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Imagine a secretive mastermind pulling the strings behind some of the world's most successful companies - that's the concept of a holding company. These parent companies, often in the form of LLCs or corporations, quietly acquire and control the ownership interests of other firms, creating a web of subsidiaries under their command. Some holding companies, like Berkshire Hathaway, Alphabet, JP Morgan, Nestle, and Goldman Sachs, may not actively conduct business operations.
Many companies are turning to the holding company structure in today's business landscape to protect and grow their smaller subsidiaries. But how exactly does a holding company work? Stay tuned as we uncover the secrets of a holding company's operations.
How does a Holding Company work?
Corporations can become holding companies in one of two ways. One method is to acquire sufficient voting stock or shares in another company, granting it control over its operations.
The second method is to form a new corporation from scratch and then retain all or a portion of the resulting corporation's shares.
Subsidiary companies in a typical holding company structure sell, manufacture, sell or conduct general business. These are known as operating corporations. Other subsidiary companies own vehicles, intellectual property, equipment, real estate, etc., used by the operating companies. The holding company can own all the subsidiary's stock or membership interests. In other cases, it can own just enough membership interests or stock to control the subsidiary.
Control implies that it has enough membership interests or stock to ensure that an owner's vote goes its way. The figure maybe 51%. However, the percentage may be much lower in a situation with many owners.
Each subsidiary has its management team running the daily operations. The management of the holding company is in charge of overseeing how the subsidiaries are run. They can appoint or remove LLC managers and corporate directors and make major policy decisions, such as whether to merge or dissolve. The people in charge of the holding company are not involved in the day-to-day operations of the operating companies.
How do Holding Companies make money?
Holding companies will typically have diverse income streams that vary by company, and they earn money in the following ways:
1. Wider existing corporate investments.
Aside from subsidiary companies, holding companies may own external shares and assets, e.g., non-controlling stocks and shares in various companies, as well as a property portfolio. These external assets, like any investment, can generate dividends for the holding company.
2. Subsidiary dividends.
A holding company, as the majority shareholder, will receive dividends from the subsidiary companies it owns. They may regularly take excess capital from subsidiaries in some cases.
3. Asset acquisition and disposal.
Purchasing and disposing of subsidiaries and assets can also be a significant source of capital for holding companies. Naturally, this entails investing in and growing a subsidiary company before profitably selling it. Subsidiaries are frequently distinct brands that offer different services or products. Selling a subsidiary company is easy because they are separate legal entities.
4. Assets and Equipment Leasing
Subsidiaries can access assets and equipment by leasing them from the holding company. It shields the assets from subsidiary liabilities while aiding in the transfer of capital to the holding company. One example would be real estate assets. They may own the office space that the subsidiary company leases. Such a strategy reduces operating costs while retaining revenue in the corporate group.
Advantages of Holding Companies.
1. Protection against liability.
The separation of operating companies and the assets they use provides a liability shield. Each subsidiary is considered a separate legal entity. If one of the subsidiaries is sued, the plaintiffs do not have the right to sue the other subsidiaries. If a subsidiary facing a lawsuit acted independently, the parent company is unlikely to be liable.
2. Lowering the cost of debt financing.
A financially strong holding company can often obtain loans at lower interest rates than its operating companies, especially if the business needing capital is a startup or venture deemed a credit risk. The loan can be obtained and distributed to the subsidiary by the holding company.
3. More power for a lower investment.
A holding company must have control over its subsidiaries but does not have to own all of the shares or membership interests. It enables the holding company to control another company with its assets at a lower cost than if it acquired all subsidiary ownership.
4. Lower tax liability.
Filing consolidated tax returns can benefit holding companies that own 80% or more of each subsidiary. A consolidated tax return combines the financial records of all acquired companies with the parent company's records. If one of the subsidiaries suffers losses, the profits of the other subsidiaries will compensate. Furthermore, filing a consolidated return reduces your tax liability.
5. Daily management is not necessary.
A holding company can own companies in unrelated industries. It makes no difference if the holding company's owners and managers are unaware of those businesses because each subsidiary has its management to run daily operations.
Final Thoughts
A holding company is a powerful business tool that allows companies to diversify risk, centralize management, and consolidate ownership. By acquiring and controlling the ownership interests of other firms, holding companies can create a web of subsidiaries that operate under their control. As more and more companies turn to the holding company structure to protect and grow their smaller subsidiaries, it's important to understand how these entities work.
This recommended guide provides a comprehensive overview of the inner workings of holding companies and can be a valuable resource for those looking to learn more about this business structure.
