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A holding company – protecting major business assets

“XYZ Limited – Part of ABC Group plc”, reads the website (names changed to protect the innocent).  It goes on to reassure us that the parent company provides “secure backing” for its subsidiary.

An essential characteristic of a limited company is that it protects the assets of the shareholders (owners) and directors (managers) of the business in the event that the company fails and goes into liquidation.  This is generally known as the veil of incorporation.  It is then the creditors of the company who bear the brunt of its losses.

In many small companies, of course, the expenditure giving rise to such losses will have been funded by bank lending, secured by guarantees given by directors/shareholders.

However, in the good times, as companies grow, they will often develop their own asset base and will try to fund day-to-day running costs (including current wages, administration costs, stocks and work in progress) out of trade creditors and other current creditors (which may include HM Revenue & Customs in relation to PAYE tax and National Insurance, VAT and Corporation Tax).  At this stage, prudent directors may want to see if there is a way to preserve major assets against risk and the possibility of bad times to come.

One way of protecting key assets is for a company to form a wholly owned subsidiary, and to transfer the trade into it, along with its current assets and most or all of its future liabilities.  Major assets of the original company can be retained in it.  If this is contractually problematic, it is usually possible to achieve the same results by forming a new holding company above the main trading company.  The original shareholders become shareholders in the holding company instead, and the trading company becomes a wholly owned subsidiary of the holding company.  With care, major assets of the trading company can then be transferred up to the holding company at little or no cost, leaving the risky end of the business in the subsidiary.  With the new “group” structure in place (by either mechanism), if the trading subsidiary goes into liquidation at a later stage, its creditors have no automatic right to the assets of the holding company.

Assets to be protected in this way might include buildings, intellectual property (goodwill, patents rights, and so on), and major items of plant and machinery.

So let’s not be fooled by the suggestion that an established holding company is there to provide secure backing for its subsidiary.  It may have been formed for exactly the opposite purpose  –  so that the subsidiary can sink without trace at the expense of its creditors, whilst protecting the real asset base of the holding company (and the ultimate shareholders).

On the other hand, should you be thinking about creating a holding company to protect the major assets of your own business?

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