Holding Company vs Operating Company: What's the Difference?
A business can be structured in many different ways (read more about the types of legal forms of a business here). In the end, it all comes down to business goals. For example, if we have two real estate agencies, both can have different structures based on business goals.
A dual company structure is one where there is a holding company (which we’ll call "HOLDCO") and an operating company (which we'll call "OPCO"). Both the HOLDCO and OPCO are corporations, but they are used for different purposes. Understanding the difference between a HOLDCO and OPCO is essential in determining whether this structure may be suitable for your business.
What is an Operating Company?
An OPCO is a corporation that directly manages the company and is responsible for day-to-day operations. The HOLDCO owns 100% of the shares of OPCO, making it a wholly owned subsidiary.
What is a Holding Company?
A HOLDCO is an inactive corporation - meaning it doesn’t engage in any business. Instead, it owns the assets that the OPCO uses to operate the business - stock, equipment, real estate, and intellectual property. Holding companies help limit liability by splitting the assets from the operating company.
For example, Alice owns a restaurant and wants to set up a dual company structure. In this case, Alice will own 100% of the shares in HOLDCO. In turn, HOLDCO will own all the assets of the restaurant - the tables, chairs, stoves, fridges, computers - and it will own all the shares of OPCO. In terms of directors and officers, Alice will be the director and officer of both HOLDCO and OPCO.
Now, let's say Alice and Marie own the restaurant together. In a dual-company structure, Alice and Marie would be the shareholders of the HOLDCO, and in turn the holding company would own 100% of the shares in OPCO. In this case, both Alice and Marie would be the directors and officers of HOLDCO and OPCO.
Next, we can go even further. Alice and Marie can own the restaurant together through their own holding companies. Alice would be the sole shareholder, director, and officer of HOLDCO A and Marie the sole shareholder, director, and officer of HOLDCO B. In this case, HOLDCO A and HOLDCO B would each own 50% of the shares in OPCO.
Benefits of a Holding Company
There are various reasons and benefits of operating through a dual company structure. One is the enhanced asset protection granted by splitting the assets and liabilities in two two separate companies. Another is the possibility of transferring dividends tax-free from OPCO to HOLDCO, so that the shareholder does not have to report dividends as personal income.
Enhanced Asset Protection
By using a dual company structure, you can have additional safeguards against risks. The HOLDCO generally owns the valuable assets of the company, including:
IP and trademarks;
Property such as buildings
Meanwhile, the OPCO takes on the liabilities of running a business, including contracts with customers/clients and those with suppliers or vendors. So if the business becomes insolvent, or is performing poorly you can rest assured that the risk of losing assets is minimised. Only those assets owned by OPCO will be at risk if a claim is made against the business.
A Tax-Free Transfer of Dividends
This dual company structure allows you to limit personal income taxes. This is especially useful where there are many shareholders in an OPCO. By using a HOLDCO, the OPCO can distribute dividends when it is beneficial for the business. These dividends are transferred to the HOLDCO tax-free. By doing so, the shareholders will not receive OPCO’s dividends as personal income. Instead, they can decide when they want to use their dividends as personal income and how much of the dividend they will include in their personal income.
Additionally, as the dividend is transferred to the HOLDCO tax-free, shareholders have access to a much larger sum of money to invest. If there is no HOLDCO, then the shareholder will receive the dividend as personal income, pay taxes on it, and only be able to invest the after-tax money.
Disadvantages of a Holding Company
An OPCO and HOLDCO structure can help separate risk, and streamline operations. However, this structure requires more paperwork and can be more expensive to maintain. Therefore, businesses should carefully consider the added costs associated with incorporating an OPCO and HOLDCO in order to determine if the potential benefits are worth it. While the advantages of an OPCO and HOLDCO structure may outweigh the added costs, businesses should be mindful of the time and money associated with the setup and ongoing maintenance of this corporate structure.
On-going Maintenance Costs
A HOLDCO and an OPCO are two separate entities, which means they are both responsible for their own annual obligations. This includes filing separate corporate tax returns, maintaining separate corporate registry information, and covering the costs associated with the bookkeeping for both companies. Having two separate entities requires more work and can be more expensive because of the additional costs associated with filing separate returns and maintaining separate corporate registry information. Furthermore, there are compliance requirements that must be met for both companies, which adds to the administrative burden. Therefore, it is important to consider all aspects of the process in order to determine whether it is beneficial to maintain separate entities.
This blog post is not legal advice and is for general informational purposes only. Always speak with a lawyer before acting on any of the information contained herein.