As a business owner or entrepreneur, you may have seen the term “holding company” before. Holding companies are a type of legal structure used by businesses across many different industries. If done right, a holding company can provide unique legal protections that cannot be achieved with just one business entity.
Many well-known corporations use holding companies as part of their legal structure. However, you may not understand what holding companies are and how they work.
In this article, we breakdown what holding companies are and how to set them up. We also dive into whether you should consider forming a holding company for your business.
What Is a Holding Company, Exactly?
A holding company, also called a “parent company,” is a business entity used for the sole purpose of owning and managing other companies. The point of a holding company is to keep valuable company assets legally separated from daily business activities.
Holding companies typically do not have any business operations. They do not manufacture products or sell any services. A holding company simply owns a majority interest in all the related businesses operating underneath it. These operating businesses are called “subsidiary companies”.
For companies with multiple streams of income coming from different businesses, a holding company can provide additional layers of legal protection for both the business and its owners.
How Does a Holding Company Work?
A holding company acts like a buffer between a business’s daily operations and its valuable assets. Subsidiary companies owned by the holding company carry out typical business activities, like selling products or services, hiring employees and signing contracts with vendors.
The holding company owns the company’s valuable assets, like real estate, patents, or trademarks. A holding company structure can keep a company’s assets separate from any potential liabilities generated by the business activities of the subsidiaries.
Subsidiary companies typically have their own management in charge of the day to day operations of the business. However, the leadership of the holding company usually oversees how the subsidiaries are being run and can make major decisions on behalf of these companies.
How Are Holding Companies Used?
Businesses of all sizes use holding companies and subsidiaries for a variety of reasons. Entrepreneurs primarily use holding companies to protect assets from liabilities generated by everyday business activities.
A good example is real estate and rental properties. In a holding company structure, each rental property is owned by a separate LLC. These individual LLCs are all wholly owned by the holding company.
The rental income generated by each property can flow up to the holding company, however, liabilities associated with each property are restricted to the LLC owning that property. If one property gets hit with a lawsuit, or some other type of legal action, the other properties may avoid being impacted.
Some of the largest companies in the world use holding companies to separate different lines of business. For example, Google and YouTube are wholly owned subsidiaries of their parent company, Alphabet, Inc.
Is a Holding Company an LLC?
Holding companies and subsidiaries are often set up as limited liability companies, or LLCs. This is because LLCs are easier to set up and maintain than corporations.
Starting an LLC requires less paperwork and administrative requirements compared to a corporation. For example, LLCs do not need to appoint a Board of Directors or hold Annual Meetings. In addition, transferring ownership in an LLC is a simpler process than transferring stock in a corporation.
How to Form a Holding Company: 3 Steps
Here are the steps you need to follow to set-up a holding company:
Step 1. Form At Least Two Business Entities (LLCs)
To set up the holding company structure, you will need to form at least two business entities. Delaware LLCs are the most popular type of business entity, especially for forming holding companies and subsidiaries.
Step 2. Set Up Ownership
Ownership in an LLC is established in the company’s private Operating Agreement. The LLC Operating Agreement for a subsidiary company should name the holding company as the sole-Member and owner of LLC.
Step 3. Open Separate Business Bank Accounts
The holding company and its subsidiary LLCs should all open their own business bank accounts.
An important part of operating a holding company structure is keeping each business separate. Business income and assets should not be commingled between subsidiary companies or the holding company.
Pros and Cons of Using a Holding Company
There are some important points to consider when deciding whether to set up a holding company for your business. Here are some pros and cons of using a holding company:
Pro: Legal Protections
A holding company can keep business assets legally separated from daily business activities. If you are running multiple businesses, or have separate streams of income, a holding company can provide limited liability protection for each business and their owners.
Con: Start-Up and Maintenance Costs
Starting a holding company involves creating and maintaining multiple business entities. This requires paying necessary state filing fees and any annual fees to keep each company in good standing.
For example, Delaware charges a filing fee to form an LLC in the state. In addition, Delaware LLCs need to pay the Delaware Annual Franchise Tax each year. The Delaware Annual Franchise Tax for LLCs is a flat fee of $300 that an LLC needs to pay to stay compliant in Delaware
Con: Complex Legal Structure
A holding company structure only works if you can properly maintain it. Keeping track of multiple business entities can be difficult. With multiple LLCs, you will need to keep accurate records to make sure business income and assets are not being mixed across multiple companies. This is called “commingling”.
If a holding company commingles funds across multiple businesses, the whole organization could lose its limited liability protection. This puts each business and all their respective owners at risk.
Should I Start a Holding Company for My Business?
Holding companies can provide many legal advantages. However, setting up a holding company may not be the best choice for every business. Here are some things you should consider when deciding whether to start a holding company:
1.) Assess Your Business Needs and Goals
Consider the long-term plans and immediate needs of your business before deciding to set up a holding company. Does your business need layers of legal protection? Will you be acquiring other businesses or assets in the future? Answering these questions can help you determine whether a holding company is in line with your business’ strategic goals.
2.) Evaluate Legal Risk and Protections
A holding company can provide a shield around your business assets and reduce your company’s exposure to liabilities. Think about the kind of legal risks your business faces. If your business engages in legally or financially risky activities, you might consider using a holding company to keep valuable assets separate from potential liabilities.
3.) Consider Complexity and Costs
Setting up a holding company can be costly. In addition, a holding company needs to be well managed in order to maintain its legal protections. Are you prepared to handle multiple business entities? Be sure to understand the costs, along with time and resources, of operating a holding company.
4.) Explore Alternatives
Before committing to a holding company, explore and research other legal structures, like the Delaware Series LLC. A Delaware Series LLC can provide similar benefits as a holding company, without much of the costs or administrative hassle.