What Is A Holding Company?
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What Is A Holding Company
A “holding company”, also known as a parent company or umbrella company, is typically a business entity such as a corporation or limited liability company established to strictly own stock in other business entities.
In other words, the company “holds” stock or securities in other companies.
This is in contrast with an operating company that is primarily intended to operate a business by selling goods and services, producing goods, or actively engaging in business operations.
A holding company can be established to own controlling interests in any other companies and in any industry such as real estate, insurance, financial, or other.
The holding corporation can have an impact on the subsidiary companies’ policies and management decisions but will not have an active role to play in the actual operations of the subsidiary.
What’s notable in a structure where a parent company holds stock in subsidiaries is that the parent or holding is shielded from losses or business risk affecting the subsidiaries.
Business owners may choose to divide their business operations in many business entities as a way to reduce business risk and mitigate legal and financial liability exposure to the business.
Holding Company Definition
According to Investopedia, a holding company is defined as:
A holding company is a business entity—usually a corporation or limited liability company (LLC). Typically, a holding company doesn’t manufacture anything, sell any products or services, or conduct any other business operations. Rather, holding companies hold the controlling stock in other companies.
Based on this definition, we can state that a “holding” company is:
- A corporation
- Owns voting stock in other companies
- Has controlling interest
- Does not have a business operation
What Is The Purpose of a Holding Company
Most often, the sole purpose of establishing a holding company is to own controlling stocks in other companies or corporations.
For example, a holding company will own stocks in subsidiary entities.
However, a holding company can be established for other purposes as well, such as:
- Hold investments
- Own real estate assets
- Own property
- Hold patents
- Hold trademarks
- Hold cash and other marketable securities
One famous example of a holding company is that founded by the billionaire Warren Buffet called Berkshire Hathaway.
Berkshire Hathaway is a business entity that owns shares of stock in multiple businesses such as Coca-Cola, GEICO, IBM, Apple, and more.
Types of Holding Companies
There are three types of holding companies, namely:
The pure holding company is a type of holding that was formed strictly to own stocks in other companies and does not participate in the operations of the other businesses.
A mixed holding company is a company that owns controlling interest in other businesses but also has its own business operations (also known as a holding-operating company).
An immediate holding company is one that owns controlling shares in another company and at the same time it is held by another holding company (it’s like the holding of a holding).
The fourth type of holding company is the intermediate company where it is a holding company and a subsidiary of a larger corporation.
Advantages of Business Holding Companies
There are many benefits in setting up a holding company, such as:
- Liability protection for the business entities in the corporate group
- Holding company can have controlling interests in various business entities
- Can obtain lower debt financing costs
- Not responsible for the day-to-day management of the business entities
The main benefit of setting up a holding company to own subsidiaries or other business entities is to create a legal separation between each business entity.
As such, each subsidiary is responsible for its own financial obligations.
Business creditors dealing with the subsidiary cannot pursue their claim against the holding company as it is a separate legal entity.
Even in the case where a subsidiary goes bankrupt, the parent company will not be impacted or be held legally responsible for the debt of the bankrupt subsidiary.
Generally, larger companies or those operating in risky industries may structure their business entities so that a separate entity operates a different line of business.
Another advantage that may result from splitting business operations into different entities owned by a holding is that each business entity can benefit from certain tax advantages, beneficial rates, or lower tax rates.
From an operational perspective, a parent company can help the entities in its group to benefit from its overall credit and capital resources.
For example, it can provide downstream guarantees or make pledges on loans allowing the subsidiaries to benefit from lower borrowing costs and reduce the interest paid on debt.
This strategy should be considered carefully as the main objective of holding companies are to shield company assets or create legal and financial separation between each business entity within the group.
Disadvantages of Holding Companies
Although there are important benefits, holding companies do come with drawbacks, such as:
- Increased formation and compliance costs
- More difficult management of the business operations
- More complex business structure to manage
In essence, when you have multiple corporations in different jurisdictions or of different types, the business owner will need to ensure that each business remains in good standing.
As such, it will require a more rigorous tracking and management of each business entity to ensure that they produce their annual reports, are properly managed, maintain their minute books, are duly registered, and so on.
Another notable disadvantage is that with more business entities managed by different people the overall management of the company can become challenging.
In certain cases, minority shareholders in subsidiaries may have diverging views from the majority shareholder (holding company) and so decisions are not as easy to be made.
Many publicly traded companies with dozens, if not hundreds, of business entities may require a team or even an entity management software allowing them to manage the complexities of their business structure.
If the structure is not well maintained, the limited liability protection sought by the shareholders may be compromised or even the courts may allow the piercing of the corporate veil allowing a business creditor to reach the shareholders.
How to Form a Holding Company
Here are the steps to form a holding company:
- Decide on what type of business entity you wish to form
- Assess the tax impact of the contemplated business entity on the overall business
- Decide where to form the business entity
- Decide what name you wish to give each entity in the group
- Who should be the registered agent of the business entity
It’s important to decide how your business is going to look like with the different business entities.
For each subsidiary, what line of business will they be responsible to manage?
Will the holding company have 100% of the shares in the subsidiaries (wholly-owned subsidiary) or will there be other minor shareholders involved?
What assets will each subsidiary own and what will be the holding company’s role within the group?
Example of a Holding Company
Let’s look at an example of a holding company to better illustrate what it is.
Let’s take a real estate development company in the business of purchasing land, developing real estate properties, and selling them.
This company is located in several states and runs many projects at the same time.
This company can decide that each construction project will be operated under a separate legal entity.
For instance, it can take it can structure its company as follows:
- Subsidiary A: Handles all the real estate operations
- Subsidiary B: Owns the company’s trademarks and brandmarks
- Subsidiary C: Purchases land and real estate property
- Holding Company: Owns the stocks in Subsidiaries A, B, and C
In this example, each line of business of this real estate development company is held by a different business entity.
Also, the company’s intellectual property rights and trademarks are controlled by a separate business entity who in turn is controlled by the parent company.
This is a good setup allowing the holding company to shield itself from risk and capital losses impacting each of its owned business entities.
What Are Holding Companies: Takeaways
So, what are holding companies?
Why are holding companies formed?
Let’s look at a summary of our findings.
What Is A Holding Company
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