One of the biggest concerns for experienced business owners is liability protection; one way business owners can increase their liability protection is by setting up an LLC parent company and creating an LLC parent-subsidiary dynamic. As with all business decisions, you’ll find significant advantages and some disadvantages to this business structure. There are several ways to do this, and one possible way is to set up an LLC and create subsidiary LLCs for each business entity. But is this a good idea? What are the pitfalls? How good an idea this is also depends on your willingness to administer a more complicated business entity. Let’s take a look at parent/umbrella LLCs.
The legality of parent LLCs
While small businesses often launch LLCs, you’ll find that large multi-venture conglomerates own some LLCs, and the business structure has its place in mutual funds, real estate companies, and other ventures. LLCs are highly beneficial for tax purposes and offer solid personal asset protection.
As for the legality, nothing is preventing an LLC from owning another LLC. LLC laws place few restrictions on who can be LLC members. LLC owners may be known as “members.” LLC members can be individuals or businesses, including separate LLCs or corporations. It’s also possible to form a single-member LLC that another LLC owns.
Why would an LLC own another LLC?
From parent companies and holding companies, business owners often have several lines of business. Because of the legal protections provided by LLCs, it makes sense to have multiple companies, so if an LLC fails, it won’t impact the others.
Real estate developers, investors, movie studios, and other companies often have multiple ventures. The different risks, obligations, and assets involved mean they often form parent and subsidiary entities. Businesses with riskier dealings, including construction firms, may consider having a parent LLC and a subsidiary LLC to hold assets and another to manage general administrative tasks.
A typical real-world example is, let’s say you own three rental properties, each property presents a risk of financial failure and lawsuits or damage. To avoid one building’s problems affecting another, a business attorney may advise setting up separate entities under a parent-subsidiary LLC structure. The parent LLC oversees general tasks, while three subsidiary LLCs own and manage each property. Each would be a single-member LLC with the parent company as its sole owner.
Let’s say that someone becomes seriously injured at one of your properties and sues that property’s LLC. That LLC may lose all of its assets, but your other subsidiary LLC, you, and the parent LLC are all safe from liability. However, if you’d registered all buildings under the same LLC, you could lose your entire business in one lawsuit.
Disadvantages of parent-subsidiary LLCs
Creating and operating multiple LLCs is time-consuming and expensive – setting up an LLC involves filing Articles of Organization and creating an LLC operating agreement for each LLC. If you set up multiple LLCs, you’ll need to complete the full process and pay state filing fees for each one. Each LLC also needs to keep its distinctive records and maintain its business bank account, payroll, and tax documents. Each will have its own obligations to the IRS.
You may also become personally liable for an issue if you were fraudulent or negligent in any of your dealings or if you personally guaranteed a loan or borrowed against your assets.
LLCs vs Corporations
Corporations traditionally have more tax liabilities – shareholders are taxed on distributions they receive, and corporate income tax is also owed. The way to avoid this is to start up as an S-corporation. However, S-corporations have stricter eligibility rules, fewer benefits, and can’t be owned by an LLC or other corporation. LLCs enjoy pass-through taxation, like S-corps. However, if you want to set up subsidiary companies and enjoy pass-through taxation, you must set them up as LLCs as they won’t qualify as S-corporations.
Creating parent and subsidiary LLCs is one way to minimize your liability risk; whether the strategy is best for you will depend on whether you’re protected enough to justify the additional financial and time cost. You may want to consider consulting a professional business formation service, lawyer, or business attorney to help you decide.
Series LLC vs LLC
The Series LLC is a relatively new concept, introduced by Delaware in 1996. The concept was inspired by Delaware’s statutory trust law, which meant that one investment company could be formed as a trust with a separate series. A series LLC consists of a parent LLC with one or more established series, and each can have its members, managers, purpose, and assets. As long as certain statutory requirements are met, each business venture has its assets, debts, liabilities, and obligations, allowing for better protection. But not all states permit Series LLCs.
Which states allow Series LLCs?
- District of Columbia
- North Dakota
- Puerto Rico
Some states, including California, don’t allow you to start a new business with this business structure, but they’ll recognize the validity of such a startup formed in another US state.
Your LLC’s biggest benefit is protecting the personal assets belonging to the owners of the LLC. Owners of an LLC have personal asset protection, but this protection is further solidified if you set up an LLC holding company or Series LLC. The precise legalities of your situation will depend on your state and business activities.
The main intention in the business formation process is to protect each individual LLC from others, so if there’s a claim against one of your businesses, the assets of the other existing LLCs are protected. Series LLC is the most convenient way to achieve this protection, but they’re not valid or recognized in all states.