The limited liability company, or LLC, is a popular business structure for small business and startup ventures because it blends the advantages of traditional corporations and partnerships. LLCs can also be used to own other businesses. The same flexibility in tax treatment and membership, as well as their owners' limited liability from law suits, has made LLCs useful as holding companies.
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Membership in LLCs and Shares in Corporations
As state law governs all non-tax aspects of LLC existence – and most states do not restrict ownership in LLCs – any individual, corporation or partnership can theoretically own membership interests in an LLC. That LLC can in turn own any number of other LLCs, or it may hold shares in one or more corporations, including an Subchapter S Corporation, or S corp. No corporation, however, can own shares in an S corp.
LLCs as Holding Companies
When an LLC is set up to be a holding company, it conducts no operations other than owning the other company and its assets. The company where operations actually occur, and where most of the employees and liabilities are, is called an "operating company." Frequently, not only does the holding company own the shares or membership interests in the operating company, but it also owns the operating company's most important assets – it just leases them out to the operating company. The operating company can also purchase assets with cash borrowed from the holding company, which takes a mortgage or other security interest in the asset.
When an LLC operates as a holding company, even if it holds only one corporation or LLC, the operators inject another level of complexity, and thereby opportunity for error, into the company's operations. The operating company's assets and accounting must be kept separate from those of the holding company; the lines must not blur, and the operators must take care to observe the formalities with respect to both companies. Failure to do so creates the danger that a court will declare the holding-operating company distinction a sham, allowing a civil plaintiff to pierce the limited liability shield for the operating company and reach the assets of the holding company – which include ownership of the revenue-generating operating company.
Despite the complexity of dividing a business into holding and operating companies, the division offers significant advantages to the members of the holding company LLC. The limited liability of the operating company shields its sole member, the holding company LLC, from torts committed by the operating company's employees. The holding company in turn provides limited liability to its own members, creating two levels of limited liability protection. As the holding company probably owns all of the operating company's assets and takes most of its cash in the form of lease or debt payments, creditors of the operating company have little recourse against cash or assets. As the holding company conducts no operations of its own, its opportunity for any liability at all is virtually nonexistent.