Depending on the type of business you are in, you may find yourself owning multiple companies as your business (or businesses, I suppose) grow. Most people are aware that when you’re doing business with a large global company, it is likely that you are technically dealing with a smaller affiliate of that larger company. Health insurance is a great example. I tell people that I have Blue Cross for health insurance. But technically my insurer is Blue Cross and Blue Shield of Illinois, Inc. It is a subsidiary or affiliate of a larger company.
There are benefits to this type of arrangement for small business as well. The times when this is appropriate generally fall into three categories.
- Real Estate. Whether you flip real estate, develop real estate, or hold real estate for rental, it is a good idea to divide up your real estate holdings into separate companies (almost invariably LLCs in today’s legislative environment). This way, if something happens on one parcel, the others are isolated from those losses.
- Cash Cow vs. Liability Pit. Another reason to separate into separate businesses is when you have one aspect of your business that is a cash cow or has valuable assets and another that is high-risk. A great example is a distributor that runs its own deliveries. Trucking is a high-liability operation with trucks on the road, potential accidents and injuries, etc. Distribution can also be relatively dangerous with expensive equipment and high value inventory. Why subject the valuable assets of each of these operations to the liabilities of the other? We would advise that clients consider running one trucking company, and one distribution company.
- Profit Balancing. In the example above, perhaps your distribution operation is running too high a profit and will incur tax. But your trucking operation just purchased a few new trucks and was able to write them off under Section 179 accelerated depreciation. So you’ll incur a tax on the distribution side, and a paper loss on the trucking side. Why not just raise the prices your trucking operation charges your distribution operation to move profits over to trucking where they will be absorbed by the Section 179 depreciation? The key is to keep your pricing reasonable. Keep the price increase within reason. It still needs to be similar to an “arms-length transaction” or it won’t pass muster with the IRS. But this profit balancing can be a great benefit of operating your business through separate entities.
- You own the land where you operate. A simple rule: If you own the land where your business operates, you always purchase the land through one company (usually an LLC) and operate the business through a separate company (often, but not always, a corporation). If the business fails, you still have a valuable piece of land you can lease to another tenant. And there are also profit balancing opportunities here as well, as noted above.
The concepts described here only scratch the surface on what can be a fairly complex business structure. But there are more benefits to this concept beyond just those listed here including estate planning benefits, and possible benefits when it comes time to sell your business (Exit Strong!). If you think your operation may be well suited to splitting up into separate companies, talk to your lawyer and CPA about it and see if it’s right for you.
Have an awesome day. Go launch, build and exit strong!