Asset Protection: Should a Holding Company Own Your Business?

Over the years, numerous strategies have been developed to help business owners, professionals, and owners of vulnerable assets protect their interests against litigation, creditor claims, and other future legal and financial threats.

In our asset protection practice, we utilize a variety of legal structures, special trusts, and other planning vehicles to help our clients achieve their legal and financial goals and achieve peace of mind.

That assortment of asset protection options includes a long-standing, battle-tested option: the holding company.

Simply stated, a holding company is a legal entity – typically an LLC or a corporation – that owns, in whole or in part, multiple “subsidiary” or “operating” entities.

Creating a holding company and subsidiaries achieves legal separation between the owner(s) and their downstream entities and assets and, as we discuss below, reduces owner liability if one of the entities encounters legal or financial problems that otherwise might expose the owner personally.

As its name suggests, a holding company’s primary purpose is to hold other companies and/or business assets. In its simplest or “pure” form, it does not manufacture a product, provide a service, conduct any normal business operations, or even closely manage its subsidiaries’ operations; it simply owns – hiring and overseeing the upper management (e.g., you) for each entity, making major policy decisions, and perhaps buying, selling, and dissolving its subsidiaries.

(Not all holding companies are so pure. A “mixed” holding company or “holding-operating” company wears two hats, conducting its own business operations while also owning subsidiaries. An “immediate” or “intermediate” holding company might be pure or mixed and is owned by another holding company that is higher on the food chain. And a “personal” holding company is an entity for which 50% of the ownership rests with five or fewer individuals and at least 60% of its income is passive.)

Small Businesses. Many business owners associate the holding company concept with very large corporations and conglomerates and mistakenly conclude that it is not for them. 

In fact, a holding company can be a very effective tool for private companies and individual entrepreneurs. Consider two common scenarios:

• You own a retail business. You might form two LLCs – an operating entity to own the store, and a holding entity to own the LLC that owns the store. If you open another store, you create another operating LLC that is owned by the holding LLC.
• You own a sand-and-gravel operation that includes trucks used for deliveries. You might form three LLCs: one to own the sand-and-gravel operation, another to own the trucking operation, and a third (owned by you) to own both of the operating entities.

Liability Protection and More. There are many reasons why holding companies are used (you can see a comprehensive list in an article by Wolters Kluwer), but in the context of asset protection, the primary benefit is reduced liability – for you and for each entity.

The debts of each subsidiary belong to and are limited to that subsidiary. If a subsidiary goes bankrupt and is the subject of an adverse judgment, its creditors generally have no recourse against the holding company, its owners, or another subsidiary. The worst-case scenario is that the holding company suffers a capital loss and a hit to its net worth.

If a company has multiple types of assets, each major asset can be owned by a separate operating entity. To take our sand-and-gravel business a step farther, separate subsidiaries might exist for the basic business and its underlying real estate, front-end loaders, screening infrastructure, delivery trucks, and intellectual property (proprietary processes, logos, etc.).

Another structuring option is for the holding company to own the major assets used by each subsidiary and to lease them back. If a judgment is entered against a subsidiary, it would own few, if any, vulnerable assets that the plaintiff or creditor could pursue.

Also, as Investopedia points out, holding companies also make it easier to escape unfavorable changes in state tax policies. If your current state imposes higher business taxes, the holding company can relocate to a more business-friendly environment while continuing operations in the original jurisdiction.

Drawbacks. The asset protection benefits should be weighed against a variety of potential drawbacks. The Investopedia article points out multiple considerations, including these:

• entity formation and ongoing compliance costs (we should also mention the burden of Corporate Transparency Act reporting requirements for each entity);
• greater organizational complexity (the use of holding companies and subsidiaries adds a degree of difficulty not found in a single-entity structure); and
• roadblocks to business growth (investors and lenders might find it more difficult to assess the financial health of the enterprise).

Conclusion. As is the case with most legal strategies, the holding company option should be evaluated in the context of your specific situation and business and legal objectives.

An experienced business or asset protection attorney can explain to you the major considerations and describe your options in creating a multi-entity ownership structure that will best preserve your major assets against a future legal threat.