Should I Form a Holding Company for My Businesses?
Do You Own Multiple Businesses?
Many small business owners have several businesses. A young friend of mine named Carlos Mendosa has lots of ideas for online businesses, and he asked me if he should set them up as separate limited liability companies and then form a holding company as an overall entity. His reasoning for setting up separate businesses was to keep their liability separate, so one company would not be liable if another company was sued.
What is a Holding Company?
A holding company is a company (usually a corporation) that owns a controlling interest in one or more companies, called subsidiaries. A holding company might be called an "umbrella" company or a parent company. The holding company doesn't do anything except manage the companies under its umbrella.
A Holding Company can own:
- Shares of stock in a corporation
- Securities, like stocks, bonds, and mutual funds
- Intangible assets like patents and copyrights
- Real estate
- A number of subsidiary companies in one or more industries
- In other words, anything that has value.
Each type of asset could be set up as a separate business (LLC or corporation for example).
Do I Need a Holding Company?
If your multiple businesses are very small with few assets (like an online business, as Carlos has), it seems a lot of expense and trouble to form a holding company. Another possibility is to form just one company, Mendosa Enterprises LLC, and then to have several "projects" within that LLC. Carlos could then file a fictitious name ("doing business as") designation for each of these projects.
For example, Carlos has one online entity that sells used books, and another that provides websites to non-profit organizations and he has more ideas for other online businesses. Each one of these entities could have a fictitious name under Mendosa Enterprises LLC
Another alternative would be for Carlos to start a new LLC for each entity and not form a holding company. He would then have to keep the accounting for each one separate, and divide up some expenses (like his Internet service) among each company. Since he doesn't really have any assets except a computer, the holding company would not really have a purpose, except to bring together the accounting for income and expenses.
How Do I Start a Holding Company?
Before you start a holding company, you'll have to decide what type of company legal structure you want. The two most common types of companies are LLCs and corporations. Starting a holding company as an LLC or a corporation is a pretty painless task, but you should get the help of an attorney to make sure you do it correctly.
As you set up your holding company, you will need to find a board of directors to manage the holding company and oversee the subsidiaries. These people should be familiar with the holding company concept.
Are There Restrictions on LLC's Owning Corporations?
Different business legal entities can own each other, but there are restrictions. From the standpoint of a state, there are usually no restrictions - an LLC can own a C corporation, for example. The restrictions come with the IRS. If an LLC is an owner of a corporation, the LLC must elect C corporation tax status.
An LLC cannot own an S corporation because only individuals and certain trusts and estates can own this type of corporation.
A sole proprietorship is not eligible to own another company because it isn't registered with a state and its tax status is limited.
This article on Who Can Own a Business has more detailed information on what kinds of companies or individuals can own businesses.
Is a Holding Company Liable for Acts of a Subsidiary?
In general, the liability of a holding company for one subsidiary's actions relates to the degree of control the holding company has over the operations of the subsidiary. In United States v. Bestfoods, in 1998, the Supreme Court held unanimously that a holding company isn't liable for acts of a subsidiary if the parent didn't actively participate in, and have control over, the actions of the subsidiary, but there are exceptions.
The most important exception is if the corporate veil is pierced, meaning that the action was outside the normal activities of a business (fraud or negligence, for example). In this case, the owners of both the subsidiary and the holding company could be sued.
More important, if you set up the individual companies within your holding company correctly, the liability for debts of one won't affect all the others. For example, if one subsidiary is set up to own real estate, and it goes bankrupt, the other companies should not be affected by the bankruptcy.
What about Taxes for Holding Companies?
The individual business entities each file their own tax report and the reports for all subsidiaries are added together. Each LLC (assuming he is the only member) files a Schedule C. The losses and gains of each LLC would be added up and placed on his personal tax return. Let's say his book sales entity had a net income this year of $5,000, and the website service had a loss of $2,000. He would record a net income of $3,000 on his tax return. So a loss by one entity can be used to offset a profit by another.
This is a complex issue, with liability and taxes to consider. Before you form a holding company, talk to an attorney and a CPA who are familiar with the laws and accounting for holding companies. Discuss your current situation and future plans to make sure everything you do is according to all federal and state laws and regulations