What is a Holding Company?
As the name suggests, a holding company holds the stocks of another company. Such a company does not usually carry out any traditional business activities, such as manufacturing or offering services. Instead, it owns enough assets or equity of other companies to hold voting power or influence their policies and management decisions.
Another name for a holding company is a parent company. And the company that the parent company control is an operating company or subsidiary.
- What is a Holding Company?
- How does a Holding Company Make Money?
- Advantages of Holding Company
- Disadvantages of Holding Company
- Final Words
Since holding companies do not usually offer any product or services, their objective is to control operating companies and benefit from them. Apart from shares, holding companies can own the rights to the business, real estate, and more of operating companies.
How does a Holding Company Make Money?
As said above, holding companies do not usually carry out usual business activities. So, a question that arises here is how holding companies make money. The answer to this is simple; it makes money from the operating companies. It makes money from operating companies in three ways;
- Interest, dividend, or profit earned from the subsidiaries.
- Any service it may offer to the operating company.
- From the sale and purchase of assets or stock of the subsidiaries.
All such things are decided beforehand, like profit sharing, cost of service, and more. Both the companies sign an agreement that includes all these things and also the budget of the operating company. Primarily, this budget allocation is what helps holding companies evaluate the performance of their subsidiaries.
Advantages of Holding Company
There are various advantages of holding companies, such as providing asset protection, risk reduction, etc. Let’s discuss these and other advantages in detail.
Reduction of Risk
Big corporations prefer a holding company structure. Such a structure limits the risk as the holding company can’t be held responsible for the losses of operating companies. For example, if an operating company files for bankruptcy, the holding company may face financial challenges. But, creditors and courts can’t hold holding companies responsible. Moreover, it is seen as a distinct entity from the operating company and thus, can’t be legally held responsible for the losses and debts.
Since the ownership of assets is with the holding company and not the operating company, the assets are safe in case of insolvency. Holding companies usually keep the ownership of assets, intellectual property, and more. This works like insulation for the company if things go wrong. This does not mean that the holding company is safe from the negative financial impact on the operating company. If an operating company is financially in trouble, it will reflect on the holding company as well. However, the holding company would be safe from any legal proceedings against it. But, there could be instances where the holding company is held responsible for the action taken by the operating company.
A holding company helps the operating company bring down the overall amount of tax. Management can decide to create a holding company overseas with low corporate tax. This way profit of operating companies could be transferred to tax heavens, resulting in tax savings.
Economies of Scale
According to the experts, holding companies can also help build economies of scale in operations. There might be more than one company under a holding company. In such cases, it becomes possible to get huge discounts and improved credit terms as the company buys in bulk.
Gain Competitive Edge
The relationship between the holding and operating company is at par with the strategic partnership. Since the resources of both companies come together, it helps the operating company to get an edge over others in the industry.
Limit of Investment
There is a benefit for the investors as well. Equity investors have the freedom to select the company in which they want to invest in. If there is one big organization, an investor would be putting money in all the verticals, whether or not they like it. However, it becomes possible for the investor to invest in the company of their choice with a holding company.
Easy to Form
All you have to do is incorporate your business. After incorporation, you just need to buy the shares of the companies you want. You do not need the approval of the shareholders of the companies in which you are investing, as you are not going for a full takeover. One good example of a holding company is Berkshire Hathaway, which owns a significant amount of shares in Apple, Bank of America, Coca-Cola, and more.
Disadvantages of Holding Company
Holding companies usually do not report on the internal management and operation of the companies. Since holding companies are responsible to their shareholders; thus, they only convey about dividends they get from operating companies. Often, consumers invest in companies that are partially or wholly owned by the holding companies. Therefore, the lack of transparency makes it difficult for them to make an informed decision.
Holding companies usually prefer influencing the policies and management decisions of the operating companies. This often results in a management conflict if the operating company does not agree with the decision of the parent company.
Personal over Professional Gains
Management of the holding company might use critical information from the subsidiary companies in their favor. This could lead to various speculative activities, which would eventually be bad for the investors.
Threat of Monopoly
A company that keeps on acquiring other organizations might eventually end up creating a monopolistic structure. Although not necessary, these holding companies can reduce the competition, thereby resulting in a price monopoly.
Not Easy to Sell Shares
Sometimes, holding companies may find it difficult to sell the shares of subsidiaries. This forces the parent company to hold onto the shares even if they don’t want to. It eventually results in losses for the company.
Require Massive Capital
We said above that it is easy to form a holding company. Yes, it is very easy, but only if you have a big capital backup. You need money; it buys shares in large quantities.
Despite the drawbacks, holding companies is a sound business model. However, it is suited only for those with tons of industry and investing experience and massive capital backup.