If you’re an entrepreneur or director of a small business, I’m sure you’ve heard about setting up a holding company to reduce risk and minimise tax while your business grows.
Many people end up setting up holding companies for the protection it offers, but it’s worth noting that there are limits to that protection.
For example, holding companies don’t always offer protection from debts incurred by subsidiary companies.
So, before setting up a holding company, you’ll need to understand how it works and what some of the pitfalls are.
The benefits of creating this type of business entity can be huge if done correctly. But even with all these perks in mind, there are also possible drawbacks that might cause problems down the line.
Here’s what you need to know.
- 1 What Is a Holding Company?
- 2 What are the Advantages of Setting Up a Holding Company?
- 3 Do Holding Companies Have Any Disadvantages?
- 4 Key Takeaways
What Is a Holding Company?
Business owners typically set up holding companies to buy and hold all the shares and assets in one or more of their subsidiary companies.
The purpose of a holding company is not to carry out day-to-day business activities such as producing goods or services and simply setting up to own the shares in the subsidiary company.
So, the holding company has a controlling interest in the subsidiary company and its assets; while the subsidiary company:
- hires employees;
- undertakes operational activities;
- enters into contracts; and
- bears liability.
This means that the wholly-owned subsidiary company can also be referred to as the operating company.
Holding companies are similarly referred to as the parent company of the operating companies.
Company H, the parent holding company, owns Company S (the operating company).
So, Company H is the holding company, and Company S is its subsidiary.
Susan enters into a contractual relationship with Company S. If Company S were to be in breach of its contract with Susan, she could only sue Company S because that is the company she has a legal relationship with.
The significance of that is that the assets held by Company H (the holding company) will be protected from Susan’s lawsuit.
When a business grows larger and starts to diversify, it’s common for business owners to set up a holding company for protection.
This is because the holding company can provide more significant safeguards against risks while also streamlining operations on behalf of your growing business.
What are the Advantages of Setting Up a Holding Company?
There are various ways having a holding company can benefit you as a business owner.
1. Asset Protection
When establishing a holding company, the general objective is to have all the assets transferred to that company.
This way, as with the example of Company H and Company S, the operating company can continue its business operations without exposing valuable assets to potential creditor claims or other liability risks.
So, essentially, you can separate your business assets from the management and obligations of one or more other companies, which minimises the risk of losing your valuable assets to repay debts.
2. Tax Benefits
Setting up a holding company can allow you to structure your companies in a manner that will enable you to minimise the amount of tax your business is liable to pay.
Some business owners even set up their holding companies in other countries that propose lower tax rates.
Your small business can save considerable amounts of tax each year by implementing effective tax minimisation strategies with your holding company. However, consider seeking professional advice on the one – especially if you’re thinking of establishing your holding company in another country.
3. Diversification and Development With Reduced Risk
With your business’s valuable assets held in the holding company, the subsidiary company will have a lot more freedom to diversify and develop to grow the business without risk to the business assets.
For example, the subsidiary can invest in new and more significant projects.
4. Centralised Management Structure
The holding company directors usually manage and control the different subsidiary companies, especially in circumstances where the holding company holds a controlling interest in the subsidiary company.
Having centralised corporate control creates a streamlined management structure that allows for maximum growth and performance.
For example, having a holding company can boost the subsidiary’s credit standing when applying for finance.
Do Holding Companies Have Any Disadvantages?
As with any business structure, you must consider the benefits and the potential pitfalls.
A holding company won’t necessarily work for all business owners, so it’s worth considering the potential pitfalls as well.
1. Potential Liability
Although a holding company can provide a form of asset protection and reduced risk because its subsidiary establishes a separate legal relationship with its clients, customers and creditors – liability can extend to the holding company in certain instances.
So, the protection of assets held by the holding company is limited.
The most common circumstance where the subsidiary company’s liability extends to the holding company is where one or more of the directors were aware of potential insolvency but allowed the operating company to continue trading anyway.
It’s the responsibility of the holding company board of directors to keep track of the subsidiary’s financial status.
2. Administration Complexities
You’ll end up with two or more companies under one umbrella – a holding company and its subsidiaries – which means that all of the usual red tapes will be doubled.
For example, you’ll need to cover additional set-up and maintenance costs from the Australian Securities and investments Commission (ASIC).
So make sure you’re prepared for the extra paperwork and administrative duties.
If your business is fast-growing and exposed to greater risk, you may want to consider establishing a holding company.
The most significant benefit of utilising a dual structure for your company (in other words, having a holding company own your operating companies) is the protection of your assets.
For example, suppose your business owns valuable intellectual property or your asset portfolio is growing, and your business involves high-risk trading. In that case, a holding company could reduce the risk of losing your assets if something goes wrong.
Holding companies also provide:
- tax minimisation strategies;
- centralised control; and
- the ability to develop and diversify your company investments with reduced risk of insolvency.
However, asset protection is limited, so the holding company directors must closely monitor the financial status of the subsidiaries.
So, there are a few considerations you need to take into account before establishing whether a holding company is a good fit for your business.
Seeking professional advice on commitments that could affect your company’s structure is an integral part of the decision-making process.
To find out how Box Advisory Services can help you with your holding company queries, book a free consultation with us today!