Holding Company Structure: Everything You Need to Know
With a holding company structure, you are essentially investing in a variety securities in the form of assets. 6 min read
With a holding company structure, you are essentially investing in various securities in the form of assets. Holding companies are most appropriate for large entities with diverse investments in business and industry. A holding company is an entity with no operational system and has no other purpose than holding valuable assets. In addition to stocks and bonds, holding companies can retain:
- Song rights
- Brand names
- Private equity funds
- Hedge funds
Holding Company Assets
Holding companies can be grouped into sub-groups, such as medical devices, consumer health care, or pharmaceuticals. However, each holding represents a lone company that can be operated by employees with offices, facilities, etc.
For instance, Johnson & Johnson stockholders appoint a board of directors to draft a dividend policy. The board hires the CEO (or officer) who guides the subordinates accordingly. The subordinates have full domain over a parent holding company. The holding company itself lends support to the subsidiaries by lowering capital cost because of overhead strength. The company is a vessel which dispenses bonds at low rates, lending money to internal subsidiaries at rates they could not get anywhere else. Such a method reduces interest costs and return on assets and other forms of equity.
Holding Company Sample
Imagine yourself and another partner creating a new company called Blue Ocean Holding Company Inc. You file the necessary documents at your Secretary of State's office and honor the fees. Further, you offer 1 million shares at $10 per share and manage to get $10 million raised. Moreover, you elect the board of directors, and the board hires a CEO.
You then decide to construct an office. Afterward, the company begins investing the cash you raised in another company called Sweet Desserts of Harmony LLC.
The new business is owned 100 percent by Blue Ocean, and the company contributes $1,500,000 in direct cash to the company. You then hire a manager to operate the new business. Further, you decide to establish a Dairy Queen that would yield $170,000 in profit before taxation.
Blue Ocean would then establish a brokerage account at a discount brokerage firm and deposit $3,000,000 in cash into an account. Further, you purchase a group of valuable blue chip stocks. The stocks you purchased amounts to $150,000 in pre-taxed dividends annually.
You then start another company known as Northeast Hospitality LLC that is owned 100 percent by Blue Ocean. You also lend $2,000,000 of cash to the new venture and get the latest subsidiary to finance $2,000,000 from a local bank. The financing gives it a capitalization structure of $4,000,000 in assets and $2,000,000 in liabilities, including $2,000,000 in value on the books.
You then use the $4,000,000 venture to purchase a hotel franchise, which would generate $320,000 in pre-taxed profits. With that, the debt is not secured by the holding company since you decided to permit non-recourse liabilities if the hotel you financed is not successful. This means that you are only liable for the equity that you invested in the business if the subsidiary enters bankruptcy.
Additionally, you could write off the bankrupted hotel venture for $2,000,000 in net worth in capital losses on your investment in Northeast. The holding company essentially protected your other assets from a subsidiary that went bankrupt. Further, you keep your Dairy Queen and other assets. You only lose money that was invested in that lone subsidiary that went under.
Corporations commonly use this method to protect their operations.
Holding Company Silos
Holding silos isolate an asset from other investments to protect the overall value of the holding company. For example, a Dallas Property Management LLC employee embezzled all funds, and the company filed for bankruptcy as a result. A parent holding company would enter receivership and forge a new property management company the day after. The firm would only lose $100,000, which is the same amount that was placed into the business as a start-up cost. Other investments such as mutual funds and buildings could not be accessed. This is called a silo because it is a self-contained problem that did not affect the other assets.
Another example is Dunkin' Donuts, which comprises a holding company. The intellectual property in the form of the logos and name are under the operations of a subsidiary called DD IP Holder LLC. The subsidiary licenses, the logos, and name to each franchisee of the store, belong to owners of the company. The real estate end of the business may also be held in a separate subsidiary and another for business equipment that is leased to a franchisee or owner.
Further, there may be an operating company called 500 Main Street Desserts LLC. However, it pays fees to various subsidiaries to get the rights to the Dunkin' Donuts name, including equipment, real estate, etc. This means a particular location will get sued if a customer gets injured on the property instead of the entire name. This tactic would allow Dunkin' Donuts to open another one called 500 Main Street Desserts Version II LLC, and all of the assisting subsidiaries leasing any assets back to the new business.
This would render a lawsuit ineffective and a plaintiff getting little or no compensation.
If you are going to create a manufacturing operation, for instance, use the following parent holding company model:
- Dax Factory Holding Company LLC
- Dax IP Holder LLC (holding trademarks, branding, etc.)
- Dax Real Estate LLC (real estate and building)
- Dax Equipment LLC
- Dax Human Services (Employees)
- Dax Manufacturing LLC (Operating Company)
All of the aforementioned subsidiaries are under the management of the holding company itself, but Dax Manufacturing is the primary business in a traditional way.
Holding Company Taxation
To take advantage of holding company benefits, hire an accountant and attorney due to the complex rules involved.
The government levies a holding tax on C corporations in the U.S. with 50 percent or over of stock owned by five or fewer investors. This amounts to a double surcharge tax that could hurt your profit margins. However, holding companies are becoming a popular option among families forming LLCs into holdings. An LLC is an entity that safeguards members from personal liability in the event of a judgment or creditor claim. Moreover, you can use what is known as pass-through taxation, a system where profits and losses are passed on to individual members instead of the entity. This allows each member to file income and losses on their personal taxes. Therefore, no holding company taxes would apply.
For a C corporation holding company, you can gain a minimum of 80 percent of the stock of another C corporation due to the double taxation involved in dividends. This is because the tax code does not apply to distributions coming from the subsidiary to the parent company. For instance, if a holding company owns 65 percent stock in a separate business, and another business issues dividends around Christmas, the holding company would pay regular corporate taxes on those specific dividends. With that, if the holding company owned 80 percent of the other company, it would not have to pay the corporate tax on dividends it gained from the other business since it was already taxed a single time as a subsidiary.
Owners of a holding company must file tax returns for both the operating company and the holding company. This can be complex, so it may be best to consult an accounting professional.
Your company may also be subject to state franchise fees. A business attorney can help you figure out what taxes and fees you are responsible for paying.
Holding Company Internal Operations
You must be aware of the several international structures involved with holding companies:
- Simple Structure: Commonly found in informal and smaller entities with a single owner and a limited number of employees.
- Functional Structure: A structure which divides tasks, employees or technologies into groups. For instance: marketing, finance, human resources, etc. Each group works separately from the other.
- Divisional Structure: A main office with overseas divisions that have autonomy.
Internal structures usually take the form of a chart or graph representing the role and distinctions of departments and employees.
Holding Company Income
A holding company can generate income in a number of ways. These include the following.
- Holding the assets of the business and lending them to the operating company
- Lending money to the operating company and collecting interest
- Leasing land or equipment to the operating company
- Investing in shares of other businesses
It's important to keep careful records and maintain separate bank accounts for each holding company so that you can adhere to regulatory reporting requirements.
Activities conducted by a business are classed as either financing, investing, or operating. All activities in the latter category must be done by the operating company, not by the holding company. This includes any revenue-driving sales of products and services.
When a holding company engages in these activities, it is called piercing the corporate veil and affects the company's limited liability protection. This means that the holding company may be held responsible for the debts of the operating company. It's also important to pay employee salaries for those who perform operating functions from the accounts of the operating company.
To learn more about holding company structure, post your legal need on our marketplace. UpCounsel lawyers will help you through the intricacies of holding company formation, along with tax structure. Our dedicated team of lawyers will ensure you do not make any missteps or mistakes as you create your business.