“How do I protect my business?”
An ever-present, complex, and constantly evolving question for business owners of all kinds.
Two things make this question particularly tricky. One, there’s no single, simple way protect your business. If you see anyone offering to eliminate legal risk and protect your business with “Lawyers Hate This One Simple Trick”, don’t engage. Whether it’s presented on the golf course, at the networking event, or on social media, they’re fibbing.
Two, there’s no finish line to cross, no final boss, no game point or target score where you know the objective has been finally and definitively achieved. Instead, protecting your business from risk is a constant, ever-evolving puzzle.
But that’s why you make the big bucks. You’re the one who solves this. And that’s why Team Way Law exists. To help you do this. Today, we’re exploring an important asset protection and risk management strategy: the holding company.
And by the end, we’ll have the beginnings of “One Simple Trick” lawyers love for their clients, among many.
We begin by defining what holding companies are, the various types, and their organizational structure. Next month, we’ll dive into the benefits and drawbacks, helping you determine whether one makes sense for your situation.
Holding Companies Explained, Generally
Risk management and asset protection are complex, but a holding company rests on a delightfully simple premise. Owning a thing is an inherently low-risk activity. Using a thing is a high-risk activity. So, if we want to protect our assets and our business’s use of those assets, we should separate low risk activities from high-risk activities.
This is the holding company’s purpose. A holding company separates ownership of something from use of something.
A holding company is a business entity that doesn’t do much “business” itself. Instead, it owns things, a low-risk activity. These things may be ownership interests in other companies that use assets to do things (your operating companies). Or they may be assets like intellectual property or equipment used in your operations.
Your operating company, on the other hand, is where the action happens. It engages in the high-risk activity of using things. It’s the business that signs contracts with customers, hires employees, manufactures products, delivers services, and generates revenue.
Why Does a Holding Company Work?
A holding company strategy may sound too good to be true. Why would two related businesses be treated separately for liability purposes? The reason is simple. Why are you not responsible for my actions, and I’m not responsible for yours? We are two separate people. We have no ability to control each other, and we act independently of each other and in our own separate interests. I have no connection to the actions you take, nor you to mine. We are independent of each other.
The key to holding companies is structuring the entities’ independence properly. The entities must act in their own separate business interests, not exercise certain control or influence over each another, and deal with each other in arm’s length fashion. The entities must act towards each other in generally the same way that other unrelated businesses do.
When we properly observe these principles, liability belongs to the entity engaging in business activity. It does not spread to unrelated entities. The key is managing the relationship between the entities so that the holding company remains unrelated. This is where your lawyer is essential.
Types of Holding Companies
Not all holding companies are built the same. Understanding the different types can help you figure out what structure might work best for your situation. Note, this is an introduction, not an exhaustive list. This can get very nuanced and blended.
Parent-Subsidiary Holding Companies
A parent-subsidiary holding company exists solely to own other businesses. It doesn’t manufacture anything, sell anything, or provide services to customers. Its only job is holding and managing ownership interests in subsidiaries. Clean, simple, and focused.
One popular use case for a parent-subsidiary structure is to insulate multiple lines of business from each other. Where you operate multiple lines of business, a parent-subsidiary structure protects assets and operations by siloing the risk associated with one line of business away from the others. This way if there is a claim against one, that claim does not affect the others.
This type of holding company setup is incredibly common. Alphabet Inc. is the parent company of Google and other subsidiaries. Meta Platforms, Inc. is the parent company of Instagram, WhatsApp, and several Facebook entities. Johnson & Johnson is the parent of many subsidiaries.
In each case, the structure and goal are similar. The parent owns equity of the subsidiaries, allowing it to manage the operations of several different lines of business through control over the appointment of directors and officers to run those businesses. Simultaneously, risk associated with those lines of business remains walled off within the separate business entity each line of business corresponds to.
Asset Holding Companies
An asset holding company owns assets used by operating companies. It may be a subsidiary of a common parent. It may be a brother-sister entity situation, where the same individual owner (you) owns both a holding company and one or more operating companies.
An asset holding company typically leases or licenses the use of an asset to an operating company for use in its operations. The operating company then creates revenue using this asset, while the asset itself is protected from being subject to potential claims of the operating company’s customers and vendors.
Asset holding companies are also incredibly common. Any time a valuable asset will be used in a potentially risky business operation (i.e., most business operations), an asset holding company may be a useful risk management strategy. For example, owning intellectual property like a trademark or copyright is a low-risk activity. It requires some upkeep, but doesn’t involve working with others, and non-infringing IP doesn’t harm anyone. But using that intellectual property to operate a coffee shop with multiple locations or an amusement park might be very high risk indeed. Now there are customers who are owed a duty of care or other obligations with liability for breach or other harm if those aren’t met, lenders that are creditors of the business, employees that are owed compensation and regulatory compliance, and more.
Owning real estate is relatively low risk, but using it to provide office space or residential space involves contractual obligations, regulatory requirements, and maintenance involving vendors and other parties. There are many points where something could go wrong and a liability created, where there is no liability from the simple act of owning something.
An asset holding company allows a common owner (you) to both own a thing and then license or lease that thing to an operating company for use to create revenue. The operations and risks associated with them stay with the operating company. This keeps your revenue producing asset safe because by not doing business activity with anyone, no one has a claim against the holding company or your valuable asset.
What’s Next?
Now that you understand what holding companies are and how they’re structured, the real question is: should you have one? Next month, we’ll dig into the specific advantages (asset protection, tax benefits, privacy, simplified ownership) and the disadvantages (cost, complexity, corporate veil risks) to help you make that call.
But in the meantime, if you have multiple lines of business or valuable assets that you use to create value, a holding company could benefit you tremendously. Let Team Way Law help you explore your options for keeping your business safe.