CT expert insights: About holding company structures

In this edition of Expert Insights, CT’s Publications Attorney, Sandra Feldman, explores the ins and outs of holding company operating structures. Learn about what this structure entails and if it’s the right fit for your business. Hear about the number of benefits that come along with holding companies—like protecting assets and mitigating risks—along with some hurdles, such as being potentially complicated to operate.

TRANSCRIPT:

Greg Corombos: Hi, I'm Greg Corombos. Our guest this week on Expert Insights is Sandra Feldman, Publications Attorney at CT Corporation. Today we'll be discussing how using a holding company or operating company structure can be a benefit to you and your business. And Sandra, it's always great to have you with us again, thanks for your time today.

Sandra Feldman: Thank you for having me.

GC: Let's start with the very basic definitions here so we're on the same page - define holding company and operating company.

SF: Okay, well, a lot of people may not be familiar with the terms holding company and operating company, but they probably are familiar with the terms parent and subsidiary. A parent is a company that owns a controlling interest in another company, which is called its subsidiary. A holding company is a special kind of parent company, and an operating company is what its subsidiaries are called.

GC: And how does a holding company differ from the typical parent company?

SF: Typically, a parent company exists to do more than just own subsidiaries. A parent will also be actively engaged in business operations of its own. But a holding company doesn't manufacture anything or sell a product or service or conduct any other kind of business. A holding company’s sole purpose is to hold ownership interest in its subsidiaries. In many cases, it owns the subsidiary’s most valuable assets as well.

GC: So, what about the subsidiaries? Do they conduct business?

SF: Yeah, a holding company’s subsidiaries do conduct business operations, which is why they're referred to as operating companies. And each operating company has its own separate existence, its own assets, liabilities and business purpose, and each has its own officers, managers and employees who run the day-to-day business.

The holding company's role when it comes to the operating companies is to provide oversight. Because the holding company has, at the very least, a controlling interest in each operating company, it can elect directors if the operating company is a corporation, or managers if it's an LLC, it can influence policies for the whole group of subsidiaries and make major decisions like whether to merge or dissolve. But the people who own and manage the holding company don't participate in the day-to-day business of the operating companies.

GC: Sandra, are you seeing a lot of this? In other words, are there a lot of holding companies? Is this a popular business structure?

SF: There are a lot of holding companies and it is a popular business structure. In fact, many of the best non-publicly traded corporations are holding companies. Many banks, for example Bank of America and JP Morgan Chase are holding companies. One of the largest holding companies in the world is Warren Buffett's Berkshire Hathaway. It owns a controlling interest in more than 100 companies in a wide variety of industries. Its holdings include Duracell Batteries, Dairy Queen, Fruit of the Loom, and GEICO among others.

GC: Well, JP Morgan and Berkshire Hathaway are one category. What about for smaller businesses? Is the holding company operating company structure also useful for smaller business owners?

SF: Yes, the holding company operating company structure is also very useful for anyone who owns or wants to own multiple small businesses.

GC: Well, let's talk about the pros and cons now. What are the advantages of using a holding company operating structure?

SF: The main advantage is asset protection. Let me give you an example to illustrate. Let's say we have an entrepreneur, and she forms a holding company. That holding company owns two operating companies. One operating company owns and operates a restaurant, the other manufacturers widgets. Now let's say the restaurant had to close for a while because of COVID-19 and it ran up debts it is having trouble paying.

The restaurant’s creditors can only look to the assets of the operating company that owns the restaurant to satisfy the debt. The creditor can't reach the assets of the operating company that owns the widget manufacturer, or the assets of the holding company, or the assets of the holding company's owner.

Now, let's say the holding company also owns the operating company's most valuable assets, including the machinery used to manufacture the widgets. If the operating company that owns the widget maker files for bankruptcy, the machinery is protected because it's the holding company that owns it.

GC: Well, asset protection is a huge plus to go with the holding company operating company structure. But there's got to be other advantages I'm guessing. If so, what are they?

SF: There are. I'll name a couple. Another advantage is that this kind of arrangement can lower the cost of obtaining financing. Often the holding company will be in a better financial position than some of its operating companies, which means the holding company should have an easier time getting a loan and at a better rate than the operating company could. So, the holding company can take out the loan and distribute the proceeds to the operating company that needs it. A holding company operating company structure can also reduce operating costs because the holding company can provide back-office functions like HR, accounting, and IT for all of its subsidiaries.

It also allows the individuals who form holding companies to diversify their holdings and invest in a wide variety of businesses-for perspectives. It doesn't matter if they don't know anything about those businesses because they aren't running them.

And it can also foster innovation because the holding company can invest in startups and riskier kinds of businesses without worrying about the effect that could have on profitable businesses. In fact, a company you may have heard of called Google, a few years ago restructured itself and it formed a holding company called Alphabet, with Google becoming a subsidiary. And one reason it did that was so that it could invest in areas like robotics and life sciences and medical research, without putting its core businesses like the search engine and YouTube at risk.

GC: So, a lot of pros. But as with any sort of structure that you need to know about the potential downsides as well. So, are there disadvantages with this structure?

SF: There are. It's certainly not the cheapest way of doing business. There are formation fees, annual fees, and compliance costs to the holding company and each operating company. It's also a complex structure, and the more operating companies the more complex, which is why large holding companies invest in a good entity management system.

But even if the holding company owns only a couple of operating companies, it's important to keep the assets of each company separate from each other and from the holding company. It's also important to follow the formalities of the governing business entity law. Basically, to respect the separate identity of each company. If not, a course can pierce the corporation's or LLC's veil, and that asset and liability protection can be lost.

And one other disadvantage I'll mention is that if the holding company doesn't own 100% of its operating company, it will have minority owners to deal with and sometimes the interest of the minority owners can conflict with the interest of the holding company's owners.

GC: Just a basic question here and listening to all this Sandra, if a holding company doesn't actually operate a business, how does it get the money to buy its operating companies?

SF: Well, although a holding company doesn't operate a business, it can still generate revenue, its subsidiaries can pay dividends. The holding company can also charge for providing those back-office functions and for leasing the assets it owns back to the operating companies that use them. It can also sell equity interest in its operating companies, since it doesn't need to own the whole thing. Unlike any other company, it can borrow money.

GC: Lastly, Sandra, you've given our listeners and me a lot to think about here. Any final thoughts about what people need to consider as they potentially go further down the road and evaluating whether holding company operating company structure is right for them?

SF: I’ll sum things up again pointing out that a holding company operating company structure has a number of benefits, most notably protecting assets, mitigating risk, but it can also be complicated to form and operate.

So, I would suggest any business owners considering the structure, consult with legal experts to see if it's a good fit for them. And if they decide to go ahead, there are corporate service companies like CT that can help form the holding company and operating companies and also assist with various post-formation compliance needs.

GC: Sandra, excellent information, as always. Thank you very much for being with us again.

SF: Thank you for having me.

GC: Sandra Feldman is Publications Attorney for CT Corporation. I'm Greg Corombos reporting for Expert Insights. For more information on this subject, contact CT Corporation today.