What is a holding company? | Holding company definition
A holding company is a company that has a specific function of controlling subsidiary companies. It won’t usually provide services or products like a normal business. Instead, its only purpose is to control and manage other companies of which it holds the majority shares. This way, it provides the structure to create a corporate group.
Holding companies will either own the majority of shares in a subsidiary or, in some circumstances, fully owns all shares in a company. Either way, they will hold control over a subsidiary company. Consequently, they can influence and control the subsidiary company’s strategic decisions, policies and governance.
Holding companies and subsidiaries are legally recognized as independent companies. This limits the shared liability between the companies. They can, therefore, be protected from financial or legal issues faced by the subsidiary. This is the reason why many corporate groups will be structured using a holding company. Their assets also have a degree of protection if a subsidiary declares bankruptcy or becomes insolvent.
Holding companies are an integral part of corporate groups across the business world. This guide will explain the holding company definition, the advantages and disadvantages, and how to set one up.
How Does a Holding Company Work?
A holding company will own the controlling portion of shares in a subsidiary company. With majority control, they can elect the board directors in the subsidiary. By exercising control of management, holding companies have direct control over the subsidiary company’s operation and strategic planning.
As owners of the subsidiary, the holding company can receive dividends. In turn, they provide subsidiaries with better access to investments or capital. Many corporate groups consist of a holding company that has control of a range of subsidiaries.
When set up properly, financial and legal liability is partitioned. In most cases, valuable assets from the corporate group will be held by the holding company and leased to the subsidiaries. This provides income for the holding company and protects the assets as they are not owned by the operating subsidiaries.
The Holding Company and Subsidiary Are Different Legal Entities
Legally, the holding company and subsidiary are their own unique entities. This means limited shared liabilities between the two companies. In many cases, subsidiaries are their own distinct brands, owned by an overarching holding company.
As distinct legal entities, the holding company and individual subsidiaries will be insulated from shared financial or legal liabilities. Holding companies will be protected from loss of downturn felt by any subsidiary company.
The Difference Between a Parent and Holding Company
A holding company is similar in function to a parent company, however, there is a clear distinction. Although both parent and holding companies own and control subsidiaries, a parent company will usually be a functioning business in its own right.
A parent company will normally provide services and products, but this is different from the holding company definition - to control subsidiaries at the top of the corporate group.
Holding Companies as Umbrella Corporations
In practice, a holding company can own any number of subsidiaries. One umbrella corporation or holding company may hold a controlling interest in several subsidiary companies. This forms a corporate group that has shared strategic decisions, but limited shared liabilities.
Individual assets in the wider group are protected, but at the same time can hold unified operating or strategic aims. Beyond subsidiaries, holding companies will usually own other assets such as product patents, property, or trademarks. It may also own stocks and shares in companies it does not directly control. If a subsidiary declares bankruptcy, these assets will be protected from potential creditors.
How does a holding company make money?
Holding companies will generally have a diverse set of income streams, which will differ across different companies. It can generate income directly from subsidiaries, or through ownership of wider assets.
The holding company will receive dividends from subsidiaries, and may also gain by providing centralized services to the wider corporate group. They also make a profit from selling assets and subsidiaries. Here are five ways a holding company makes money.
1. Dividends from Subsidiaries
As the major shareholder, a holding company will receive dividends from the subsidiary companies it owns. In some cases, they may regularly take excess capital from subsidiaries. It can highlight the excess by adding the ongoing operational costs to any funds needed for continuous growth. Any excess may then be claimed by the holding company. This will be common in corporate structures that keep all valuable assets within the holding company.
2. Leasing Assets and Equipment
Holding companies will often centralize assets, equipment and services. Subsidiaries can access equipment and assets by leasing them from the holding company. This protects the assets from subsidiary liabilities, and also helps to move the capital to the holding company. An example of this could be in property assets. They may own the office space which is leased to the subsidiary company. This approach lowers operating costs and keeps the revenue within the corporate group.
3. Centralizing Services and Teams
Centralized services might be accountants, human resources, IT, or administration teams. The teams will often work across the group of subsidiaries. When it makes financial sense, these services will usually be centralized within the holding company. Subsidiary companies can be charged fees to access these services as part of the wider corporate group. Like other assets, centralized services will keep capital within the corporate group, and help to drive efficiency savings through scale.
4. Wider Corporate Investments
Holding companies may also hold external assets and shares, beyond subsidiary companies. This could include non-controlling shares and stocks in a range of different companies, or a property portfolio. As with any investment, these external assets can be a source of dividends for the holding company. The aim may be to diversify income beyond the corporate group.
5. Purchasing and Selling Assets
Buying and selling subsidiaries and assets can also be a major source of capital for holding companies. Naturally, this consists of investing and growing a subsidiary company before selling it at a profit. Subsidiaries are often distinct brands providing different services or products. As separate legal entities, it’s straightforward to sell a subsidiary company if needed. The holding company will usually weigh the potential revenue from an ongoing operation against the lump sum generated by the sale of an asset.
How To Start a Holding Company
The shareholders or owner will create the holding company in the same way as any company: through the process of incorporation. Shareholders will need to register the holding company with the relevant government body where it is based. This will be the Office of the Secretary of State in the USA or Companies House in the UK.
The incorporation process can usually be completed online and will record important details about the holding company. Expect to name the key shareholders and provide documents outlining the company’s structure and purpose. The company address and name will also need to be included. Shareholders will elect the director or board of directors, including the chairman of the board.
The board is important, as it will set the strategic direction of the whole corporate group. As major shareholders, the holding company can also elect the board within subsidiary companies. They can take a ‘hands-off’ approach, and ensure subsidiaries retain independent directors or executives. In other cases, directors from the holding company will be members of the board within subsidiary companies too.
Once the holding company is incorporated, it can create or purchase ownership of subsidiary companies. The holding company may own the corporate group’s valuable assets, equipment, and property. It can then in turn lease these assets to the subsidiary company.
Examples of a Holding Company
Holding companies are used across a range of industries to structure both multinational and local corporations. A key example is Alphabet Inc, which owns Google and other well-known subsidiaries. Google was restructured in 2015 to help better focus its business. As a result, Alphabet Inc was formed as the overall holding company.
Alphabet Inc now owns a range of subsidiaries, as well as the intellectual rights to different assets from across the corporate group. The structure contains legal liabilities within individual subsidiaries and helps to focus on strategic goals.
The holding company takes a ‘hands-off’ approach, as each subsidiary has its own CEO. This helps facilitate an environment of independence in addition to the corporation’s wider shared goals.
Advantages of a Holding Company
A holding company can bring a range of advantages to a corporate group. It can be used to structure a group of companies in a way that limits shared liabilities. Overall control is held by the holding company, with different independent subsidiaries operating underneath it. As separate legal entities, assets within each part of the corporate structure are protected from downturns or losses experienced by individual subsidiaries. This minimizes risks to the corporate group as a whole.
If the group was instead structured as one large company, financial and legal liabilities would be shared. Individuals can also protect personal assets if the holding company owns them. This gives a degree of protection against lawsuits and legal challenges across the corporate group. Costs and equipment can be shared across the corporate group, lowering operational costs to the business. Administration services or human resource services can be situated within the holding company.
Services can then be shared between different subsidiaries, improving efficiency. Assets like property or equipment can also be held by the holding company. Subsidiaries may lease these from the holding company for their day-to-day operation. Because the assets are owned by the holding company, they are protected if the subsidiary becomes insolvent.
Subsidiaries and holding companies can also take advantage of favorable corporate tax rates in their local state or country. For this reason, holding companies are an integral part of multinational corporate structures. Other benefits include the tax-free movement of dividends between subsidiaries and the holding company. This safeguards capital within the holding company in case a subsidiary company faces financial struggles.
Benefits of a holding company include:
- Create a corporate group structure that protects individual assets from shared financial liability.
- Drive down business costs by centralizing services, equipment, and property.
- Unify strategic business aims across the corporate group, while retaining the individual strengths of subsidiary brands or companies.
- Holding companies can leverage and guarantee capital and loans for subsidiaries at much better rates.
- Limit financial and legal liabilities between a corporate group, protecting trademarks, patents and products.
Disadvantages of a Holding Company
Beyond the benefits of forming a holding company, there are also potential downsides. Although they can help to partition risk across the corporate group, there will always be a degree of risk within the business. There may be the protection of assets from creditors in the worst-case scenario. But a poorly performing subsidiary will still hurt the holding company’s capital.
In cases where the subsidiary is wholly owned by the holding company, it can be difficult to raise capital through shares or external investment. Another disadvantage is the potential complexity of tax rules, especially with multinational holding companies.
Different states and countries may have varying levels of tax rules and exemptions for holding companies and corporations. Capital may be less fluid through multinational holding companies, as revenue can be faced by multiple corporate tax payments if moved across countries. It’s vital to fully understand the relevant local laws and legislation, as some may have a negative impact on the function of holding companies.
For example, the UK’s Diverted Profits Tax is a tax of 25 percent on profits moved from UK organizations to an international holding company. This is for larger holding companies with subsidiary sales in the UK of more than £10 million. Because of its complexity, it’s important to seek expert advice on the advantages and disadvantages of creating a holding account.
Tools To Manage a Holding Company
The governance and management of a corporate group can seem daunting. Strategic decisions must take into account the entire corporate entity, including the holding company and subsidiaries. Simplify the process with Entity Management Software. Keep track of governance, financial records and regulatory compliance from across the whole corporate group in one dashboard. Get real-time entity information when you need it. Find out how Diligent Entities can help your corporation. Request a demo from the team today.