What are the challenges faced by family businesses?
At first, a successful family business grows organically: its revenues increase gradually, its profits multiply, the number of its employees increases, and it accumulates more and more assets of significant value. In many cases, growth has the side effect that processes tailored to the initial smaller company size can no longer function properly, managing central back-office tasks becomes a challenge, and keeping all of the processes under one roof turns out to be increasingly difficult. There may also be a need to expand the business portfolio, to exploit new investment opportunities, or to establish or acquire new business units, all of which will necessarily result in a more complex organisation and operation.
This is the point when businesses should rethink their structure and optimise their organisation. A carefully designed holding structure not only facilitates the cost-effective implementation of day-to-day management processes, but also plays a significant role in asset protection and tax optimisation.
Features and types of holding companies
A holding company is essentially a company (usually a limited liability company or a company limited by shares) which exercises ownership rights, management and control over the companies in the group, and may also perform central functions, but is typically not engaged in operational activities.
In practice, holding companies occupy a place in the company structure between the operating company(ies) and their private owner(s). This means that holding companies own the shares of the company(ies) carrying out the operating activity (perhaps providing centralised services to the members of the group),while the beneficial owner(s) (individuals or family members) acquire ownership of the holding company, making them the indirect owners of the operating companies.
- Pure or passive holding company: in this case, the holding company "only" performs ownership functions and central management functions.
- Mixed or active holding company: a company that is engaged in separate activities (typically management services) in addition to performing ownership functions.
It is worth pointing out that the above distinction is primarily relevant in terms of the deductibility of value added tax arising in connection with the operations of holding companies.
In special cases, other entities could perform the functions of a holding company: fiduciary trusts or even trust funds could also potentially operate as holding companies.
What are the benefits of a holding structure?
Asset protection and holding companies
A successful business often owns a significant portfolio of assets. Some of these assets are associated with the operating activity: these may include valuable real estate or assets, machinery and intellectual property. Additionally, there may be assets that are not directly linked to the income-generating activity, such as other capital market or real estate investments acquired using retained earnings, additional shares in businesses, etc.
The risk lies in the fact that the risks inherent in the operation of the company, i.e. the liability and possible legal obligations associated with the operational activity, can be enforced against all of the assets of the operating company, that is, against the previously generated and accumulated assets or cash. This may involve, for example, liability under a warranty or guarantee, liability for damages, other adverse legal consequences for breach of contract, or the assessment of a significant amount of tax.
However, by integrating a holding company into a group of companies, significant assets and the accumulated profits generated through them can be separated from the risks and liabilities of the operating companies. Furthermore, liability is split among the operating companies, with the liability of each operating company being limited to the value of its own assets.
The reason why this is relevant is that owners often decide not to pay out the majority of the profits generated as dividends to avoid taxes levied on individuals, which, in the absence of a holding structure, means that the profits of previous years can easily be lost as a result of an ill-fated transaction.
By outsourcing real estate, high-value machinery and vehicle fleets, real estate management and asset management companies can also be set up within the structure, which can continue to provide the assets and intellectual property necessary for the day-to-day operation of the operating company in exchange for a rental fee and, as a result, these assets will no longer be subject to the risks inherent in day-to-day operations.
Therefore, under normal circumstances, the use of a holding structure provides adequate protection in most situations to ensure that a mistake or a dispute with a partner doesn't wipe out the entire business that took so much effort to build and doesn't cause sleepless nights for business owners.
This way, the company's owners never run the risk of losing all of their personal wealth held in the operating company. Of course, risks can also be mitigated through other legal instruments, such as a contractual limitation of liability clause for operating activities and liability insurance for the activity.
Favourable taxation for holding companies and tax advantages for business owners
A major benefit of setting up a holding structure is that the profits generated by the operating companies can be paid out to the holding company in the form of tax-exempt dividends. This allows further investments to be made without incurring tax liabilities at the level of the private owners. At the same time, dividends paid to the holding company are no longer affected by the risks associated with the operating activity. Of course, whenever necessary to satisfy the personal needs of the private owners, dividends can also be paid out through the holding company; however, in this case, the private owners will be liable to tax.
Holding companies are tax-efficient arrangements not only in terms of annual dividends, but also in cases where the owners are planning to sell an operating company.
This is because the capitals gains on the sale of a subsidiary will also be tax-exempt for the holding company, provided that certain conditions are met. In contrast, if a business is sold by a private owner, deferring taxes on the income generated through the exit is not an option, and such income is immediately taxable.
This is why startup owners should also consider setting up a holding structure before an upcoming exit.
If the number of intra-group transactions is high, opting for group taxation for corporate income tax and VAT purposes may be something to consider. With group taxation, administrative burdens can be reduced significantly and considerable cost savings and tax savings can be achieved, but not in all cases, so such a decision requires careful planning.
Centralised functions of the holding company
The holding structure also allows certain back-office functions such as accounting, payroll, HR, marketing, IT, finance, controlling, administrative services and some areas of procurement to be centralised.
In line with the above, the holding company can also play a central (re)financing role. Also, the profits generated by one operating company can be channelled to another operating company more easily. By doing so, the resources available within the group can be allocated in a flexible manner to the entity where such resources are required at the time, either temporarily (e.g. as a loan or additional capital contribution) or permanently (through a capital increase).
The centralisation of management services not only allows for intra-group financing, but also promotes a more efficient organisation of work. This facilitates uniform reporting and administrative procedures within the group, which greatly assists in managerial decision-making.
However, it is important to underline that services provided to members of the group should be accounted for at arm's length prices, with intra-group transfer pricing being an area of particular focus for the tax authority. Accordingly, the services provided to members of the group will generate income and profits for the holding company, so the payment of dividends might still be possible even if the operating activity is loss-making, and the holding company will also be eligible for VAT deduction, given the ongoing taxable operation.
More favourable commercial position
The use of a holding structure projects a professional image to partners and conveys the message that the business owner has a clear plan for operating its businesses. By concluding favourable framework agreements, the group may become eligible for special discounts and may also be able to make centralised purchases on more favourable terms (such as the procurement of IT assets or vehicle fleets, or the purchase of security or cleaning services).
Holding companies are also useful when the business is sold
The benefit of using a holding structure is that operating units within a group which are capable of carrying out separate economic activities independently (from an organisational perspective) on a permanent basis can be organised into separate operating companies. In addition to the liability management aspect, another reason why this has relevance is that, in many cases, the owner may wish to include only a specific part of the existing company in a transaction. This may be justified by reasons involving internal reorganisation, carve-out objectives or divestment considerations.
FIND OUT MORE ABOUT OPPORTUNITIES FOR SELLING A BUSINESS
Such a transaction may also be accomplished through a demerger or a business transfer, but these options are typically more costly and time-consuming than the conventional sale of a business. Therefore, plans should be made in advance to sell a particular business unit quickly and easily and in a favourable tax environment by organising certain businesses into separate companies or, in the case of a purchase rather than a sale, to facilitate the integration of a business acquired through an acquisition into an existing structure.
Share-based benefits provided to key employees within the holding company
The holding structure enables key employees to receive share-based benefits in the business unit (at the given operating company) where they actually work, both as a reward and for motivational purposes. This allows the share of profits to be differentiated, and employees are not compensated for the performance of the part of the entire operation for which they are not responsible. In line with the paragraph on preparing for the sale of a business, a holding arrangement also facilitates the execution of the management buyout of a business.
Relationship between holding companies and family wealth management
One of the major risks to the operation of a company is the chief executive becoming incapacitated or an unexpected death, which is a particularly serious risk factor for family businesses. A holding company is also suitable for ensuring business continuity in such an unforeseen event,
the reason being that, if the head of family is not the only person authorised by the management of the holding company to represent the holding company (as the founder of the operating companies),the financial statements of the operating companies can be approved and directors of the operating companies can be appointed even during a probate procedure lasting several years. Regulating decision-making powers and preferential rights (e.g. voting or dividend preference and veto rights) within the holding company also provides an opportunity for the parties to settle family matters in more detail, for example depending on whether a given family member works at the company or only has an interest in the profitability of the company as an owner. Accordingly, family members may, either in the deed of foundation of the holding company or in a separate syndicate agreement, agree on a long-term vision for the company, the circumstances in which they agree to sell a business or launch a major development project, the rights and obligations each person has and the financing requirements each person is subject to, the restrictions that apply to the transfer of shares, and the mechanism that is used in the event of a deadlock, i.e. in cases where family members are unable to reach a majority or unanimous decision on a critical issue.
FIND OUT MORE ABOUT FAMILY WEALTH PLANNING
At the same time, it is worth pointing out in this regard that, in order to create a truly bespoke system that also manages inheritance and matrimonial property matters in a sophisticated manner, setting up other structures (such as a fiduciary trust) in addition to the holding arrangement is also advisable. Certain situations can be managed more effectively if the holding structure is complemented by, for instance, a fiduciary trust.
Is it worth setting up a holding company?
Establishing a holding company is simple, inexpensive and can be quickly executed, essentially by setting up a limited liability company or a company limited by shares.
However, designing the holding structure itself, incorporating existing companies into a holding structure and transforming the company structure require careful tax planning. In order to ensure that the transactions necessary to set up the structure take place in the most favourable tax environment and that the structure serves the long-term objectives of the owners, particularly if the owners plan to incorporate foreign companies into the holding structure, a complex review is required.
The legal aspects of the group's operations should also be carefully planned out to allow the group to take full advantage of all of the benefits listed above.
The cost of maintaining a holding arrangement depends on the complexity of the company structure: if the holding company exercises only ownership rights (management and control),then no additional employees are required and there is minimal extra cost, while enjoying the substantial benefits outlined above. Higher maintenance costs are to be expected in the case of an active holding company; however, even this option does not necessarily entail significant additional costs, given that the services performed as central functions (legal, accounting, tax, controlling, etc.) are essentially taken over from the operating companies, which means that only the accounting and the breakdown of the costs will actually change. So, in general, the benefits offered by holding arrangements easily outweigh the costs of maintaining them.
The legal aspects of the group's operations should also be carefully planned out to allow the group to take full advantage of all of the benefits listed above. If a change in legal form, a merger or a demerger is required due to a change in company structure, then most companies are advised to adopt the necessary decisions in the period when the annual financial statements are approved as this will allow the balance sheet of the financial statements to be used for such transformation.
