Today, I'm going to share with you four things to consider when you are thinking about forming an LLC as a holding company for your online businesses.
Today's question comes from Myles. He says, “Could you create a video discussing how to set up a holding company? I have a few side hustles that generate income. I want to expand what I'm doing, so I'm interested in learning how I would approach that. I've read that setting up a holding company to house the other businesses is a good strategy in terms of legal protection and for filing taxes. I've also read that it's a better idea to form the holding company prior to creating the other LLCs or whatever structure, if possible. I'm not sure what's legit and what's nonsense. Could you broach that topic in a video? Any guidance or common practices as a starting point would be appreciated.”
Thank you Myles for the question. I appreciate it. I'm going to try and answer that as best I can. I'm going to start by first discussing what an umbrella LLC, also called a holding company LLC is, then we're going to talk about the main benefits of forming an LLC as a holding company for your online businesses, we'll touch a little bit on the downsides of forming multiple LLCs and what can happen if you do that, because it's not for everyone, I'll be honest, but we're going to talk about that. And then we're going to finish up by talking about when is the best time to form an LLC as a holding company to house all your multiple businesses.
What is an Umbrella LLC?
Okay. So when we're talking about an LLC, what we're really talking about here is an umbrella LLC. We are going to call the umbrella LLC as LLC#1. And this LLC right here is going to own all the other LLCs. So let's say you've got two other brands that you want to own, so this is going to be LLC#2 and LLC#3.
So LLC#1 is actually going to own LLC#2 and LLC#3. And so what you're going to do is, you'll form LLC#1 first, and then you can form LLC#2 and LLC#3 next. And that's basically what an umbrella LLC is.
So the member of LLC#2 is going to be LLC#1, and the member of LLC#3 is going to be LLC#1. And there's all sorts of other complicated strategies that can be used, but this is the basic idea when we're talking about what is an umbrella LLC.
Main Benefits of Forming an Umbrella LLC
All right. Now we're going to jump into number two, which is the main benefits of forming an LLC as a holding company for your online businesses. And there's really two main benefits that we're going to talk about here today, and those are liability protection and tax benefits.
Liability Protection
So let's start with the first one, liability protection. A good example of this is if you own rental real estate. I've had clients that own multiple rental properties. If you own more than one rental property, then generally speaking, you'd want to form a separate LLC. These can be called series LLCs, for each of the rental properties you own.
The reason for that is, let's say somebody gets injured, or maybe you rent to college students and they have a party and somebody gets hurt, and that happens in one of your rental properties. If you've got all the rental properties in the same LLC and somebody sues you for what happened with one rental property, then all the other rental properties can be basically attached to a judgment. So, they're not protected from liability there.
If you put one rental property in one LLC, and another rental property in another LLC, and another rental property in another LLC, and if somebody sues one of those LLCs because they got hurt in that rental property, they can't get at the other two or three or four, however many rental properties you have, because there's a shield of protection in place there. I mean, we're assuming you're not doing anything to pierce the corporate veil. But as long as you're not doing that, then your liability is limited to what's in that LLC.
The same is true for your online business if you've got multiple that you're operating under one single holding company. The example I like to use is Pat Flynn, because he's got a number of businesses now that he's running under the Smart Passive Income brand. He's got this switch pod, and he's got his smart podcast player, and he's got his general affiliate revenue that he makes. And I don't know what his legal structure is because I'm not affiliated with him at all. Chances are, I suspect he probably has a lawyer and he probably has different LLCs, maybe, maybe not. Pat, if you're watching this and you want to reach out, I'm happy to help you.
The idea being that you would have a different LLC for each of those unique businesses, because if something were to happen with the switch pod player, maybe you knock yourself over the head with the switch pod, or maybe it swings around and you jam your knuckles or I don't know how you could get injured using that. But if you did get injured using that, then you can't sue him with the smart podcast player. If that makes sense. And so if you've got an online business and you're making some affiliate revenue here, and perhaps you've got some courses here, and maybe you've got some other digital products here that you're selling, or maybe you've got an e-commerce business over here, you would want to separate all those out into different LLCs.
That way, if somebody sues you for something related to the affiliate business, they're not also going to be able to get at your e-commerce revenue from that business. Does that make sense? So that's the first main benefit of forming the LLCs under one holding company.
Tax Protection
The second benefit is tax protection and the tax liability. So one of the nice things about an LLC is that it doesn't have to file its own tax return, unless you elect to be taxed as an S corporation. So if you do an S-corp or if you have partners, you need to file your own tax return for the LLC. But if you don't have those, then this is just going to go on your 1040. And the way this will work is, if you have multiple LLCs that this LLC owns, then the income from those LLCs are going to flow through to the parent LLC. So what that means is that, whatever income this makes, the taxes on that are going to flow through to that LLC and that LLC. So then what you'll have is the profits from this LLC, you basically have profits, and that's going to go onto your 1040 onto schedule C, I believe.
I'll correct that if I'm wrong, but I believe that's correct. And so that's how the taxes work for LLC. So you've got multiple LLCs that's all going to flow through to your parent LLC. Now there's a lot of nuances to this, and this is a gross oversimplification of the way this works. But in general, that's what you need to know, is it makes it very easy for tax reasons. Now, you're still going to want to have a separate accounting program or software for this and a separate accounting for this that can flow through that. You don't necessarily need a separate program, but you're going to want separate bank accounts for each of these LLCs to keep everything separate, and that's good, and then you'll be good with that. So that's the tax benefit to having the umbrella LLC, is you can have everything in one. And if you formed another LLC, the income just flows directly to that, so you're good to go.
Related Resource: Here is a video about tax strategies.
So there you have the two main benefits of forming an LLC as a holding company, you got the tax protection and the liability protection.
Downsides of Forming an Umbrella LLC
Now, let's talk about some of the downsides of forming an LLC as a holding company for your online businesses.
It is Expensive
The first main downside is that it's expensive, right? You're going to have to pay a lot of money to keep up all these LLCs on an annual basis. If you live in California, where the annual filing fee is I think around $800, then you'd have to pay that fee for each one of your businesses. And so that is the first main drawback, is it is expensive to maintain all these businesses. You're also going to have to have a registered agent for each of these businesses, and there could be other just corporate fees and things associated with them.
So you just want to make sure that you understand going in what all the costs are going to be to setting up these LLCs. It's a lot easier if you've only have one LLC, because you only have to pay one annual fee and one registered agent fee, and you only have to set up one. But when you're doing multiple LLCs, it can get a little bit more expensive. So that's the number one drawback.
You Need a Registered Agent for Each LLC
And the second downside I've already kind of touched on, is you would need to actually hire a registered agent for each one of the LLCs. It's not enough to just have a registered agent for the umbrella LLC. If you've got an umbrella, you're going to have at least two more LLCs underneath it, possibly three, and you're going to need to have a registered agent for each of those.
And typically the fees for that are between 100 to $150 a year. A lot of times it could be 99 for the first year, but then it goes up in the second. That's the way we do it. And so that's just another fee that's going to get tacked on to all the other fees you're going to have to pay, but it's the cost of doing business, and if you're running your own online business, and you want to do it the right way, these are the things you're going to need to be aware of and that you're going to need to pay for if you want to do it correctly.
A Lot of Paperwork
The third downside is that there's just going to be a lot of paperwork to keep track of. Here in my office, we do things mostly paperless, and that's what I would encourage you to do too.
So create a good system for how you're going to organize all your documents, a good filing structure. You should have it all in one centralized location, whether that be on Dropbox or Box or on Google Drive, or some people use Evernote. Just make sure you have a good filing structure in place, and you're going to want to have a file for each one of your LLCs with all your articles of organization, with your registered agent paperwork, with all your annual report notices and things like that.
Usually even for me here in North Carolina, we can get most of that information online, I believe that's the case also in Florida. So you don't always necessarily need to have copies of all this in hand, but if you want to, it's always nice to have a central location where you've got access to all this information.
The one exception I would say to that, is you definitely want to have a copy of the EIN number paperwork that you received from the IRS, because they're only going to send that out to you once. If you misplace it, you're going to have to jump through a bunch of hoops to call the IRS and figure out what that number is, but typically they only send that out one time. So always make sure you've got that in a safe place, possibly in multiple places, so you don't lose it.
If you use a firm like ours to set that up for you, we'll have copies of that if you ever need to get it, but that's another thing you need to consider if you're forming more than one LLC. More than one LLC means more than one files with paperwork that you need to keep track of and maintain.
I think the big thing to take away from all of this, is that the more LLCs you have, the more complicated your structure is going to be, and the more likely it is that you're going to need legal help at some point from an attorney to help you organize and figure out exactly what you're trying to do with all of these LLCs. That's again, one of the drawbacks.
Related Resource: To start your own LLC, click here. (affiliate link)
Now there is an alternative to all of these things. What some people will do is form the umbrella LLC, and then you can have different DBAs. So for different brands or businesses you're running, you could have a different DBA for each. And that's going to be a lot less expensive, but the drawback to doing it that way is you're not going to get the liability protection that you get with having the multiple LLC. So that's one option for people if you're looking at forming an LLC as a holding company, and then just having several deviates underneath that LLC. That is one way to do it.
When is the Best Time to Form an Umbrella LLC
Last but not least, who should form an umbrella LLC, and when should you form that umbrella LLC. Generally speaking, I would say you're ready to form an umbrella LLC if you're a business that's big enough where you have two distinct businesses that have their own revenue streams and their own systems and processes, and they're separate and distinct.
If that's the case, and they're both operating under the same main holding company, I think it's time to start that holding company as an LLC, and the two main businesses as part of that. And this is really important if you're thinking about getting acquired, or maybe you want to spin off one of your brands at some point, then you definitely want to have two separate LLCs at a minimum to house each of those brands, or maybe more.
So other people that would be great to, or other businesses that would be in a really good spot to form a separate LLC or an umbrella LLC will be businesses that are looking to basically create another business, but they want to fund it with revenue from your existing business. That might be a good way to do that second business, is to start it as a separate LLC. And I know I've talked about this in the past, there are reasons why at this point Hawthorn Law is just part of my main law firm. In the future, I am considering actually Hawthorn Law as a separate entity and making it its own LLC moving forward. So, that's something you want to think about.
So if you're running a business, and you're kind of starting another little side business where it's starting to get some traction and generate some revenue, you might want to use money from your existing business to fund that business and help it grow. And that's another way to do it, and you would want to have that be a separate LLC. I would say the last example of someone who might want to form an umbrella LLC, is any online business owner or a coach or a course creator, or anyone like that, who they have multiple profit centers in their business that each generate revenue for the main hub of your business. And so you can identify and say, okay, yes… Like I talked about before, you've got an affiliate profit center that generates money through affiliate sales, you've got maybe a courses profit center that generates money through courses, and maybe you have another one that's in e-commerce or digital downloads or products like that.
So if you have multiple profit centers in your business, then you're getting closer to where you may need to form multiple LLCs. If it's just you and one business right now, and you're trying to do a side hustle to generate some additional revenue, you probably just need a regular LLC, but when you start to have multiple revenue streams, then that's when you start thinking about whether you might want to have multiple LLCs and have them all under one parent company. This is why I tell people when they ask me this on the phone when we do consults, which should I form first, or what should the name of the LLC be, does that matter. And it doesn't really matter, because if you look at this long-term and you think, well, at some point I want that LLC to become the holding company for my business, then you might want the name of the LLC to be somewhat bland.
And you can always change it if you want, but you might want it to be something like… My initials are JWH, so like JWH Holding Company might be the name of a holding company for my businesses. It's not. You can look it up, I don't have that. But something like that might be… Or you might want to use the initials of your kids. I've seen this happen a lot with a lot of clients where they do something like that. So initials are a common way to do it, or if you're a big fan of different movies, sometimes people will use names from derivatives from movies that they like and things like that. I mean, you got to be careful you're not violating any trademark or intellectual property issues, but you can get creative with the way you want to do that, maybe a nickname you had as a kid or something like that.
You can name the holding company anything you want, and you can always create different products and brands, or you can set up a DBA from that LLC as you're operating your business as the DBA. So, that is not necessarily a big deal. And like I said, you can always change the name of the LLC later. It can be somewhat of a hassle with changing bank accounts and different things like that, but for privacy reasons, that might be something you want to do, is set up the LLC as something that's somewhat private and unique to you, and then you can set up a DBA underneath that, if that makes sense. Hopefully that makes sense.
Related Resource: If you want to form your LLC or DBA through our website, click here.
Hopefully this jogs some ideas in your mind and got you thinking about how you might want to do this, or how you might want to continue to build your business moving forward.
And if you're looking for a checklist to help you when you're forming your LLC, here is a link to a checklist that you can download, get on my email list and get notified whenever I post new videos as well. So that's there to help you out if that's something you're interested in.
