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Holding Companies Explained- Protect assets and enable tax strategies.

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hey guys it's uh david david barnett

from davidcbarnett.com the blog site

youtube channel itunes soundcloud google

play

amazon podcast where i talk about buying

selling financing and managing small

medium-sized businesses

this week we're talking about holding

companies i got a bunch of questions

from people

asking about holding companies what

they're for how they work

if there are any like serious you know

tax advantages or other real perks to

why someone would want to have

a holding company whatever the heck that

is so

i decided to put together a little

powerpoint presentation because it can

be easier to understand

when you can see it and i'll do as good

a job as i can describing

what i've got on the screen for those of

you that listen in the audio stream

let me share my screen we'll head right

over here so

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as you can see the very first thing i'd

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look

very first beginning someone gets into

business so

on the screen here it just says person

in business and there's a sole

proprietorship

and that's simply me doing business in

my own name

and any attorney out there would tell

you that this is risky because if

i do something wrong and someone sues me

all my personal assets

are exposed to

anyone who sues me because there's no

legal difference between the business

i'm conducting

and my own personal affairs and so

at the very start what most people will

do when they're getting into business

is they will create some sort of limited

liability business entity

and i'm leaving it as a broad term like

that because depending on where you live

in the world

uh these could have different names so

common names would be a corporation

or an llc or some kind of limited

partnership etc

it's a a legal entity so under the law

it's a person unto itself it can sign

its own contracts

and there's a division between what goes

on in that business

and you personally as the owner so if

something were to happen in the business

somebody enters your premises they slip

and fall there's a lawsuit for example

that business could be found culpable

and the assets

et cetera in that business could be at

risk of being lost in that lawsuit for

example

but if it's set up properly that's where

the liability ends

if you owned your own house for example

or a cottage or a sailboat or something

then the the person who has a problem

with your business

won't be able to come up and take your

personal assets

now a little disclaimer

there are issues and things that happen

within business that do become affairs

that

are the responsibility of the owner what

we call directors

directors liabilities and and things

like this um

often to do with taxes and if if a

limited liability entity is not set up

properly then they

the good attorney for someone

prosecuting you

could uh or someone suing you could with

what they call pierce the corporate veil

which is a way to get around someone's

company so

it's important to get proper advice from

you know qualified people when you're

going to be setting these things up

so this is this is the level that most

people get to and they never go beyond

this

within this operating company this

limited liability entity they've got

assets and liabilities the equity that

they own in the business

there's business activity going on in

here employees customers payables

receivables inventory this is where we

do

business okay think about any business

basically describes it

and we refer to this as an operating

company because it does

stuff now in the beginning

if you owned a bunch of expensive

equipment for example in your business

and you borrowed money from the bank

there's really no risk that your assets

could be lost because the bank will have

a lien on those assets that

to hold them as collateral so if someone

sued the company

that person suing the company couldn't

necessarily take the equipment because

the bank is ahead of them in line

they've got a legal

um you know entitlement to those assets

because of the debt that you owe to the

bank

as time moves on and you pay off that

bank loan for example

now you've got assets in the business

which are worth something which may not

necessarily be encumbered with any kind

of direct debt

that's when we start to have a greater

degree of risk

again in something like a lawsuit for

example

so this is when we're going to start

seeing the first instance of what

what we're going to refer to as a

holding company so

here i've got the owners in the blue box

and below them in the purple box is the

limited liability entity

and then there's a separate box here

which is a business entity

notice i removed the term limited

liability because we may or may not want

to use a limited liability entity to be

a holding company

it depends on what the strategy is what

the purpose is

here's why sometimes we might have a

holding company

that has losses in it and we may want to

move those losses

upstream to the entity above it whether

that's the individual owner

or some other entity as we're going to

see shortly and so

it takes planning and strategy to figure

out what are the ultimate goals

in creating these different corporate

setups

what i'm going to show you here today is

something that someone would do for

example to protect assets in the case of

being sued so we've got our operating

company

and we have a business entity which has

important assets only as it says there

and so i'll give you an example i've got

a friend of mine here locally he's in

the construction industry

the construction business only owns a

few pickup trucks and some other minor

pieces of equipment

all of the other major items of

equipment that they own the biggest

pieces of equipment are held in a

holding company

and are leased to the construction

company

why in case something were to ever

happen heaven forbid you know an

accident involving someone getting hurt

or something like that

the the ability of somebody to sue that

operating company

is there but they wouldn't be able to

get hold of those assets because those

assets the equipment they belong to

another company

that operating company is simply leasing

them so

it would be like if i was renting a car

and somebody tried to sue me they

couldn't take the car because it's not

my property

belongs to the car rental company right

and so

this is what happens as entities get

bigger

if it's a successful business we want to

take these important assets and move

them into separate legal entities

to separate them so that they're not

available to someone who might come

after

the operating business now how do you

get the

assets from an operating company into a

holding company

without for example triggering a capital

gain or some kind of tax bill

those questions are going to be answered

by your cpa and so

you have to figure out number one what

is my goal in this

so there's legal stuff there can also be

financial stuff that you want to achieve

through reorganizing into

you know using holding companies and

stuff and this is why you need to have

advisors that are expert on this

on this kind of thing who can give you

advice

i would just i would love to remind

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all right so what then is the next

iteration or

evolution beyond the owners owning an

operating company and a holding company

well

you might want to add another layer

between the two

and so in this example we have the

owners who own

the shares of a sharehold co

which is simply a holding company which

owns the shares or ownership interest

in other companies in this case the

operating company

and the holding company now why would

you have this kind of setup

this kind of setup adds another layer of

protection or separation between the

operations of the business and the

ultimate owners

you know at the very top who are

ultimately going to benefit from the the

corporate and the business enterprise um

but if you get into a situation where

you have

multiple uh holding companies and

multiple operating companies

a structure like this can make it more

efficient

from a tax strategy perspective to move

resources between these different

entities

and really the sky's the limit as you

can see from this next slide we've got

the owners only

owning a shareco and then we have the

shareco owning

you know one two three different

operating companies then we have one of

the operating companies owning another

operating company over in jamaica

and we've got four different asset

company

asset uh holdcodes and you can see here

one of the asset hold codes actually has

some other shareholders involved in it

and so

really you can you can get involved in a

very very complex

corporate structure through having all

these different kinds of things

big companies will do this for things

like joint ventures they might open a

new entity a new opco

and own part of it with another company

then they're both contributing something

for a mutual gain what is the downside

to creating a very complex corporate

structure like this well

every one of these entities is is an

entity that probably has to file a tax

return

every one of them has to have a minute

book every one of them has to

have regular maintenance and it's not

free and so

this is why people often only get into

this once they've

gotten their enterprise up to a level

where they feel that

there's there's really something to

protect there you can also

use different structures like this to

make

it easier for you to exit for example so

oftentimes i'll have a business seller

that i'm talking to

who wants to sell their business and the

business owns the business

operations affairs but it also owns the

piece of real estate

well they might find a buyer who can't

afford to buy them both

and so they might end up agreeing to a

deal where they sell

the operations of the business maybe in

an asset sale and they keep the legal

entity which owns the building

and they become the landlord of the

buyer if they had structured it such

that there was an

a holding company owning the building

which was leasing to an operating

company

then they would have a much easier time

selling either the assets or the shares

of the operating company

without having to worry about how to

move the building into another entity it

would already be in another entity

and so in that scenario those people

would be set up already

in order to easily sell the operations

while continuing to be the landlord

and then enjoy some income from

collecting rent maybe

for a few years down the road until they

sell the building to somebody else

so so these are just some of the ideas

that you can get involved in

with a holding company and

there are also some tax strategies that

i mentioned before

so for example if you can imagine a an

asset holding company which has a big

piece of equipment

there might be a depreciation schedule

that

is a declining balance depreciation

maybe 30 a year

if that holdco is leasing the piece of

equipment to an operating company

for a set amount per month over many

years for example whatever the the

contract agreement is

that holdco may have financial losses

in the beginning because of the

depreciation and if those losses can be

moved up to a parent for example then

there could be

some tax strategies at play eventually

it's it's not tax avoidance it's tax

deferral

because eventually that's going to play

in the opposite direction once the

depreciation expenses go lower every

year

soon that lease income is going to

exceed

the the expenses of the depreciation and

then the

the hold co is going to start to have

profitability and so

again this is complex stuff you need a

proper team of advisors

cpas and attorneys who have been

involved in this kind of thing before

and can give you some advice

it's not cheap which is why again we

only see this kind of thing as companies

really grow and become successful

if you are interested in learning how to

buy an existing business that already

has customers profits and cash flow

in a risk-reduced way under realistic

scenarios that happen

all the time out there in the real world

then you should be heading over to

businessbuyeradvantage.com

that's where you will find an

illustration of how i help people buy

businesses

i've been in this business now for over

a decade helping people buy and sell

businesses

the online course is over 12 hours of

content

and i recently added new modules about

buying a business during a recession

how covid will impact the marketplace

and

on buying distressed businesses so you

can learn more over at

businessbuyeradvantage.com

and if you want even more of my help

beyond the online course

i do a group coaching program and i'm

available for 101 consulting

consulting to help you buy the business

of your dreams

and with that i'll say see you later

it's been a pleasure

and don't forget hit like really helps

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cheers