Establishing a holding company for your expanding business is beneficial for many reasons. It can reduce your tax burden and protect your personal assets. Although, it’s essential to create a holding company structure that will provide all those benefits and not create an added burden.
The best holding company structures for small business acquisitions are limited liability companies (LLCs) or S corporations. They provide legal liability protection. And owners can benefit from registering a holding company in a business-friendly state and thus reduce their tax burden.
Even though establishing a holding company for your small business acquisition may seem relatively straightforward, there are some potential pitfalls that you need to be aware of.
Before we delve into the best-holding company structures, it’s essential to first get to grips with what they are, including their benefits and downsides, so that you can make a fully informed decision and establish a scalable holding company structure that suits your business needs.
So, if you want to make the correct call – read on!
What is a Small Business Holding Company?
A holding company, commonly known as a “parent” or an “umbrella” company, holds a controlling business interest in one or several companies or subsidiaries. Thus, you can legally set up a holding company even if you only acquire one small business.
A holding company is any company owning at least 60% of its subsidiary’s gross income derived from disbursements, interests, and royalties.
Holding companies do not trade with products or provide services like regular businesses as their primary purpose is to manage their subsidiaries. Holding companies may also hold or own patents, trademarks, stocks, real estate, including other business assets. Holding companies are predominantly established to limit the company and its subsidiary’s legal and financial liabilities by strategically relocating business units into states with lower tax requirements.
It is also essential to point out that while a holding company may only own a part of its subsidiary, it can also be wholly owned, which means that the holding company has the power to hire or fire employees in the subsidiaries.
The Main Holding Company Structures For Small Business
The two main holding company structures for small business acquisitions are limited liability companies (LLCs), and corporations. So, here’s an overview of how they are structured, including their respective benefits.
Here we go.
1. A Limited Liability Company (LLC) Structure
Aptly named limited liability companies (LLCs) provide liability protection and significant tax benefits for business partners, owners, or shareholders. This hybrid company structure is like a safety net that provides the same liability protection as giant corporations enjoy.
Thus, should you register an LLC holding company, your personal assets will be protected if your business is sued for damages and a judgment is passed in favor of the plaintive.
An LLC company structure provides greater management flexibility as it can be managed by you as the owner or via a manager overseeing the company's day-to-day operations. And, LLCs have the added advantage that profits or losses do not have to be equally distributed between one, or more members. If that sounds like an excellent option, let’s look at the cost implications of establishing an LLC holding company.
As per TRUiC LLC state filing fees typically range between $40 and $500, although it depends on your state. For example, according to the LLC University, it will cost you $200 for a New York Department of State LLC registration, including $9 for the biennial fee.
2. A Small Business Corporation Structure
Even though there are numerous kinds of corporations ranging between C corporations, B corporations, closed corporations, etc. S corporations are structured for small businesses.
It’s essential to point out that corporation-holding companies are only suited to established small businesses with directors and adequate capital levels, not home-based start-ups. And filing fees vary depending on the state your business is currently operating in.
S corporations are more lucrative as they offer significant tax benefits as you will not have to deal with double taxation, so they function like an LLC. Corporations are also beneficial for the following reasons:
Corporations are also riskier as they are legally classified as separate legal entities with their own rights. Thus, it can be sued and own or sell its property.
The Main Benefits of Setting Up a Holding Company
Suppose you are still in two minds about whether registering with a holding company is worth it. In that case, the following overview might help you decide.
A holding company’s main benefit is that it offers greater protection against incurring losses. Thus, if your newly acquired small business is owned by an LLC or an S corporation, and is declared bankrupt, its creditors cannot recoup their losses from your holding company.
To illustrate this point, the Supreme Court ruled in favor of a holding company in the United States v. Bestfoods 1998 court case. The owner was found not legally responsible for the subsidiary’s business dealings.
So, even though your holding company’s net worth will decline if one subsidiary ceases to trade, you will remain in business. And you can protect your assets further by creating different holding company subsidiaries for your trademarks, brands, and real estate portfolio.
The other massive advantage of creating a holding company is that you can relocate it to a more business, or tax-friendly location and still operate your newly acquired business where it is currently. Most importantly, holding companies are relatively easy to set up and manage, especially if you have established small businesses.
Small Business Holding Company Disadvantages
Like everything in life, holding companies have some potential red flags you must know before you “sign on the dotted line.”
Investors and creditors may find it challenging to ascertain whether your holding company is financially sustainable as unscrupulous directors have been known to hide substantial business losses, by allocating them to other company subsidiaries.
Holding companies may also manipulate their subsidiaries by insisting that they purchase products from other subsidiaries at a far higher or lower cost or appoint certain directors to the detriment of the subsidiary.
Some holding companies have also been implicated in “vulture capitalism” to increase their revenue by selling their subsidiary's valuable assets and laying off most of their workforce. Although the previously mentioned examples are extreme, it’s vital to be aware of the potential pitfalls, especially if you create a holding company with a business partner.
Final Thoughts
The best holding company structure for small business acquisitions is a limited liability company (LLC) or an S corporation. Establishing a holding company is an excellent way to protect your personal and business assets, avoid double taxation, and expand your growing business.