In order to safeguard their investments, business owners constantly seek new methods. And various methods have been created over time to aid them in doing so. One of the most efficient ways to accomplish this is to split the firm into several sub-companies owned and controlled by the same holding company. This article will examine this time-tested and widespread risk mitigation method in greater detail.
List of contents
What Is a Holding Company?
Holding companies, typically corporations or limited liability companies, are legal entities that own stakes in other companies (LLC). A holding company is a corporation that does not produce, sell or provide goods or services. Instead, holding firm’s own the majority of shares in another company.
Despite being the legal owner of subsidiary businesses, a holding corporation typically solely serves in an advisory or monitoring role. Therefore, while it may have some say in managing the company, it does not get involved in day-to-day operations.
People may also refer to a holding company as an “umbrella” or “parent” corporation.
Example of a Holding Company
Berkshire Hathaway is a well-known example of a holding company, as it has assets in over a hundred public and private firms. These companies include Dairy Queen, Clayton Homes, Duracell, GEICO, Fruit of the Loom, RC Wiley Home Furnishings, and Marmon Group.
The Coca-Cola Company, Goldman Sachs, IBM, American Express, Apple, Delta Airlines, and Kinder Morgan are all companies that Berkshire owns a small percentage of.
How It Works
The primary function of a holding company is to exert management on subsidiary businesses. Real estate, patents, trademarks, stocks, and other assets are some of the many types of property that a holding company could control.
The holding company and its subsidiaries’ exposure to financial and legal liabilities is mitigated by this arrangement. A corporation’s tax burden can be reduced by moving operations to countries with favorable tax rates.
Wholly-owned subsidiaries are businesses their holding company owns to the fullest extent possible. A holding company has the power to recruit and fire executives at the companies it controls, but those executives are ultimately accountable for the business’s performance.
Types of Holding Companies
The nature of a holding company’s business determines which category it belongs in. Companies can exist for various reasons, with some existing solely to hold a single subsidiary. Learn about the different holding company structures in the following sections.
Pure Holding Companies
Simply put, a holding company is a business entity whose sole purpose is to hold the shares of other companies. None of these firms engage in any other fields of activity.
Mixed Holding Company
Companies that manage subsidiaries and engage in operations are “mixed holding companies.” Holding-operating company is another term for this type of business structure.
Immediate
If a firm owns multiple other companies but is not a shareholder in the holding company itself, it is considered an instantaneous holding company. To sum up, these organizations are themselves holding companies that other welcoming organizations have.
Intermediate
It’s a holding company subsidiary of a larger company, much like an immediate holding company.
Advantages and Disadvantages of a Holding Company
Advantages
As a holding company, you are shielded from liability. A holding company with a failed subsidiary could suffer a loss of capital and a drop in net worth. However, the bankrupt corporation’s creditors have no recourse to the holding company for payment.
Accordingly, a parent firm may set itself up as a holding company and set up subsidiaries for each business line to shield its assets. The parent company’s real estate may be owned by a separate entity from the company’s brand name and trademarks.
Also simple to form or alter are holding companies. The holding company can move to a lower-tax jurisdiction while maintaining its operations in the original location, making it simple to take advantage of differences in taxing regimes between different regions.
The holding company can help its subsidiary cut costs by utilizing its resources to fund operations. The parent business can guarantee the subsidiary’s debt through a downstream guarantee.
Disadvantages
As with anything, there are drawbacks to conducting business via a holding company to own subsidiaries. It may be difficult for investors and creditors to get a clear picture of the holding company’s financial condition. Dishonest board members might also cover up financial missteps by shifting liabilities amongst their several companies.
Subsidiaries of holding corporations can be taken advantage of in several ways, including being forced to acquire items from one another at above-market pricing or having their directors appointed by the holding company. Additionally, they may mandate that divisions sell things to one another at prices below market value.
Holding firms have the power to have their subsidiaries do anything from laying off a significant number of employees to strip their purchases of valuable assets. These tactics often referred to as “vulture capitalism,” are designed to benefit the parent company at the expense of the subsidiary.
To summarize, a holding company is a type of corporation that does not engage in producing or providing goods and services. Instead, it invests in and oversees subsidiary businesses. Organizations of different shapes and sizes and functioning in various fields use holding corporations and operating companies. In addition to helping businesses reduce the possibility of having assets seized by creditors, there are several other benefits to doing so. It’s important to remember that this somewhat complicated structure isn’t appropriate for many kinds of businesses. Nonetheless, if business owners and attorneys aren’t already familiar with this strategy, they could find it helpful to learn more about it.
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Source: Investopedia