by Holding Company is one which controls one or more companies either by means of holding shares in that company or companies or by having powers to appoint directly or indirectly the whole, or a majority, of the Board of Directors of those companies.
A company controlled by a holding company is known as a subsidiary company. Practically, it is a part and parcel of the combination movement in business and is operated for the purpose of controlling companies engaged in a similar line of business.
There are two main ways through which corporations can become holding companies. One is by acquiring enough voting stock or shares in the other company; hence, giving it the power to control its activities. The second way is by creating a new corporation from the ground up, and then retaining all or part of the new corporation’s shares.
Although owning more than 50% of the voting stock of another firm guarantees greater control, a parent company can control the decision-making process even if it owns only 10% of its stock.
The relationship between the mother company and that of the corporations they control is called a parent-subsidiary relationship. In such a case, the mother company is known as the parent company while the organization being acquired is called a subsidiary. If the parent company controls all the voting stock of the other firm, that organization is called a wholly-owned subsidiary of the parent company.
Types of Holding Companies
- Pure
A holding company is described as pure if it was formed for the sole purpose of owning stock in other companies. Essentially, the company does not participate in any other business other than controlling one or more firms.
- Mixed
A mixed holding company not only controls another firm but also engages in its own operations. It’s also known as a holding-operating company.
Holding companies that take part in completely unrelated lines of business from their subsidiaries are referred to as conglomerates.
- Immediate
An immediate holding company is one that retains voting stock or control of another company, in spite of the fact that the company itself is already controlled by another entity. Put simply, it’s a type of holding company that is already a subsidiary of another.
- Intermediate
An intermediate holding is a firm that is both a holding company of another entity and a subsidiary of a larger corporation. An intermediate holding firm might be exempted from publishing financial records as a holding company of the smaller group.
Benefits of a Holding Company
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Greater control for a smaller investment
It gives the holding company owner a controlling interest in another without having to invest much. When the parent company purchases 51% or more of the subsidiary, it automatically gains control of the acquired firm. By not purchasing 100% of each subsidiary, a small business owner gains control of multiple entities using a very small investment.
- Independent entities
If a holding company exercises control over several companies, each of the subsidiaries is considered an independent legal entity. It means that if one of the subsidiaries were to face a lawsuit, the plaintiffs have no right to claim the assets of the other subsidiaries. In fact, if the subsidiary being sued acted independently, then it’s highly unlikely that the parent company will be held liable.
- Management continuity
Whenever a parent company acquires other subsidiaries, it almost always retains the management. It is an important factor for many owners of subsidiaries-to-be who are deciding whether to agree to the acquisition or not. The holding firm can choose not to be involved in the activities of the subsidiary except when it comes to strategic decisions and monitoring the subsidiary’s performance.
It means that the managers of the subsidiary firm retain their previous roles and continue conducting business as usual. On the other hand, the holding company owner benefits financially without necessarily adding to his management duties.
- Tax effects
Holding companies that own 80% or more of every subsidiary can reap tax benefits by filing consolidated tax returns. A consolidated tax return is one that combines the financial records of all the acquired firms together with that of the parent company. In such a case, should one of subsidiary encounter losses, they will be offset by the profits of the other subsidiaries. In addition, the net effect of filing a consolidated return is a reduced tax liability.
Functions of a Holding Company
Successful entrepreneurs with multiple small businesses are typically concerned with limiting liability, streamlining management and retaining ownership control over each entity. Using a holding company can sometimes be the solution to all three concerns. The company works as an umbrella to give you centralized control over your endeavors while maintaining the liability firewall between each business.
- Parent Company
A holding company is a corporation or limited liability company that holds a controlling ownership interest in other companies or the assets that those companies use. Typically, a holding company simply holds equity interests or assets, rather than actively engaging in business, such as selling goods or services. Another name for a holding company is a parent, and the companies under it are called operating companies or subsidiaries.
- Centralized Control
Entrepreneurs who want to open multiple small businesses can use a holding company to centralize control. The entrepreneur can set up the holding company and designate himself as the sole owner. Each business can be set up separately with the holding company as the owner. In this way, the holding company is the central repository of the equity interests in those companies, and the entrepreneur can select executive management for each company while retaining the ability to direct each entity.
- Limiting Investment
Using a holding company also enables you to raise money and create partnerships for each individual entity without losing overarching control of the business conglomerate. An equity investor can invest in one of the companies under the holding company without interfering with any of the others. If you had simply created a single company with multiple divisions or projects, an investor would take an interest in your whole business empire instead of just a single project that is set up as its own business.
- Limiting Liability
One of the best uses of a holding company for small-business owners is to further limit liability. Creditors of a corporation or an LLC can go after anything that the entity owns. If you’re in a high-risk business, you can use a holding company to own all of the assets that your business needs to operate, such as real property, vehicles and equipment. The holding company leases those assets to the operating company, so if the operating company gets sued, it owns very little that can be used to satisfy a judgment. The operating company can easily be closed and declared bankrupt, and you can set up another business that leases the exact same assets from the holding company.
- Considerations
Creating an interlocking ownership structure for multiple small businesses using a holding company is a sophisticated endeavor with significant tax consequences that are tied to your legal structure choices and tax elections. For example, special personal holding company tax rules apply to corporations but not necessarily LLCs that are used as holding companies. Consult with qualified legal and tax professionals before setting up your businesses.
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