If you’re a small business owner who owns multiple businesses, you may wonder whether or not starting a holding company is right for you. Holding companies can offer advantages, like letting you own multiple companies through one entity, protecting your personal assets from business debts, and keeping business liabilities separate.
Other benefits of a holding company include owning business assets and registering intellectual property (IP) like other incorporations. However, there are drawbacks that you need to keep in mind.
What Is a Holding Company?
A holding company is a company that owns a controlling interest in other businesses, called subsidiaries. For example, Company A makes shoes, Company B sells sports goods and Company C owns 100% of the shares in A and B. This means that Company C is a holding company, while A and B are subsidiaries of C.
Typically, holding companies do little in the way of business operations outside of managing their subsidiary companies. They’re often used to hold valuable assets (real estate, stocks, etc.) apart from their operating companies. One example of a holding company you may be familiar with is Berkshire Hathaway, where Warren Buffett is the longtime CEO.
Advantages of a Holding Company
There are a few reasons that people own holding companies.
Liability Protection
Each company within a holding company is its own separate legal entity. If you have multiple businesses and only form one official business, each business will impact the others. But, if you set each one up as a subsidiary with its own legal structure, their liabilities remain separate.
Easier Management
Keeping each business as unaffiliated and fully separate entities can lead to a more complicated business structure. Instead, using one holding company to manage multiple subsidiaries under a separate business bank account can simplify the process of running those businesses.
Tax Advantages
Holding companies owning 80% or more of all of their subsidiaries can file consolidated tax returns. This combines the financial records of each subsidiary, allowing the gains of one to be offset by losses in another to reduce corporation tax liabilities.
Disadvantages of a Holding Company
While the benefits of having a holding company may seem appealing, there are also important drawbacks to consider.
Complexity
Holding companies require their own legal entity and structure and must comply with various rules specific to holding companies. These rules include:
- Stock ownership requirements
- Separating entity finances properly
- Legally-required reporting rules
- Other crucial details
It’s truly too complex for anyone but an expert in the unique rules regarding holding companies to handle. Forming a new business entity and following those rules can be annoying and expensive.
Cost
All of that complexity translates to cost. Unless you’re a lawyer and tax accountant, you’ll have no chance of managing all of the rules and regulations on your own. It’s just too complicated for any normal business owner to understand fully.
Instead, you’ll need to hire help to make sure you form your holding company properly and follow the rules. When you have to bring in professionals to help with compliance, it can add up quickly and eat into your bottom line.
Tax Problems and Audits
If you don’t know what you’re doing or don’t get good legal advice, you could easily break tax rules. While this misstep would likely be unintentional, it could expose you to a significant risk of profit-reducing tax penalties.
You’ll also be in trouble if you get audited and struggle to understand your own business structure. Beyond that, dealing with an audit from the IRS can be time-consuming, distracting you from running your businesses.
Holding companies can be subject to additional taxes such as the accumulated earnings tax which is imposed by the IRS on companies with retained earnings deemed to be unreasonable or in excess of what is considered ordinary. The accumulated earnings tax is a 20% annual tax.
Holding companies can also be subject to the personal holding company tax, which is an additional 20% annual tax imposed on undistributed personal holding company income.
Potential for Abuse
This wouldn’t apply to someone using a holding company to own their own companies, but in the world of big business, holding companies exert a lot of control over their subsidiaries. They can force changes in the board of directors or make them buy and sell to each other at unfair prices triggering IRS scrutiny with potentially severe penalties.
Holding Companies and S Corporations
When you own an S Corp, nothing is stopping you from using it as a holding company to own other businesses. S Corps can own other businesses, including limited liability companies (LLCs), C Corps, or even other S Corps. If you participate in multiple lines of business, you could form multiple LLCs and use a holding company to own each of them.
You can form a holding company the way you’d create any other type of business. Choose a location, name your company and draft corporate bylaws. Once you’ve filed your Articles of Incorporation, you’ll be assigned an Employer Identification Number (EIN) from the IRS.
It’s usually easier to establish a holding company before subsidiaries, as you’ll have to change the subsidiaries’ bylaws if you own businesses first and form the holding company later.
Should You Start a Holding Company?
You should ask yourself a few questions if you’re still confused about the purpose of a holding company.
- Do I have multiple unrelated businesses? If you’re really only doing one thing, it doesn’t make sense to have a holding company to own one other company. However, if you have a few different businesses, such as a car wash, a vending machine route and a writing business, you might consider a holding company that lets you manage them together while keeping them legally separate.
- Do my businesses have assets? One of the perks of holding companies is that you can manage the subsidiaries together while keeping their liabilities separate. The holding company structure is particularly useful for asset protection. Remember that holding companies can make money through subsidiaries’ assets, including intangible assets like copyrights and patents.
- Do the benefits outweigh the costs? Setting up a holding company can be complicated and costs money. If your businesses aren’t producing a significant profit, the benefits may be less than you’d pay to set up the holding company.
Ultimately, the answer will likely be no. For anything but the largest of companies, the cost and complexity of holding companies aren’t worth the limited benefits.
Alternatives to Holding Companies
Consider these alternatives if you’re unsure that a holding company is right for you.
- Multiple LLCs: Instead of a holding company that owns different businesses, you can set up each business as its own entity without a parent company. This is an easier solution and often cheaper, but you might miss out on some tax benefits.
- One LLC using DBA names: Another option is to open one LLC and have it create multiple doing business as (DBA) names. This is a cheaper option and means you only report taxes for the one LLC. However, the activities of each DBA are under the same LLC, so they share liabilities and risks. DBAs may also confuse customers and vendors.
What about a Series LLC?
A series LLC is designed for multiple different business units called series. Each series in a series LLC is a siloed business unit that can hold its own assets, have its own members, and pursue different business objectives while insulating the other series from claims or creditors. However, series LLCs are only available in a few states.
Like holding companies, series LLCs can become as, if not more, complicated than a holding company and generally aren’t a good alternative if you’re looking to simplify your business structure.
Bottom Line
Most small business owners will find holding companies to be more trouble than they’re worth. Unless you have multiple profitable companies with many assets you want to protect, you’ll likely be better off with a simpler structure, such as forming multiple LLCs.