Holding Company : Features, Structure and Types

What is a Holding Company?

A Holding Company is defined as a business that possesses the ownership of other firms. The pivotal purpose of a holding company is to own shares in other firms rather than produce goods or services themselves. They are parent companies that exercise control through equity ownership. A holding company does not directly engage in any business activities or provide any services. Its main assets are its shares in other companies, rather than physical assets or production facilities. A holding company allows owners to control a group of companies through concentrated ownership. The holding company owns enough voting stock in the other companies to control management decisions. This allows the holding company to govern the policies, financing, and operations of the companies it owns.

Features of Holding Company

1. Owning Controlling Interests: The primary feature of a holding company is owning controlling shares (usually 50% or more) of other companies. This high percentage of equity ownership gives the holding company control over the subsidiaries’ operations, policies, management, and board membership.

2. Centralised Control: By owning controlling stakes in subsidiaries, the holding company can centralise major decisions. It ensures coordination and consistency of core functions, despite having diverse operations. The holding company manages capital allocation, resource sharing, and high-level planning centrally.

3. Parent-Subsidiary Structure: The holding company is the parent entity, while operating companies it owns stakes in are subsidiaries. It creates a hierarchical structure, with the holding company having oversight over subsidiaries. The holding company has the power to govern the management and operations of subsidiaries.

4. Investment Purpose: The main aim of a holding company is to own investments in the form of subsidiary companies. Its purpose is to hold shares of subsidiaries as investments and oversee their performance.

5. Limited Liability: A key benefit of the holding company structure is limited liability for owners. Losses in one subsidiary are contained and do not affect the holding company or other subsidiaries. It separates financial risk between operating companies and protects the owners.

Purpose of Holding Company

Holding companies play a pivotal role in the business world, mainly centered around owning and controlling other companies.

1. Ownership and Control: A holding company’s primary job is to own controlling shares in subsidiary companies, giving it the power to influence its operations, policies, and management decisions.

2. Strategic Decision-Making: While subsidiaries handle day-to-day tasks in their specific industries, the holding company takes charge of big-picture decisions. This includes setting the overall vision, making investments, defining performance targets, and appointing leaders.

3. Financial Risk Management: A significant goal of the holding company structure is to limit financial risks and legal liabilities. By housing subsidiaries under separate legal entities, the holding company ensures that one subsidiary’s debts, obligations, and losses stay contained. This separation protects the finances of other units and the parent holding company, offering a crucial layer of protection for the owners.

Role of Holding Company

1. Strategic Oversight: The holding company manages and coordinates high-level policies, objectives, and decisions across subsidiaries. This includes setting performance targets, making investment choices, and appointing leadership positions. The holding company is responsible for steering the overall direction of the corporate group to maximise shareholder value. It develops the vision and long-term goals for the subsidiaries and provides guidance.

2. Financial Control: A key role of the holding company is financial oversight and capital allocation across the corporate group. It directs how financial resources will be distributed between subsidiaries for optimal growth. The holding company manages funding activities like raising external debt or issuing stock. It decides on internal resource allocation, and which units will receive the most funding and investments based on performance and needs.

3. Centralised Functions: The holding company structure allows certain functions to be centralised and shared between subsidiaries. Centralisation results in standardisation and economies of scale. The holding company sets the overall policy in these areas. However, the specialised resources can be shared between subsidiaries through cross-deployments as needed. This creates coordination benefits.

4. Risk Management: The holding company structure provides a layer of risk management across the subsidiaries. Subsidiaries have operational autonomy, but financial and legal risks are contained separately. The failure of one subsidiary does not directly threaten the stability of the overall group. It is responsible for monitoring and mitigating risks through governance mechanisms, controls, and cross-collaboration between subsidiaries when needed. This provides a degree of risk diversification.

Structure of Holding Company

1. Parent Holding Company: The parent holding company is the apex of the corporate structure. It does not directly engage in any business activities or provide any services. Their role is to oversee the overall vision, strategy, and governance of the subsidiary companies. They make major policy and investment decisions. The core assets of the holding company are the shares it owns in subsidiaries. Its income comes from the earnings and dividends of operating subsidiaries.

2. Subsidiary Operating Companies: The subsidiary companies are separate legal entities that conduct business operations. They produce goods, provide services, and deal with customers directly. Each subsidiary has its management team responsible for day-to-day operations, products, and services. Subsidiaries function independently regarding routine business activities. However, they must align with the overall strategy and directives of the parent holding company on high-level policies, major investments, acquisitions, etc.

3. Separation and Limited Liability: A key feature of the holding company structure is a separation between the parent and subsidiaries. Though connected through ownership, each subsidiary’s finances, obligations, and liabilities are separate. This contains the risk of financial loss. The failure of one subsidiary does not directly impact the holding company or other subsidiaries.

4. Shared Resources and Synergies: While subsidiaries operate independently, the holding company structure allows certain resources and functions to be shared. This includes finance, administrative services, human resources, IT, legal, etc. Sharing resources results in coordination and cost efficiencies across subsidiaries.

Types of Holding Companies

Holding companies come in various types, and their classification often depends on the nature of a company’s business operations. They are,

1. Pure Holding Companies: A pure holding company does not engage in any other business activities. Its sole purpose is to possess other companies. Unlike some, it doesn’t explore multiple ways to possess other companies; it’s all about ownership.

2. Mixed Holding Companies: Mixed holding companies, also known as holding-operating companies, not only control other businesses but also actively engage in additional operations. When these companies participate in other businesses alongside their subsidiaries, they take on the label of conglomerates.

3. Immediate Holding Companies: Immediate holding companies are held by another holding company. However, despite being under the control of a higher entity, this type of holding company retains its voting stock.

4. Intermediate Holding Companies: They play dual roles as both holding companies and subsidiaries. One interesting aspect is that these companies enjoy an added layer of privacy and are exempt from the obligation to publish their financial records.

How Do Holding Companies Make Money?

A holding company generates funds for investments in subsidiaries through multiple sources. A pure holding company with no direct operations raises money by issuing shares in itself or subsidiaries, taking on debt, or receiving payments from subsidiaries in the form of dividends, distributions, rents, interest, and service fees. It can also channel profits from high-performing subsidiaries to fund other units. A mixed-holding company has the additional option of using revenue from its business activities to fund subsidiary investments and operations. The holding company management decides on capital allocation between subsidiaries to achieve strategic growth.

Examples of Holding Company

1. Berkshire Hathaway: This is a holding company run by renowned investor Warren Buffet. It owns large stakes in companies like Geico, Duracell, Dairy Queen, and Fruit of the Loom. Berkshire provides high-level oversight and capital allocation but does not get involved in day-to-day management.

2. Alphabet: Google restructured to create Alphabet as a holding company in 2015. Alphabet owns Google as its key subsidiary, along with other companies like Waymo, Fitbit, Nest, Verily, etc. This provides separation between its core search business and emerging tech bets.

3. General Electric: GE has operated with a holding company structure for decades. The parent company oversees strategic direction, while subsidiaries like GE Aviation, GE Healthcare, and GE Renewables focus on their industry verticals.

4. Hindustan Unilever Ltd: This Indian FMCG firm possesses controlling stakes in regional subsidiaries like Lakme, Brooke Bond, etc. It manages strategy and financing centrally.

How to Create a Holding Company?

1. Selecting Business Entities: The first decision is to choose what legal entity to form for the parent holding company and the subsidiary operating companies – an LLC, corporation, partnership, etc. Factors like limited liability, taxation, ownership structure, and governance should guide this choice. Using the same entity type may simplify management, but differencing can also be beneficial.

2. Determining Taxation Approach: Determine if each entity will be taxed as a separate entity or as a pass-through, based on the overall tax implications. The taxation model can be optimized between holding and operating companies.

3. Choosing Where to Incorporate: Decide which state to incorporate the holding and subsidiary companies in. Considerations include compliance requirements, governing laws, and taxes across jurisdictions. Companies can be constructed in different states.

4. Selecting the Name: Naming each entity appropriately by checking name availability and following naming conventions. Distinct but related names indicate group linkage.

5. Appointing a Registered Agent: Appoint a registered agent in each state the company operates in to receive official and legal correspondence. This could be an attorney, a company executive, or a professional third-party service provider.

Advantages of Holding Company

1. Limiting Financial Risk: Holding companies allow operating companies to be housed in separate legal entities. This provides a liability shield so that the debts and obligations of one subsidiary are contained. If a subsidiary struggles financially, it does not directly impact the assets of the holding company or other subsidiaries. This structure limits the financial risk for the overall corporate group.

2. Lower Cost of Gaining Control: A holding company only needs to acquire a controlling interest in a company, not 100% ownership. Often, a 50% or lower equity stake is enough for a holding company to gain controlling power if other investors are fragmented. This allows for gaining control over assets and management at a lower upfront cost.

3. Access to Capital: Holding companies, especially large ones, can raise capital through debt and equity more easily and cheaply than smaller subsidiaries. A strong holding company can borrow at lower interest rates and funnel capital down to high-risk operating subsidiaries at more favourable terms.

4. Encouraging Innovation: The holding structure makes it easier for parent companies to fund risky, innovative ventures through subsidiaries. A loss in one subsidiary does not hurt the entire organisation. This provides a contained environment for experimenting with new technologies, products, and business models with less downside risk.

5. Separate Oversight: The holding company does not need in-depth knowledge or expertise in the subsidiary’s business. It provides high-level oversight and strategy, while each subsidiary has its management team to handle day-to-day operations and industry-specific decisions.

Disadvantages of Holding Company

1. Higher Compliance Costs: Forming a holding company along with multiple subsidiaries leads to more legal entities. This results in higher startup and ongoing compliance costs for formation, annual taxes, and administrative filings. Maintaining good record-keeping across entities also requires effort. A single-company structure avoids such complexities.

2. Management Challenges: The holding company may not fully own subsidiaries, so it must collaborate with minority owners whose interests may not align. Also, the holding company provides oversight despite not being an expert in subsidiaries’ niche operations. This could result in ineffective decision-making. Appointing competent, industry-specific management teams for each subsidiary is crucial. Lack of expertise at the subsidiary leadership level can undermine performance.

3. Less Agility: The layered holding structure can slow down decision-making and reduce agility due to multiple levels of bureaucracy. Ideas and innovations need approval across the hierarchy. A flatter, leaner organisational structure may execute faster. Too much hierarchical control from the holding company can stifle innovation and flexibility at subsidiary levels. This can be a competitive disadvantage.

Conclusion

A holding company enables ownership control over operating subsidiaries while separating financial and legal risk. The holding company structure offers benefits for diverse business interests. However, the layered structure adds complexity compared to a single company. Business owners should evaluate if its advantages outweigh the complexities of their specific situation. With proper implementation, it can be an effective corporate structure.

FAQs

1. What do we mean by a holding company?

A holding company is a company people create to buy and own shares in other companies. When this company “holds” stocks, it gets the power to influence and control the decisions of those businesses.

2. What makes a subsidiary different from a holding company?

A subsidiary is like a child company owned by another company, often called the parent or holding company. The parent company has the power to control the subsidiary because it owns more than half of its stock.

3. How many subsidiary firms can a holding company have?

In India, a company is allowed to have only two Indian subsidiaries. However, this rule doesn’t apply if the company has subsidiaries incorporated outside India.

4. Are there any tax benefits for a holding company?

Yes! LLC holding company taxes can be reduced because losses from one subsidiary can balance out profits from another. Additionally, the dividends paid to the holding company don’t incur tax liabilities, unlike when paid to an individual.

5. Will a holding company safeguard its assets?

Yes, a holding company can shield its assets by refraining from engaging in business activities and minimizing liability exposure.