaurant are different than those of driving around and operating food trucks. Both types of businesses would be owed by separate companies and thus, a claim involving a food truck accident will not endanger the restaurant assets or revenues. The subsidiary can also shelter profits by periodically sweeping retained earnings to the holding company, thus reducing the amount of assets that might be exposed in the event of a claim against the subsidiary.

2. Maintaining Control of Multiple Operating Entities. Savvy business owners know that owning equity in a company does not necessary equate to control. Holding companies can be used to own controlling interests in operating entities while holding a minority membership interest position. Holding companies can be positioned as mangers of operating entities or have reserve powers over certain fundamental transactions. This allows the operating entities to attract investors to fund operations.

3. Lower debt financing costs. A holding company that has financial strength can often obtain loans for a lower interest rate than its operating companies could themselves, particularly where the business in need of capital is a startup or other venture considered a credit risk. The holding company can obtain the loan and distribute the funds to the subsidiary.

4. Foster Innovation. Businesses that start with a relatively narrow business purpose often develop new products or lines of business. Entrepreneurs with companies that have investors may not want to share those new ideas or product lines with their investors. They could launch these new ideas and business lines in a holding company, thereby reserving the benefits of those new ideas for themselves. One example is a brewery that launched with capital from about a dozen investors. The entrepreneur behind the brewery develops new product lines, such as kombucha, or expands to provide bottling services for other breweries. The entrepreneur could hold and launch these separate but related ideas in a holding company.

5. Own Digital Assets, including Intellectual Property. A holding company can own digital assets, including intellectual property, used by its subsidiaries. For example, the operating company may have a trademark for its logo, name or branding. The holding company can own those assets so that if the operating entity is every expanded or sold, the holding company can license use of the intellectual property to the sold or expanded entity, thus reserving a valuable stream of income for the original business owner.

6. Estate and Succession Planning. Business owners looking to transition their business to internal successors or family members can use a holding company to retain decision-making authority but also hand over the day-to-day operations to the next generation. Some states exempt family-owned businesses from inheritance taxes. If there is a maximum business value that can be transferred to qualify for this exemption, a holding company can be used to own multiple family-owned businesses and qualify all of them for the tax exemption.

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What are the disadvantages of a holding company?

There are some drawbacks to using a holding company and subsidiaries as well, including the following:

1. Formation and ongoing compliance costs. The holding company and each subsidiary that is formed require the payment of formation fees. There will also be, in most cases, expenses for accounting and tax returns for each business entity. Using a single operating company avoids these additional per-entity compliance obligations and their associated costs.

2. Complexity. The use of holding companies and subsidiaries adds an element of complexity not found in the single-entity structure. The entire structure can be very complex, with many subsidiaries to keep track of. Keeping track of all the important information, records and due dates for all of the companies can be a challenge. It is important to keep the records, assets, liabilities and properties of each company separate from each other. Failure to do so can increase the risk of a court piercing the veil and allowing a creditor to reach assets beyond the debtor subsidiary.

Is a holding company right for your business?

Holding companies and operating companies are used by businesses of all sizes and in all industries. Doing so has several advantages, including helping businesses mitigate the risk of losing assets to creditors. Keep in mind, it is a complex structure and not right for every venture. Nevertheless, it is an option business owners may wish to familiarize themselves with if they have not done so already. The experienced business attorneys at Fiffik Law Group can help you determine if a holding company is right for you.