One question I seem to be hearing more often from prospective clients lately:
“How do I set up a holding company for my startup?”
The answer is you don’t. Or, perhaps more precisely, you shouldn’t.
A holding company is a company that owns other companies. The classic and most successful example is Berkshire Hathaway, the company that has made its majority owners Warren Buffett and Charlie Munger among the wealthiest and most famous investors on the planet. Berkshire Hathaway owns all or part of dozens of other companies, including See’s Candies, Clayton Homes, Duracell, Geico, General RE, Apple, John Deere, Coca-Cola, and many others. Berkshire Hathaway isn’t actively involved in running any of those companies; it puts the capital into those other entities, ensures good managers are in place to run those companies, and then reaps the rewards.
The formula is this: Well-funded parent company buys out smaller company with a solid revenue stream. The parent company retains previous managers or recruits top-quality new managers to run the smaller business. The compounding earnings of the smaller business earns the parent company more money. The parent company continues to keep an eye open for other businesses to acquire. Rinse and repeat.
This is very different from the proposed structure of most startups that want to set up a holding company. Almost invariably, the scenario is the same:
The ownership and management structure of the parent company and the subsidiary are identical or nearly so. The holding company and the subsidiary have overlapping IP concerns. Neither the holding company nor the subsidiary have any substantial business dealings, customers, or revenue yet. The founders looking to create a holding company have never run a multi-tiered business before and are not familiar with the nuances and legal requirements related to their unique and complex corporate governance.
Let’s compare and contrast these two situations.
With Berkshire Hathaway, Warren Buffett and Charlie Munger have a very clearly defined role: Find and acquire, at reasonable prices, great businesses with recurring revenue streams. And the owners of its subsidiaries have clearly defined roles: For Coca-Cola, management’s role is to market and sell beverage products around the world. For Geico, it’s the same, but for insurance. Warren Buffett and Charlie Munger aren’t selling Coke or insurance—they’ve got people at those companies who do those things for them. As long as the businesses are well run and don’t engage in fraud or other activities that damage the parent’s reputation, they leave them alone to do their thing.
In a startup, usually the owners and managers of the parents and the subsidiary are the same or similar. So much so that it’s often difficult to tell when they’re acting in one business’s interest and when they’re acting in another business’s interest. The founders often send emails related to the business activities from one of the entities from the other entities’ email account. Put simply, the companies are treated by the owners and managers as if the entities—and their assets—are interchangeable. Staff, accounts, expenses, and business activities are all intermingled. It’s hard to know where one business starts and the other ends.
For Berkshire Hathaway, Coca-Cola and Geico aren’t competitors. Other than financial reports, the owners don’t get involved in the nuances of the company’s inner workings. For startups, this is rarely the case. Usually, there are similar or identical owners and employees working from identical laptops trying to work on multiple things at the same time. Again, it’s not clear where one business ends and another begins.
For Berkshire Hathaway, combined, their total assets are worth nearly a trillion dollars. Given the enormous complexity and diversity of their portfolio, it’s an absolute necessity to maintain a siloed entity structure.
By contrast, for most startups, there is no “there” there yet. There’s almost no reason why a company that does not yet have any revenue or customers would need to create more than one entity to run their business. If you have zero revenue and customers, your primary focus should be on customer acquisition, not on complex entity structures. Facebook, Apple, Microsoft, Google, Uber, Intel, HP—all these businesses were one entity when they went IPO. If one entity is sufficient complexity for these multibillion-dollar startups, then one entity is plenty enough complexity for your startup, too.
(It is also worth noting that Berkshire Hathaway started as a textile manufacturer that was just focused on textiles. Warren Buffett purchased a majority of Berkshire Hathaway later and started buying into other companies, while still operating as a textile company (which he accurately viewed as a dying industry). Warren Buffett did not start an umbrella company for another fledging, pre-revenue company.)
Finally, Warren Buffett and Charlie Munger are among the most sophisticated businessmen on planet earth. In terms of legal nuances, before he joined forces with Warren Buffett, Charlie Munger was also one of the most respected corporate lawyers in California, where he founded the still-very-highly-respected law firm Munger Tolles. He understands good corporate governance practices as well as anyone. As such, he’s well able to handle the many risks and other challenges wrought by having a complex organizational structure.
Few startups, if any, are equipped to handle these conflicts of interest.
This isn’t to say that a holding company structure is totally unheard of in the startup world. But the examples that we find are often cautionary tales, not paradigms of excellence. One famous example is WeWork. In 2019, WeWork was preparing its filing for IPO. But when its complex structure, filled with conflicts of interest and other problematic relationships, became known to the public, as is required by law for a company that is looking to go IPO, the business world harshly criticized its corporate governance structure. So bad was the situation, that an IPO that was planned for $40 billion, was later marked down to $10 billion, and then eventually cancelled, with its CEO ousted and its reputation left in shambles.
Starting a business from nothing is an incredibly hard thing to do. Most new businesses fail. Most startups never get clients or customers, or, at least, don’t get enough to keep the lights on or grow to become successful.
All that’s to say, there are enough business challenges to keep you busy when starting a new business. Creating additional logistical and organizational challenges, as well as additional costs, by creating an unusual corporate structure is the last thing you need.
No, you don’t need a holding company your startup.