Do you own a successful business and plan on owning a second one? Make sure to choose the right legal structure for your new business venture. Generally speaking, you could form an individual corporation or LLC, but you’ll have to pay additional maintenance fees to the state. You’ll also need to get separate licenses and file taxes for each company. A better approach may be to set up a holding company and operate the two businesses as subsidiaries. Read on for a brief introduction to the holding company structure and the advantages it brings to businesses.
What Is A Holding Company?
A holding company is a “parent” firm that owns equity in other companies. Those other companies are referred to as operating companies or subsidiaries. The operating companies conduct business activities (such as the sale of goods and services), while the holding company receives a payout from after-tax profits in the shape of dividends.
Equity owned by a holding company could come in many forms, including:
- Real estate
- Interest-earning securities
And other assets.
Typically, the holding company has ownership of 50% or more of the operating company’s assets, which provides it with the authority to make management decisions. It can remove or appoint the board of directors, as well as control the policies and workings of the operating firm. However, the holding company’s people do not participate in the operating company’s day-to-day decision-making.
The holding company structure is prevalent across the globe. Many renowned companies function as holding entities where they manage subsidiaries under their umbrella. Famous holding company examples include Alphabet Inc., Johnson & Johnson, and The Walt Disney Company. Each of these firms holds several profitable businesses that generate dividend income for the parent company’s shareholders.
Do I Really Need a Holding Company?
If you’re looking to achieve a separation of financial and legal liability between two or more businesses, then starting a holding company can be one of the best decisions you can make. Below are a few advantages of using this business structure.
1. Liability Protection
The liability of the holding company and each of its subsidiaries is distinct and separate. If one of the subsidiaries has to file for bankruptcy or is attacked by a lawsuit, its creditors cannot seize the assets of the holding company or other subsidiaries. If the ruling against one subsidiary is given, the risk of loss is limited by what assets are held in that company, and other operating entities will be safe from the verdict.
Say you have a retail store, and you haven’t been able to pay your suppliers or employees. They can sue you and reach the assets of the business but not the assets of other operating companies you might own, including any online business you hold under a parent corporation. Additionally, any profits transferred to the holding company in the form of dividends cannot be held for creditor repayments.
2. Tax Planning
A holding company can help you save tax on earnings because dividends from subsidiaries are allowed to flow tax-free between entities. This means you can defer your tax payments until you withdraw the earnings at a later date. Until then, the dividends can be reinvested in other assets through the parent company.
You can also set up a holding company in a low tax location. States like Wisconsin and Delaware are considered to be prime examples of such places. Moreover, you can minimize tax by selling shares of the holding company. Friends and family members can become shareholders in the company, and taxes can be minimized by dividing the earnings amongst people in different tax brackets.
3. Investment Vehicle
You can also use a holding company to purchase and manage additional assets, such as buying real estate or investing in another business. To strengthen your overall portfolio and reduce risks, consider investing in assets with high returns. For example, investing in a profitable business and growing it through a subsidiary can improve performance and value.
The holding company can acquire the funds to make new investments by getting subsidiaries to pay dividends or by selling equity shares in itself. You can also apply for a loan against the shares of your entity. These shares are typically classified as tangible assets, so they can be used as collateral when you have to borrow for some reason. Loans are offered at a low interest because there is a minimum risk for the lender. If the new company ends up making a loss, the shares can be used to cover the debt.
4. Estate Freeze
A holding company can play an essential role in your retirement planning. Say you want to pass on the future growth of your ventures to your children. You can implement what’s known as an estate freeze with assistance from your holding company. This allows you to freeze your shares in the holding company and shift all future dividends to the next generation. It also enables you to maintain control of your business.
Another benefit of implementing an estate freeze is that it helps to minimize your tax liability. A properly executed state freeze enables you to defer taxes levied on the accrued gain in the shares of your entity. Because the growth is passed on to your spouse and/children, you reduce the amount of tax levied on the deemed disposition or the sale of your company’s shares. In addition, if the beneficiaries are in a lower income tax bracket, their future tax liability will automatically reduce, meaning they will pay less tax than you would on the company’s future earnings.
5. Resource Synergy
Starting a holding company is on par with creating a strategic partnership. You can combine its resources with the resources of the operating companies to gain a competitive edge. For example, one company might possess marketing resources that would benefit other companies by improving their exposure. The collective purchasing power of the group can also be used to obtain more favorable prices from vendors.
The fiscal resources of the companies can also be combined to get better quotes in case of purchases. For instance, you can use the holding company and its subsidiaries to buy supplies in bulk and benefit from better credit terms.
How to Form a Holding Company
A holding company is just as easy to form as a normal company. You can set up one by taking the following steps.
Determine Your Business Structure
As mentioned at the beginning, you can choose to set up a holding company either as an LLC or a corporation. LLCs are simpler to create, have less operational requirements, and offer better asset protection than other business structures. However, a large number of holding companies out there are operating as corporations. If your primary goal is to segregate different business activities, units, or assets, or if you want to create a more efficient financing and tax planning structure, then setting up a corporation might be a smarter way to go about it.
Choose A Domicile
While you can set up a holding company in any location, some states simply stand out as excellent options for incorporation. Examples include Delaware, South Dakota, Nevada, and Wyoming. All of these states are good choices due to their business-friendly rules, knowledgeable courts, and affordable cost of living. Google best and worst states to start a business to get an idea of your options. You can also incorporate your company in a foreign country like Singapore, but this may carry higher fees and more extensive paperwork.
Pick A Business Name
Whether you form a corporation or an LLC, you will have to register with a state by providing its name. Choose a name that is meaningful to you, but which does not infringe on someone else’s trademark. If you’re short on ideas, you can use a tool like the Oberlo Business Name Generator to come up with business names. Legally, you may have to include an appropriate identifier, i.e., LLC or Corp/Inc, in your name, so keep this in mind when finalizing a name for your holding company. We recommend doing a name search against the companies in your state’s database to ensure your desired name is available for use.
File Articles of Organization
The next step in your holding company registration is to file Articles of Organization with your state’s LLC office, usually the Secretary of State. You can obtain relevant forms through the Secretary of State’s website. The instructions will ask you to state the objective of your company and its purpose, the names of the board of directors, and the address of the principal place of incorporation. Once filed, you can submit the documents by mail or online based on your preference.
Write an Operating Agreement
The operating agreement serves as your governing document, outlining your roles and responsibilities as the founder/shareholder of the holding company. You should draft and sign one to document how the operations will be organized and run internally while you do not need to file this agreement with the state. There are the corporate bylaws for a corporation, and for an LLC, there is the operating agreement to ensure the rules set by the founder are officially followed.
Get Your EIN
As you’ll be filing taxes and submitting reports on your dividend income, you must apply for an EIN (Employee Identification Number). Without this number, you won’t be able to open a company bank account or submit your tax returns to either the state or federal government. You can apply for your holding company’s EIN online. The instructions are straightforward, and you should receive your EIN on the same day that you apply through the IRS website.
Obtain Your Business License
Almost every business with an income stream must have some type of business permit, registration, or license to operate in compliance with local rules. You’ll need to contact your city or state to find out what licensing requirements apply to your company. Even if you don’t need a basic business permit (since you’ll be performing commercial activities through your subsidiaries), you may require licensing for patents and other intellectual property. As a holding company, you may be able to obtain an IP license for multiple entities, including all the subsidiaries that come under your hold.
Transfer Your Assets
Most of your assets should be deposited with the holding company, giving loans as needed to the subsidiaries. If the subsidiaries were formed before the incorporation of the holding company, you could sell their assets to the parent firm. To expand the portfolio of your holding company, consider investing in businesses that offer a high return. Entrepreneurs, for instance, can acquire profitable online businesses through Exchange.
On Exchange, there’s a business for every niche, budget, and passion you’re looking to pursue. You’ll find automotive businesses for sale, electronics businesses for sale, and many other opportunities. If you’re looking to add a foreign business to your portfolio, the marketplace will help you find those too. Search for businesses for sale by location, and you’ll identify potential opportunities in no time. With the right investments, your holding company builds a reputation that helps define its future success.
Extending your business endeavors beyond that first venture is a great way to feed your passion for entrepreneurship. However, it requires you to utilize a framework that allows for the minimization of liability and tax. Starting a holding company might be the best way to preserve profits and enhance your business’ long-term health. This type of corporation allows you to cross-transfer resources between ventures, reducing operating expenses, and providing opportunities to generate hefty profits.