iStock

A shell company is either a shady business executive's best friend or a legitimate business entity that helps companies better keep track of their assets.

That, of course, depends on who you talk to.

What Is a Shell Company?

In a formal sense, a shell company is a business entity formed to protect, or even hide, a company's assets, in a perfectly legal manner. Shell companies usually have no discernible business operation or generate any real assets, and in the real world, are used as a vehicle by companies to control or even disguise assets.

Shell companies may be created in several ways. For example, anonymous shareholders of a company buy enough shares of a shell company to take full control of it, and ultimately merge it with a private company.

The resulting publicly-traded entity is referred to as a shell company, as little is left of the original company that was bought out but the "shell." In the new company, shareholders hold all the control, garnering a significant majority of the public company's shares and using that leverage to control the newly-merged company and to control its board of directors.

Structurally, a shell company must register with the country where it's created. For example, shell companies in the U.S. have to register with the U.S. Securities and Exchange Commission.

Corporations and other entities that create shell companies usually hire a registered agent who is wise to the ways of shell company operations in the country where it's being established. Their workload is administrative in nature, handling the paperwork and cutting through the bureaucratic red tape that often accompanies the opening of any company overseas.

Registered agents have to register their names when opening a shell company, along with the name of a nominal owner or shareholder director to complete the signup process.

Depending on the country where the shell company is created, the price for establishing that company varies widely, anywhere from a few thousand dollars to several hundred thousand dollars for larger companies.

Why Businesses Use Shell Companies

A deeper dive into shell companies reveals other highly rewarding ways why corporations rely so heavily on shell companies. These benefits are at the top of the list.

Tax avoidance is key. Ultimately, the goal of any shell company is to avoid paying taxes to the federal and state government. In fact, dodging taxes is the actual reason a shell company exists in the first place. Basically, as long as the assets held in the shell company were earned abroad (and in an accounting sense, they were) then those assets are perfectly legitimate and can't be taxed by outside countries.

Companies set up shell companies in off-shore venues that are more efficient from a tax point of view (which is why they're referred to as "tax havens".) These tax havens, found in popular, tax-advantaged offshore hotspots like Panama, the Cayman Islands or Switzerland, fit the bill nicely.

Essentially, by parking corporate assets in offshore bourses in a shell company, a company could hide assets from Uncle Sam and significantly reduce their tax burden in the process.

It insulates companies from chaotic intra-country economic conditions. By parking a company's assets in a shell company, corporations can also protect their assets from volatile national economies. Consider Greece a decade ago, where the public rioted in the streets over national economic belt-tightening and inflation and the national deficit skyrocketed.

Or, more recently, consider Venezuela's plummeting economy in the second half of the decade, where citizens starve and businesses topple. Yet if a regional corporation placed assets in an offshore shell company, capital was protected and the corporation was insulated from toxic national economies that were swallowing up the assets of other companies.

Shell companies as sales vehicles. Businesses can also use shell entities to protect assets from taxation via the sale of a shell company.

For example, a corporation might steer assets into a shell company and then sell that shell company to shield the assets in the shell company from taxation.

Let's say a company had a large real estate asset which is listed as a piece of a shell company. In that scenario, the corporation could sell the shell company (and with it, the real estate) and avoid the fees and taxes usually linked to real estate ownership, and generate more of a profit on the real estate property.

Access to foreign markets. Besides benefiting from lower taxes, shell companies afford corporations the access to potentially lucrative foreign business marketplaces.

An organization that sets up a shell company in Panama or Switzerland, for example, not only gains the tax benefit, it also has people on the ground in these countries - contacts who could point the company to other business opportunities in Latin America or Europe, respectively.

What Business Operations Can Shell Companies Conduct?

Shell companies have surprising flexibility to undertake common business practices on behalf of shareholders.

Shell companies can open bank and brokerage accounts, shift funds around inside and outside the company, conduct regular financial transactions, purchase real estate and buy other companies, and hold copyrights and rake in royalties.

That's just for starters.

Shell companies can also be used to stage a hostile takeover of another company or hold assets in preparation for creating a new company.

Shell companies can even hide the identity of shareholders, executives and others linked to the shell company to steer clear of not only regulators and tax officials, but also evade shadier characters like criminals and fraudsters who may wish to steal assets and threaten their safety.

Risks of Running a Shell Company

Shell companies are not all upsides - there are distinct risks involved in running a shell company:

The optics can be negative. To the outside world, shell companies can generate a public relations problem. If a shell company is used to shift jobs away from a major national brand, and shareholders or customers get wind of the move, the company could lose business and suffer financial losses in the stock market.

Stalling growth. Equally troubling in the eyes of shareholders and potential shareholders of a major national brand, is the questionable movement of money abroad.

If, for example, a company takes profits outside the country and stores them in a shell company, instead of using the money for researching new products and hiring new workers, that could be a turnoff for shareholders and investors. They may well view the move as self-indulgent and one that doesn't help the company grow and generate more profits.

Legal troubles. If a shell company draws the attention of the IRS or federal regulators, that could give the underlying corporation that started the shell company a black eye - or worse, lead them down the path to litigation. If a company can't prove that its shell company is legitimate, bad publicity may be the least of its problems.

Criminal enterprise "gray areas." While shell companies pass the legal smell test, they can be used for criminal purposes, which may catch the eyes of law enforcement.

It's not pervasive, but shell companies have been known to launder dirty money, engage in illegal business ventures, like the sales of narcotics, hide money earned from illegal arms sales, or involvement of large-scale sex trafficking.

The Takeaway on Shell Companies

There's no doubt that shell companies are legal, but that hardly makes them pure in the public eye

Even so, shell companies can play a key role in the management of an entity's assets and control the flow and storage of those assets, without any prying eyes.

In business, operating in secrecy is often viewed as a big positive - and secrecy is exactly what business entities get when they open a shell company.

For better or for worse.

How Much Money Will I Need to Retire?

Want to learn about retirement planning from some of the nation's top experts? Join TheStreet's Robert "Mr. Retirement" Powell live in New York on April 6 for our Retirement Strategies Symposium. For a limited time, tickets are available for $99 for this full-day event. Check out the agenda, learn about the speakers and sign up here.