NONPROFITS: Consider Holding Companies

What are the advantages of the holding company?

There are different reasons why holding companies are used. Below are a few:

1. Liability protection - Placing operating companies and the assets they use in separate entities provides a liability shield. The debts of each subsidiary belong to that subsidiary. A creditor of the subsidiary cannot reach the assets of the holding company or another subsidiary.

Say our entrepreneurs’ horse farm is struggling and has been unable to pay its trainer and veterinarian. They can sue and reach the assets of the subsidiary that owns the horse farm but not the assets of the subsidiaries that own the restaurant and apartment building, or the LLC holding company.

2. Control assets for less money - A holding company needs to control its subsidiaries but doesn’t necessarily need to own all shares or membership interests. That allows the holding company to obtain control of another company and its assets at a lower cost than if it had acquired all of the subsidiary’s ownership interests.

3. Lower debt financing costs - A holding company that has financial strength can often obtain loans for a lower interest rate than its operating companies could themselves, particularly where the business in need of capital is a startup or other venture considered a credit risk. The holding company can obtain the loan and distribute the funds to the subsidiary.

4. Foster innovation - Because operating companies are separate entities, there is less risk in investing in startups or other ventures that seem risky. In fact, when one publicly traded technology company (best known for its search engine and video sharing websites) changed to a holding company-operating company structure, one of the reasons cited for doing so was that its shareholders were concerned about the company’s investments in areas like robotics, life sciences, and medical research. By restructuring, those investments were separated from its core and profitable functions.

5. Day-to-day management not required - A holding company can own businesses in a variety of unrelated industries. It doesn’t matter if the owners and managers of the holding company don’t know about those businesses because each subsidiary has its own management to run the day-to-day operations.

What are the disadvantages of a holding company?

There are some drawbacks to using a holding company structure as well, including the following:

1. Formation and ongoing compliance costs - The holding company and each subsidiary that is formed require the payment of formation fees. There will also be, in most cases, annual report and franchise tax obligations. Each will also have to comply with the governing corporation or LLC statute and its individual governing documents. Using a single operating company avoids these additional per-entity compliance obligations and their associated costs.

2. Management challenges - As noted, a holding company does not have to own all of the subsidiaries’ ownership interests. That can be both an advantage and a disadvantage. Where it does not own 100%, its management will have to deal with minority owners. Sometimes conflicts arise when the interests of the minority owners are different from those of the holding company. The fact that the holding company’s management does not have to be experts in the operating companies’ businesses can also be both an advantage and a disadvantage. It can be a disadvantage because the holding company’s management may be overseeing and making major policy decisions for businesses or industries in which they are not particularly familiar.

3. Complexity - The use of holding companies and subsidiaries adds an element of complexity not found in the single-entity structure. When a publicly traded corporation uses a holding company structure, for example, it can be very complex, with many subsidiaries to keep track of. For enterprises like that, a good entity management system can be an invaluable tool in keeping track of all the important information, records and due dates for all of the companies.

But even for much smaller enterprises, it is important to keep the records, assets, liabilities and properties of each company separate from each other. Failure to do so can increase the risk of a court piercing the veil, and allowing a creditor to reach assets beyond the debtor subsidiary.

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