In today’s rapidly evolving business prospects, companies are constantly seeking innovative ways to manage risks, maximize profits, and protect their assets. One of the most effective strategies to achieve this is through the creation of a holding company.
In this blog, we will learn what is the purpose of having a holding company, its advantages and disadvantages, and numerous other related aspects. So without any further delay, let us dive right into it:
What is a Holding Company?
A holding company is a business entity that doesn’t serve direct products or services but supports a critical function by owning the shares in the other subsidiaries. A parent can be a corporation or a limited liability company investment company.
Purpose of a Holding Company
The primary purpose of a holding company is to serve as a parent entity, designed to own and manage shares in one or more subsidiary companies. It plays a crucial role in protecting assets minimizing taxation, and strategically guiding the subsidiaries.
While it doesn’t engage in direct business operations, a holding company structure supports the broader business structure through careful strategies, ensuring that each subsidiary aligns with the parent company’s overall goals.
A holding company may focus on increasing the overall value of its subsidiaries and in turn, enhancing the net worth of this investor or business owners. By owning shares in diverse businesses, whether in real estate, intellectual property, or commercial activities, the parent company opens the doors of various income channels by spreading out the shares in various subsidiaries.
This leads to long-term capital appreciation and consistent returns, making it an attractive option for corporations and investors. Establishing investment companies is on the rise nowadays, but do you know this idea was born late 1800s when John D. Rockefeller took control of many oil refineries and other related businesses? Before moving forward, you must know how holding companies work.
How Do Holding Companies Work?
The parent company owns a significant percentage of the subsidiary’s stock usually more than 50%.
Although the subsidiaries and the holding companies are independent entities, but the holding company provides strategic management, oversees major decisions, and ensures all the subsidiaries align with the broader goals.
A holding company owns assets such as intellectual property, real estate, or other valuable investments, making it an attractive option for many entrepreneurs and corporations.
Not only this, but the controlling holding company consolidates the financial statements if it holds 50% or more shares.
Examples of Holding Companies
- Alphabet Inc.
- Berkshire Hathaway
- JPMorgan Chase & Co.
- Johnson & Johnson
- Proctor & Gamble
- AT&T
- Comcast Corporation
- Sony Corporation
Types of Holdings Companies
Here are the different types of holding companies:
Pure Holding Companies
A pure holding company is the type of business entity that exist only by controlling specific shares in another company. It doesn’t participate in any operational or business activities beyond the financial management of its subsidiaries and works independently.
Mixed Holding Company
Mixed holding companies engage in both ownership of subsidiaries and their business operations. Mixed companies serve the dual by managing their subsidiaries and producing goods and services.
Immediate Holding Company
A company that holds 50% of its shares in the subsidiary is called an immediate holding company. Despite its control over the subsidiary, the immediate holding company itself might be owned by another larger parent company
Intermediate Holding Company
It serves as a middle layer between the higher-level parent company and its subsidiaries. It acts as a channel to oversee specific subsidiaries, simplifying the management structure in large organizations.
Moreover, The intermediate holding company manages day-to-day operations and reports back to the primary holding company, ensuring that all subsidiaries adhere to the company’s overall strategy.
What are the Advantages and Disadvantages of Holding a Company?
The following are some pros and cons you need to know before starting a holding company:
Advantages
Protection from Losses
Holding companies allows the separation of legal entities between the parent and subsidiaries by limiting financial liability.
This means if one subsidiary faces any financial difficulty and goes bankrupt, the subsidiary’s directors can only claim their assets. Rather, other subsidiaries.
An Asset Protection Strategy
Among different subsidiaries, assets like intellectual property, trademarks, or real estate facilitate the principal organizations to protect them against operational risks.
For instance, if a subsidiary holds real estate shares and the other one holds trademark shares. The incurred losses in the real estate can’t impact the subsidiary holding trademark.
Taxation Advantages
Another strategic move by the parent company is to invest in those subsidiaries, offering significant tax advantages over the parent country based on their geographical differences. So the subsidiaries will earn more by paying low taxes. Alongside, it benefits the overall parent company’s health by earning more.
Downstream Guarantee
When the controlling company makes pledges on behalf of the subsidiary’s debts from a bank, this is called a downstream guarantee. This happens when a subsidiary needs to take out a loan from a bank but being a subsidiary, it holds less credibility compared to the parent.
The proven corporation, as you know, the parent company, comes across to ensure the bank that they will repay the loan if the subsidiary is away.
Disadvantages of a Holding Company
Difficult to Analyze the Financial Statement
Holding companies supervise various subsidiaries with different products and services. The idea is that the higher the subsidiaries, the additional financial statements. Progressively, it gets difficult to analyze all the details. Hence, it is time-consuming and there are possibilities of human error.
Hidden Losses
Parent organizations may pressure the subsidiary’s workers and their selected directors to manage the subsidiary. Moreover, the parent company ordered subsidiaries to buy the products from one another company even if a seller subsidiary’s product is overpriced. In this way, one subsidiary goes up while the other falls, exploiting the buyer’s subsidiary.
Layoffs
With potential benefits, the parent companies force the new subsidiaries to lay off large sections which can also bad impact on the employees.
What are the Key Features Needed to Start a Holding Company?
- Define your business structure (either LLC, corporation, etc.).
- Create a business plan.
- Choose a name that complies with local business naming regulations.
- Register the company.
- Obtain the necessary licenses or permits.
- Set up a Tax Identification Number (TIN) or Employer Identification Number (EIN) // add links from the IRS (or your local authority) for tax purpose.
- Open a business bank account.
- Establish a governance structure.
- Create subsidiaries.
- Draft operating agreements (for LLCs, create an operating agreement outlining how the company will be managed. For corporations, develop bylaws that govern the company’s operations).
- Consult with experienced professionals.
Final Thoughts
The clarity of the knowledge gap is important before launching anything. Whether structured as a pure holding company, mixed holding, or LLC, this model can help reduce risk and streamline options.
Establish a Holding Company Today With Guidance from Xpert Advisory
Understanding holding companies, along with their advantages, and disadvantages, is essential for establishing these large corporations. Xpert Advisory can help you out with this.
Furthermore, they will assist you with legal procedures, including extensive paper and legal checks. Get in touch with Xpert Advisory to get expert guidance from seasoned professionals.
FAQs:
How does subsidiary secure loans?
By securing assistance from the parent organizations. The company makes pledges on behalf of the subsidiary’s debts from a bank that they will repay the loan if the subsidiary is away.
How do I create a holding company?
Running a holding company involves defining your business structure (LLC or corporation), registering the company, and establishing subordinate companies.
How do operating companies earn?
Holding companies make money through dividends, interest, and profit from the subsidiaries and businesses they own. They can also generate income by selling assets of other companies they hold or through capital gains from rising stock values in the companies they control.
