What is a Holding Company — And Do I Need One?

If you own or operate multiple businesses, you may have heard of the term “holding company.” But what exactly is it, and how does it differ from a regular company? More importantly, do you need one for your business ventures?

In this article, we will explain what a holding company is, how it works, what are its advantages and disadvantages, and what are some alternatives to consider. We will also provide some practical tips on how to set up one, and how to use a personal balance sheet software like Kubera to manage your assets.

What is a Holding Company?

A holding company (holdco) is a legal entity that owns or controls one or more companies, known as "subsidiaries." Typically structured as a limited liability company or C Corporation, a holdco's primary function is to protect the assets of its subsidiaries and mitigate liability risks across the group.

Holding companies are also referred to as "parent companies" or "umbrella companies."

In addition to owning other businesses, a holding company can also hold various assets, including stocks and securities, patents, trademarks, copyrights, and real estate. This diversification of investments allows the holdco to minimize risk and create a streamlined structure for managing multiple businesses under one roof.

By separating the assets and liabilities of each subsidiary, the holding company can limit the risk of one subsidiary's failure affecting the others. Additionally, depending on the jurisdiction and structure of the holdco, there may be tax benefits, such as the ability to offset losses in one subsidiary against profits in another.

Overall, a holding company can provide an efficient and cost-effective way to manage multiple businesses while offering liability protection, tax benefits, and privacy to its owners.

Types of Holding Companies

Holding companies come in various forms, depending on their purpose and structure. Some common types of holding companies include:

Pure Holding Companies: These entities exist solely to own other companies and do not engage in any other business activities. They are also known as "parent companies" or "umbrella companies." An example of a pure holding company is Berkshire Hathaway, which owns stakes in various companies such as Apple, Coca-Cola, and Geico.
Mixed Holding Companies: Also known as "holding-operating companies," these entities manage subsidiaries and also have their own independent business operations. They are a combination of a pure holding company and an operating company. Alphabet is an example of a mixed holding company, owning Google and other businesses such as YouTube, Waymo, and Calico.
Immediate Holding Companies: These companies own other firms but are themselves owned by another entity. They are often used to group similar businesses under one umbrella. Facebook Technologies, which owns Oculus VR but is itself owned by Meta Platforms, is an example of an immediate holding company.
Intermediate Holding Companies: These entities are parent companies that are also subsidiaries of larger companies. They are used to group similar businesses under one umbrella and are often part of a larger corporate structure. JPMorgan Chase Bank, which owns various banking and financial subsidiaries but is itself owned by JPMorgan Chase & Co, is an example of an intermediate holding company.

The choice of holding company structure depends on various factors, including the nature of the businesses involved, tax considerations, and the desired level of control and ownership. Regardless of type, holding companies provide a way to manage multiple businesses while offering liability protection, tax benefits, and privacy to their owners.

How Does a Holding Company Work?

A holding company serves as the owner of its subsidiary entities but does not get involved in their day-to-day operations. Instead, the management of each subsidiary is responsible for running its own business, while the holdco oversees the ownership of assets and guides the overarching policies and strategic decisions of its subsidiaries.

Each subsidiary operates as a separate legal entity, whether structured as a corporation or a limited liability company (LLC). Subsidiaries are required to submit their own articles of incorporation or organization to the state, establish bylaws or an operating agreement, maintain separate bank accounts, manage individual payroll matters, and keep distinct financial records. The activities of one subsidiary generally do not affect the operations of other subsidiaries under the same holding company, providing a degree of isolation and protection from potential liabilities.

The holdco's management team focuses on high-level decision-making, such as determining the strategic direction of the group, allocating resources among subsidiaries, and monitoring their performance. This structure allows the holding company to achieve economies of scale, streamline operations, and minimize risks by diversifying its investments across various businesses and industries.

In summary, a holding company works by owning and overseeing multiple businesses while maintaining a separation between the operations of each subsidiary. This structure offers several advantages, including liability protection, tax benefits, and privacy, while allowing for centralized management and resource allocation.

Advantages of Holding Companies

Holding companies offer several benefits for businesses, including:

Liability Protection: Separating operating companies into distinct entities creates a liability shield, protecting the assets of the holding company and other subsidiaries from the debts and obligations of each subsidiary. If one subsidiary faces legal action or financial difficulties, the holding company and other subsidiaries are not liable for the damages or debts. This structure helps mitigate risks and safeguard the overall financial health of the group.
Cost-Effective Asset Control: Holding companies can control subsidiaries without owning all shares, reducing the cost of acquiring a company and its assets. By owning a controlling interest (usually more than 50% of the shares), the holdco can make decisions and manage the subsidiary's operations without having to purchase the entire company. This approach allows for a more efficient use of capital and greater control over the assets and resources of the subsidiary.
Reduced Financing Costs: Financially strong holding companies can secure loans at lower interest rates than individual operating companies and distribute the funds to subsidiaries. By leveraging the holdco's credit rating and financial strength, the group can benefit from lower borrowing costs and improved cash flow, while also having more flexibility in allocating resources across subsidiaries.
Innovation: Independent subsidiaries can explore new ideas and investments without requiring the larger holding company to deviate from its core business or financial goals. This structure enables experimentation and diversification, allowing the group to explore new markets, technologies, or business models without jeopardizing the stability and performance of the existing businesses.
Tax Efficiency: In many cases, holding companies can file consolidated tax returns, offsetting gains in one subsidiary with losses in another to reduce overall corporation tax liabilities. By combining the financial results of all subsidiaries, the holdco can benefit from a lower tax bill and optimize the group's tax planning and management.

These holding company benefits make them an attractive option for entrepreneurs, investors, and business owners looking to manage multiple businesses, mitigate risks, and maximize the value of their assets.

Downsides of Holding Companies

Although holding companies offer several advantages, they also come with some challenges and drawbacks:

Formation and Compliance Costs: Both the holding company and its subsidiaries incur formation fees, annual report obligations, and franchise tax responsibilities. Maintaining compliance with governing statutes and individual documents for each entity results in additional costs. For instance, if you form a holding company and three subsidiaries in Delaware, you will have to pay a minimum of $300 in annual franchise tax for each entity, plus a $50 filing fee for each annual report. This means you will have to pay at least $1,400 per year, not including other fees and taxes.
Management Challenges: When a holding company doesn't own all of a subsidiary's ownership interests, management will have to work with minority owners. Making major policy decisions for businesses or industries in which the holding company isn't an expert can also require research and increased management. For example, if you own a holding company that has a 60% stake in a subsidiary that operates in the healthcare industry, you will have to consult with the other 40% owners before making any significant changes to the subsidiary's business model or strategy. You will also have to learn about the healthcare industry and its regulations, which may be different from your core business.
Complexity: Incorporating holding companies and subsidiaries introduces complexity, as it is crucial to maintain the separation of records, assets, liabilities, and properties for each company. Neglecting this separation increases the risk of creditors accessing assets beyond the debtor subsidiary. For instance, if you use the same bank account for your holding company and one of your subsidiaries, and the subsidiary defaults on a loan, the creditor may be able to seize the funds in the bank account, even if they belong to the holding company.

Despite these potential drawbacks, many businesses find that the benefits of a holding company structure, such as liability protection, tax efficiency, and centralized management, outweigh the challenges. Proper planning, organization, and expert guidance can help mitigate these downsides and ensure the effective operation of a holding company and its subsidiaries.

Do You Need a Holding Company?

If you're considering setting up a holding company, it's essential to ask yourself a few key questions to determine if this structure is the right fit for your business:

Do I operate various unrelated businesses? If your focus is on a single business, a holding company may not be necessary. However, if you manage several diverse ventures, a holding company can provide a structure to oversee them collectively while maintaining legal separation between each entity. This can help streamline management and facilitate resource allocation across your various businesses.
Do these businesses hold significant assets? Holding companies offer the advantage of managing subsidiaries together while keeping their liabilities separate. This structure is especially beneficial for asset protection strategies, allowing the holding company to generate income from subsidiary assets, including intangibles like copyrights, patents, and other intellectual property. By separating assets from the operating companies, you can reduce the risk of loss due to potential liabilities or legal issues faced by individual subsidiaries.
Are the advantages worth the time and money? Establishing a holding company involves some complexity and costs, such as formation fees, ongoing compliance requirements, and additional administrative work. It's essential to carefully consider if the potential benefits of a holding company, such as liability protection, tax efficiency, and centralized management, outweigh the costs and effort required to set up and maintain the structure. If your businesses are not generating significant profits or if the potential benefits seem marginal, a holding company may not be the best choice for your situation.

By asking these questions and assessing your business needs, goals, and circumstances, you can make an informed decision about whether a holding company is the right solution for managing your various business ventures. Consulting with legal and financial professionals can also provide valuable insights and guidance to help you make the best decision for your specific situation.

Holding Company Alternatives

If you're unsure whether a holding company is the right choice for your businesses, you may want to consider alternative options. Some common alternatives to holding companies include:

LLCs: Instead of creating a holding company, you can establish each business as an independent limited liability company (LLC) without a parent company. While this is often a simpler and more cost-effective solution, it may result in missing out on certain tax benefits that a holding company structure could provide. Additionally, operating multiple LLCs may require more administrative work and management time, as each LLC will have its own set of legal and financial obligations.
One LLC, DBA names: Another option is to create a single LLC and assign multiple "doing business as" (DBA) names to it. This is a more economical choice as you only report taxes for the one LLC. However, since the activities of each DBA fall under the same LLC, they share liabilities and risks. This means that if one of your DBAs faces legal or financial issues, the assets and income of the other DBAs under the same LLC could be at risk.
Partnerships: You can consider forming a partnership with other business owners to share resources, risks, and profits. Partnerships can be structured in various ways, such as general partnerships, limited partnerships, or limited liability partnerships, each with its own set of legal and financial implications. However, partnerships may involve more complex decision-making processes and potential conflicts among partners, which could affect the overall performance and success of the business.
Joint ventures: A joint venture is a strategic alliance between two or more companies that agree to work together on a specific project or business opportunity. Joint ventures can offer many benefits, such as shared resources, expertise, and risk, but they can also involve complex negotiations, management challenges, and potential disagreements among the partners.

When choosing an alternative to a holding company, it is essential to consider your specific business needs, goals, and circumstances. Factors such as the nature of your business, tax implications, management structure, and liability concerns should all play a role in your decision-making process.

3 Options for Establishing a Holding Company

If you decide that a holding company is the right choice for your business, there are several options for setting it up. Here are some common ways to create a holding company:

C Corporation Setup

A C Corporation provides personal liability protection as it is a distinct legal and tax-paying entity. It allows for raising capital through stock issuance and has perpetual existence. Basic steps include:

Designating a registered agent (Required for corporations, LLCs, and other business entities to receive official communications. Can be an employee, owner, lawyer, or a professional registered agent.)
Filing articles of incorporation
Appointing a board of directors
Adopting bylaws
Applying for business licenses, permits, and an employer identification number (EIN)
Opening a business bank account
Holding board of directors' and shareholder meetings
Filing annual reports

Limited Liability Company Formation

An LLC protects members from personal liability and has fewer compliance requirements than a C Corporation. By default, it is taxed as a disregarded entity, with the option to elect S Corporation or C Corporation tax treatment in some cases. Setting up an LLC includes:

Designating a registered agent
Filing articles of organization
Obtaining an EIN
Creating an LLC operating agreement
Applying for licenses and permits
Opening a business bank account
Holding member meetings (if required by the operating agreement)

Conduct a Merger

You can also transform an existing operating company into a holding company through a merger. This process, which generally requires shareholder approval, allows stockholders to hold shares in the holding company, while the holding company owns the stock of the surviving operating company. Some states provide options for a corporation to become a holding company without a stockholder vote, with additional safeguards for stockholders.

Numerous business formation professionals, firms, and digital platforms are available to guide individuals and businesses through the process of setting up holding companies, making it easier to navigate the complexities involved.

Before You Do Anything Else, Get Your Assets in Order With Kubera

Before you make the decision to establish a holding company, it's essential to have a clear understanding of your assets and their potential for growth. One of the biggest benefits of setting up a holding company is asset protection, so it's crucial to know what assets you have across your various businesses, even if they're small.

Kubera is a personal balance sheet software that was custom-built to connect to all kinds of bank, brokerage, crypto, NFT, and various other types of financial accounts. By using Kubera, you can:

Track your assets: Gain a comprehensive overview of your assets, including their current value and performance over time.
Make accurate financial forecasts: Utilize the data gathered by Kubera to create accurate financial forecasts, helping you make informed decisions about your businesses and assets.
Monitor diversification: Ensure that your assets are well-diversified to mitigate risk and maximize growth potential. Kubera helps you monitor your asset allocation and identify areas for improvement.
Calculate your net worth: Keep track of your net worth and monitor its growth as you manage your assets and businesses.

By using Kubera to get your assets in order, you can make a more informed decision about whether it's time to set up a holding company to manage, protect, and grow your assets. With a clear understanding of your financial situation, you can determine if a holding company structure is the right choice for you and your businesses.

To get started with Kubera, sign up for a trial and experience the benefits of having your assets organized and tracked in one comprehensive platform.

Conclusion

Establishing a holding company can provide numerous benefits for business owners, including asset protection, tax efficiency, and centralized management. However, it's essential to weigh these advantages against the potential drawbacks, such as additional costs, management challenges, and increased complexity.

Before you decide to set up a holding company, take the time to get your assets in order using a tool like Kubera. By gaining a clear understanding of your assets and their growth potential, you can make a more informed decision about whether a holding company is the right choice for your businesses.

As you navigate the process of setting up a holding company or exploring alternative options, consult with legal and financial professionals to ensure compliance and optimize your business structure. With the right guidance and tools, you can make the best decision for your unique situation and work towards the continued success and growth of your businesses.