Questions

About a year ago I started a company (an LLC - "parent company") that starts companies. I am 100% sole owner of the parent company. The premise is to form a team of designers, developers, and business folks around a business concept and run them through the process of de-risking the business (finding and acquiring customers). Once product/market fit is found, the idea is to spin the project out into its own entity/company (C corp) and continue the process of company building (E,g. raising money etc). Our second project is ready to move onto the next phase and be spun out. My logic of starting the parent company was always to have my equity portion of the spun out company be owned by (refer back to) the parent company instead of having it under my personal name. [Side note - the other team members of this company would also get a percentage in the newly spun out company.] From an accounting prospective does this approach make the most sense? Are there any flaws in this strategy?

There are three angles to look at this structure from: 1) Is it the best way to set things up to hold your investment from a legal perspective? 2) Is the it the best way to minimize your taxes? and 3) Is the best way to set things up from an accounting (i.e. bookkeeping) perspective? In your question above, you initially ask about tax, but then ask about accounting at the end, so I'll address all three.

The first angle is best answered by your attorney, and it sounds like they've already advised you in this regard. I will say that the structure you've described is one I've seen used often and seems to work well from a legal perspective.

For the second angle, it is imperative that you engage an experienced tax CPA to advise you, and do it right away if you haven't already. Know that sometimes the best legal structure is not always the best structure to minimize taxes, and vice versa. These two sometimes work at cross purposes and you'll have to strike a compromise based on which is more important to you. For instance, having the sub as a C-Corp is likely excellent from a legal perspective due to the liability protections afforded by a C-Corp. However, it may not be ideal from a tax perspective as the subsidiary C-Corp pays taxes on income and then the income is taxed again when it is distributed to your LLC.

I am neither an attorney or a tax CPA, my expertise is in the third angle, how to set up your financial accounting to track your financial results in a way that gives you useful information you can use to make decisions. From a financial accounting (i.e. bookkeeping) perspective, this setup should serve you well. It segregates the revenue and expenses from the new project from the operations of your own LLC, allowing you to separately measure the operations of both. Of course having two separate entities to track is more time consuming, and therefore involves more expense for accounting. But it's necessary based on the fact that you are going to have a different ownership structure and different owners for the spun out entity than the original LLC.

In summary, I'm not an expert on legal or tax matters, I know just enough to know that you need good advisors talking to each other and you in each of these areas. From a financial accounting perspective, I think your set up is a good one because it segregates operating cash flows and allows for different ownership classes. I can consult with you if you need some guidance in how to set up the recordkeeping properly. However the legal and tax questions should take precedence over financial accounting.

Helpful? Let me know if you need additional clarification, happy to help answer further questions. Also let me know if you'd like to set up a call to discuss further.


Answered 5 years ago

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