An LLC holding company is a way a business is structured that is popular with small businesses and start-up ventures. This format combines the benefits of a partnership and a corporation and provides tax benefits and solid personal protection liability. Let’s take a look at some of the most common FAQs.
What is an LLC?
An LLC, or limited liability company, is a popular business structure type that millions of entrepreneurs in the USA and abroad use. Business owners enjoy greater asset protection when choosing this entity type.
In this case, the owner and the company are two separate entities (unlike in, say, a sole proprietorship), but there are unique taxation benefits that a corporation doesn’t offer. With an LLC, taxation can be passed through, which means you’re not taxed twice – corporations often pay taxes at a corporate level before income is taxed again. With LLCs, income is taxed on your personal tax return like other personal income.
What is a holding company?
A holding company is a type of business entity, and it’s an umbrella or parent company. Typically a holding company is a corporation or LLC and doesn’t sell anything, manufacture goods, or conduct business operations.
In the holding company structure, its purpose is to ”hold” the controlling interests or stock in other businesses, as the name implies. Usually, the subsidiary companies sell, conduct business, use business assets, or manufacture. These are called operating companies. Other subsidiaries may hold assets such as equipment, vehicles, real estate, or even intellectual property.
The holding company owns 100% of the subsidiary, or just enough membership to control the subsidiary, and this can be 51% or much lower if there are several owners. You only need to have a majority stake. Each subsidiary usually has dedicated management running daily operations, and the holding company’s management just oversees the subsidiaries, like an umbrella. They can elect, remove or make significant policy decisions to dissolve or merge parts of the company.
Membership in LLCs and shares in corporations
You should consider that changing from an LLC to an S-corporation creates some ownership restrictions. S-corps have more significant restrictions, including who can own the company, how many shares can be created and sold, etc. An LLC provides ultimate flexibility regarding ownership as there are no restrictions on owners or managers and no limit on shares. Some LLCs may eventually incorporate and can turn into an S-corp using Subchapter S-corporation designation for tax purposes.
LLCs as holding companies
An LLC can be a holding company where it serves no function but to own another company and its assets. The company where business occurs is known as the ”operating company”. You can use an LLC to hold the shares and membership interests in the operating company and can have their crucial assets and lease them to the operating company. In this relationship, the operating company can also purchase assets from the holding company by taking out a loan, mortgage, or security in the interest of the asset.
Drawbacks of LLCs as a holding company
Having an LLC as a holding company isn’t without drawbacks, which include:
- There are more opportunities for error and non-compliance due to the inherent structural complexity.
- There is a greater administrative burden; the assets of the operating company and all accounting must be separate from the holding company.
- Both companies must observe the legalities of being separate business entities, with separate assets, bank accounts, etc.
Failure to keep the separation and follow proper legal procedures for both companies can result in the holding company being deemed a shill and possible legal recourse.
Benefits of LLCs as a holding company
There are some key advantages to using an LLC as a holding company, though there are complexities involved. Some of the most significant benefits are:
- The operating company can shield its only member from liability.
- You can defend the holding company from torts resulting from ex-employees of the operating company.
- The holding company members are also eligible for protection from liability.
- Since the holding company is the actual owner of the operating company’s assets, cash, etc., the company has additional protection from creditors and debts.
- You can lose your liability protection if you behave negligently – since the holding company has no operations, there are almost no opportunities for liability, so long as you keep each business separate.
An alternate structure type is a Series LLC – a Series LLC is essentially an official business structure in which several LLCs are owned under one umbrella. However, it’s a pretty new concept, and only 26 states allow you to start one, though a few more will allow you to operate one started elsewhere. Before you launch multiple LLCs, you should clarify whether a Series LLC is possible.
Do I need a holding company?
For most businesses that are small or have fewer assets, it’s probably more trouble and expense than it’s worth to create an LLC for every asset. It may be better to form under one LLC and automatically enjoy the general limited liability protection you hold.
But suppose you have significant valuable assets and multiple ventures, assets, etc, and want the freedom to borrow against them without harming the liability of your whole operation. In that case, a holding company has more purpose. You could create a single LLC for each business, though this requires a lot of administrative burdens, including separate accounting systems, and divide the expenses between each company. If you select this option, it’s known as ”business designation”.
Summing up, a holding company is a business entity that owns and controls other companies rather than producing goods and services or conducting other business operations. Doing this has several key advantages, including helping businesses reduce the risk of losses.
Holding companies are very common for businesses with more assets to lose, but some medium-sized companies (such as real estate owners) may benefit. It can be complex and isn’t right for everyone, but you can consider it as an option. It’s a great idea to get legal advice or speak to a business formation service to discuss your options when it comes to forming any business entity.