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Chances are you’ve heard of a holding company before, but you might be unsure about how they work. These types of business entities are unique among LLCs, as they don’t provide any services or produce any goods. Instead, holding companies exist purely to own—or to hold—other companies.
Organizations structure themselves around a holding company for many reasons. Most often, holding companies are established as a tax-efficient way to run a business. This is because a holding company allows owners to take advantage of more favorable tax rates in jurisdictions outside of where they do business. Holding companies are also used to limit potential losses, so that a failure in one part of the business doesn’t impact the wider organization.
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In this article, we’ll take a closer look at how holding companies are used. This is an especially complex topic, with rules and regulations that vary depending on where in the world you are, and on what you want to achieve by starting a holding company. You should seek professional legal advice from business experts with local experience if you plan on setting up a holding company.
What is a holding company?
A holding company is a business entity that owns one or more subsidiary companies but does not conduct any actual business of its own. A holding company primarily exists to own a controlling stake in other companies, as well as business assets such as office buildings, equipment, supplies, patents, and intellectual property.
Also called a “parent company” or an “umbrella company,” a holding company has some managerial oversight over the companies it owns, but it doesn’t control the day-to-day operations. Holding companies are also insulated from most losses incurred by the companies they own, meaning that if a single subsidiary goes bust, outstanding debts cannot be passed on to other companies under the umbrella, or to the holding company itself.
Purpose of a holding company
When people think of holding companies, they tend to think of international corporations seeking to manage their business in the most tax-efficient way possible. But the holding company model can be a useful tool for small- to medium-sized businesses too.
If you’re a small business owner in charge of several companies—for example, if you own three stores across town, each one its own LLC—a holding company helps to minimize risk and shield against cascading losses. You may organize multiple subsidiaries under one holding company and appoint a board of directors to oversee them. This way, it’s possible to ensure that your business assets, such as real estate, are kept safely out of the reach of creditors should one or more subsidiaries face financial problems.
That said, a holding company does not offer iron-clad protection against all losses. In many cases, a holding company can still be held liable for some of the debts of its subsidiaries, and it is often always liable for financial fraud and other crimes committed by the companies it owns.
Advantages of a holding company
Just as forming an LLC can protect an individual’s personal assets from debts incurred by their business, forming a holding company can protect a business from wider financial losses.
A holding company can experience a capital loss if a company it owns goes under, but legally it cannot be pursued by a bankrupt subsidiary’s creditors. That is to say, if a single subsidiary under a holding company folds, it won’t take other parts of the business along with it. This makes establishing a holding company an effective way to limit liability and shield against losses.
When properly organized, a holding company reduces overall exposure to risk by organizing subsidiaries, so that if one company becomes insolvent, faces a lawsuit, or encounters some other kind of financial trouble, the holding company can keep its most valuable assets away from creditors.
As an example, a large organization could restructure itself by spinning off different parts of the business into separate high-risk and low-risk companies. A construction firm could create a subsidiary company to keep hold of its trademarks and real estate holdings, and another to manage a complex, multiyear building project. That way, if the project goes disastrously wrong and incurs huge losses, the construction firm’s valuable trademarks and property cannot be claimed by creditors and the company can continue to operate.
As well as protecting against liability, a holding company can also offset annual trading losses. Each company completes its own tax returns as usual, but the losses and profits of subsidiaries can be consolidated within the holding company’s tax return. This allows you to offset the losses of one part of the business against the profits of another, reducing your overall tax liability.
Disadvantages of a holding company
Restructuring businesses around a holding company is complicated and requires careful management by specialist attorneys, especially if the goal is to reduce tax liability or to take advantage of low-tax jurisdictions.
Proper corporate structuring is also required when establishing a holding company, to ensure that control is appropriately exercised across the business. If a holding company is too involved with the business decisions of its subsidiaries, it can be considered liable for its finances and legal affairs, too.
Taxes for holding companies
Holding companies are often set up to take advantage of low-tax jurisdictions. By locating the holding company in a country or state with a more favorable tax system, a business can effectively shield its profits from being taxed in the country or state where its subsidiaries actually operate.
This type of complex corporate structuring is highly regulated. Depending on where in the world you are, the laws and rules surrounding the relationships between subsidiaries and holding companies can be very different. Finding legal help and employing the services of experienced accountants are necessary to avoid mistakes.
How to start a holding company
Starting a holding company is as straightforward as starting any LLC or corporation, but to structure it effectively and fully transfer the ownership of business assets from the subsidiaries to their parent company, you’ll need comprehensive legal guidance from experts in tax law.
You’ll also need one or more directors to form a board, which can manage the holding company’s operations and oversee subsidiaries. Starting a holding company can be a complex process—and there’s more to it than can be included in this short article—so finding local advisers who are experienced in forming these kinds of business entities is vital.
Holding company vs. an LLC
A holding company can be an LLC. The only difference between a traditional LLC and a holding company is that the holding company does not conduct any business of its own. Holding companies don’t create products or manufacture goods—they exist purely to hold ownership of the assets of their subsidiaries.
Holding company vs. a parent company
Holding companies and parent companies are essentially the same, but with one key difference. A holding company owns subsidiaries and does not conduct any business of its own, while a parent company holds subsidiaries but continues to have its own business ventures, much like any traditional company.
A parent company could be one that purchases other companies as an investment or to alleviate competition in the market. For example, a popular food brand buying out a rival brand could structure its business as a parent-subsidiary relationship. That is, the parent company would continue to produce its own products while owning and operating the newly bought subsidiary.
Examples of holding companies
Perhaps one of the most recent and high-profile examples of the formation of a holding company can be found in the tech industry. Alphabet Inc. was formed in 2015 to bring Google and its many subsidiaries under the umbrella of a single holding company. While Google is by far Alphabet’s largest subsidiary, and its best-known brand, Alphabet does not conduct any business of its own.
This corporate structure allows the tech giant to operate with less risk, while still owning and overseeing a wide range of holdings unrelated to the core Google business. The structure also allows Google to focus more acutely on its internet search services and advertising business, while the other subsidiaries under the Alphabet umbrella can pursue more high-risk and experimental projects.
Steve Hogarty is a writer and journalist based in London. He is the travel editor of City AM newspaper and the deputy editor of City AM Magazine, where his work focuses on technology, travel, and entertainment.
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