In general a holding company is a type of business structure that has no operations and does not conduct any activities. It only owns assets. These assets consist of shares of another company, real estate, patents, or other investments. The assets can be both tangible an intangible assets.
Basically, the holding company gets many advantages that other companies would not have if they operated as separate entities. In other words, a holding company can own multiple other companies such as a Real Estate Investing Company, a Bakery, a Financial Planning Service, and a Dance Studio. Individually, the four entities would be subsidiaries of the Holding Company and the Holding would provide advantages by adding Value, Control, Limiting Risks, and Taxes. Remember, the Holding Company exists for the sole purpose of controlling another business rather than for the reason of producing its own services or goods.
A member/owner of the holding company may have specialized skills and know-how that could be used to further advantage in other subsidiaries to increase their value. In the above example, the Financial Planning business has clients who have money and are looking for the best return on investment. The Real Estate Investing Company is looking for people who can contribute money so that they can make purchases. As the owner of a holding company, you would be able to bring both parties together where the Financial Planning Business provides money for the Real Estate Investing Company.
Also, the combined financial strength of the group might be used to obtain more favorable financing terms than if the subsidiaries were standing on their own. Pooling together financial resources of the holding company and its subsidiaries will enable the company to take on large-scale projects.
Creating a holding company allows the firm to control more businesses with smaller amounts of capital. For example, a holding company could gain control of a company by acquiring 51% of its stock, but in some cases you can gain control by purchasing only 25% of another company. So, now the holding company is more diverse and would be the largest shareholder.
In other words, not having to purchase 100% of a corporation enables a small business owner to control more companies with smaller investments.
Having a Holding Company allows for a simple sale of a service or product line. The sale may be sold through the selling of the subsidiary. Without a holding company, sales may mandate additional due diligence for a buy or could expose trade secrets that are not related to a service or product line.
A Holding Company limits risks. All the subsidiaries are protected from problems occurring in other companies. If the Bakery gets sued because food poisoning caused someone’s death and they get a judgment for $500,000 against the Bakery, but the Bakery and its assets are only worth $250,000. They cannot attach or collect against the other subsidiaries. Also, the holding company would not be liable as long as it did not guarantee the debts of the subsidiary.
If a subsidiary takes a risk and fails or goes into bankruptcy, the loss will not affect the holding company. The Holding Company can sell its shares in the failed subsidiary.
The main tax advantage of a holding company is that it does not have to file different tax returns for each subsidiary company.
Generally, subsidiaries can pay dividends to the holding company without creating a tax liability. After the holding company receives the cash, disbursements could be allocated to the stockholders/members of the holding company or to better investment opportunities in the other-subsidiaries.
If the holding company files a consolidated tax return, the losses incurred in a subsidiary can be offset against the profits of the other subsidiaries. The net result is a lower tax bill for all of the companies as a group.
Also, 100% owned subsidiaries may be treated as disregarded entities for tax reasons. This means that no different tax returns must be filed, while LLCs and corporate safeguards can be maintained for business reasons.
Setting up a holding company allows a small business owner to diversify his operations without taking unnecessary risks. Combining the resources of a holding company and its subsidiaries creates synergies in purchasing power, financing terms, and the ability to invest in larger projects. If you are looking for more information about a holding company and its tax advantages, give us a call at 740.346.2899. Be sure to read Part 3 How to get started with your Holding Company.