Business structuring is one of the most important decisions you will make when establishing your business. Provided you have already chosen to operate your business through a company structure, you may now also be considering adopting a dual company structure. This structure involves a minimum of two companies: a holding company and an operating company. The holding company holds the valuable assets of the business whereas the operating company is usually wholly owned by the holding company. This article will outline the suitability of a holding company for your business as well as the benefits and drawbacks of incorporating a holding company.
Before buying a business, it is important to undertake due diligence, to verify the information supplied by the seller. This guide will walk you through the due diligence process.
What Is a Holding Company?
A dual company structure consists of a holding company and an operating company. Section 46 of the Corporations Act defines a holding company as an entity that controls the composition of the operating company’s board of directors, more than half of the operating company’s shares, or voting power at general meetings.
Rather than undertaking any operational or business activities, the holding company is incorporated to hold the valuable assets of the business on behalf of the corporate group. As such, the holding company protects these major assets from liability, for example:
- intellectual property; and
- excess cash.
By separating your business’s assets from its operations, you mitigate the risk should any subsidiary encounter financial or legal challenges.
Additionally, the operating company sits below the holding company and is incorporated to carry out business activities like entering into contracts with customers and employees. In the scenario where a customer sues the business, they will have to sue the company with which they have a legal relationship (i.e., the operating company).
Moreover, an operating company will hold fewer assets, meaning that assets that are owned by a holding company may be protected if something goes wrong.
Is a Holding Company the Right Choice for My Business?
Some types of businesses will benefit more than others from using this company structure. A dual company structure may be a good choice if your business has any of the features outlined below.
Valuable Intellectual Property
If your business owns valuable and important intellectual property, setting up an IP holding company may help to protect these assets from the operating company’s trading risks. Your IP could include:
- trademarks;
- patents;
- branding; or
- copyright.
If you have multiple companies that share the same IP, having a holding company centralises the ownership of these assets. This can help to minimise risks.
Trade Risk
Certain businesses involve higher risks than others. This may be the case if your business enters into high-value contracts with third parties or operates in a heavily regulated industry.
Establishing a holding company can ensure that any valuable assets remain largely unaffected by your business’ trading risks.
Investment
A dual company structure is a good business structure if you are hoping to find external investment. Typically, investors prefer to invest in this type of company because it ensures that their investment is held separately from the operating company’s trading risk. This means that external investors can help to grow your business with greater security for their investment.
Sophisticated investors can provide crucial capital to help grow your business. Therefore, it can be attractive to offer these investors greater security for their investment through a dual company structure.
Continue reading this article below the formWhat Are the Benefits of Setting Up a Holding Company?
Asset Protection
As discussed above, setting up a holding company allows you to separate your business’ valuable assets from the responsibilities of the operating company. This means that these assets are protected from creditors if the operating company begins to perform poorly, incurs liabilities or becomes insolvent.
In most circumstances, holding all valuable assets in a separate legal entity minimises the risk of losing these assets to repay debts.
Centralised Control and Ownership
In a typical dual company structure, the directors of the holding company will also control the operating company. This can make business operations easier to manage and boost performance and growth.
A centralised board also allows the company to keep running even if key personnel leave the operating company.
What Are the Potential Drawbacks of Setting Up a Holding Company?
Additional Fees and Costs of Setting Up a Holding Company
To set up a holding company, you will need to incorporate an additional company. This means that you will face additional set-up and maintenance costs as well as reporting requirements from ASIC. This is something that you will need to consider because operating two businesses may not be in your best financial interests.
For reporting purposes with ASIC and the ATO, if your company structure meets the requirements under the relevant accounting standards, you may be eligible to submit one consolidated financial statement and corporate tax returns for all of your entities. This will assist you in streamlining the requirements and may make the reporting obligations more manageable.
We recommend speaking with our Tax Team who will be able to assist you with determining your company’s eligibility.
Legal Documents
You will also need additional legal documents to facilitate a dual company structure.
You should ensure that any legal documents you need are carefully and correctly drafted.
Liability
Although a holding company typically provides separation and protection of your assets, it may still be held responsible for the actions of its operating company in certain circumstances.
This means that you may not always be able to rely on your holding company to protect your business assets.
Key Takeaways
If you are establishing a company, setting up a holding company may be a good idea. Before you commit to this company structure, you should think carefully about the nature of your business. A holding company may be useful if your business:
- owns valuable assets (such as intellectual property);
- plans to seek investment; or
- is more susceptible to risk.
If you have any questions about structuring your business, our experienced business lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
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