Holding company: definition, structure, benefits
FOREX.com August 27, 2021 12:24 PM
Holding companies are large conglomerates used to protect business assets and are a cost-effective method for members to exert control over corporations. Many of the largest publicly traded companies are actually holding companies, so it’s important to understand how they are run and make money.
What is a holding company?
A holding company is a corporation that buys and owns majority stock in other companies. Holding companies do not sell goods or provide services; their sole duty is to manage the companies they own, which are called subsidiaries.
The control exerted by a holding company on its subsidiaries can range slightly between companies. Some holding companies are completely hands off, and others may force a subsidiary into less optimal business decisions to benefit another of the holding company’s subsidiaries. Most holding companies oversee only the most impactful decisions made by their subsidiaries, such as appointing corporate directors or transacting mergers.
Holding companies are also known as parent or umbrella companies because they typically own various combinations of companies and assets. Holding companies can be multinational conglomerates with companies covering every sector from pipelines to food and beverage, or they can be smaller, existing just to divide one business into several companies split by department to minimise loss risks.
Holding companies allow shareholders to gain control of businesses in cost-efficient ways and allows their subsidiary businesses to access more capital than they would be able to on their own. The benefits of this relationship for both holding companies and their subsidiaries are numerous but complex.
How to trade holding companies
Many holding companies are listed on global exchanges, which means you can trade their shares or get broader exposure via popular indices like the US S&P 500 or the Hong Kong 50. Take your first position with City Index in just a few steps:
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Keep reading to learn how holding companies are structured and find popular examples of holding companies.
What is the purpose of a holding company?
A holding company allows investors to effectively exert control over a company without being involved in the company’s day-to-day operations. It’s also a cost-effective method as holding companies only need 51% of the company’s shares to exert control. Instead of paying to own 100% of a company, the holding company can better allocate its assets to control multiple companies for the same price.
Another major benefit of holding companies is the ease at which it can reallocate assets among its various subsidiaries. Often holding companies will invest excess cash into different projects as needed, and in return received regular interest from the subsidiaries. This method is beneficial to the subsidiary companies as well, as they can received larger amounts of capital and pay lower interest rates than they would be able to dealing with a separate bank.
Holding companies also have limited liability for whatever a subsidiary does, giving investors added protection. If a subsidiary goes bankrupt or suffers major loses, the holding company won’t be responsible for remuneration of the company and can skate by on profits from its other subsidiaries.
Additionally, some holding companies are created from a parent corporation to separate each business line into a different subsidiary. In this case, each subsidiary would be responsible for a different element of business. One subsidiary exclusively provides human resources and employment for the parent company while another subsidiary does nothing but owns commercial real estate it can then lease out to the parent company.
The most common use of this is for a parent corporation to house its trademarks and brand name in a separate subsidiary. This protects the entire corporation if someone tries to file a lawsuit against the business, as they will likely only be able to sue one subsidiary.
This method of splitting a business into multiple subsidiaries can also serve as a strategy to depress taxes by placing different subsidiaries in jurisdictions with lower tax rates.
How does a holding company make money?
Holding companies make money from their subsidiaries in multiple ways. Some holding companies charge their subsidiaries operating costs in exchange for back-office services like accounting or IT.
As mentioned earlier, holding companies also function as banks, moving extra cash among their various subsidiaries. The subsidiaries still pay interest and other fees to the holding company for this capital, but the rates are lower than if they were forced to borrow from an unaffiliated bank.
Lastly, holding companies also make money from buying and selling assets. As majority share owners of their subsidiaries, significant profits can be made when those companies perform well.
Does a holding company need a bank account?
Yes, holding companies need different bank accounts than their subsidiary companies. They are also required to maintain different accounting records. This separation of accounting records is crucial to maintain legal distinction between the holding company and its subsidiaries.
Do holding companies pay taxes?
Holding companies do pay taxes, but generally there are advantages to paying taxes on dividends through holding companies verses as an individual.
Dividends paid to a holding company from the shares of its subsidiaries do not create a tax liability the way they would for an individual. The holding company can choose to reinvest those dividends into another company or be paid out to shareholders. Shareholders can then defer income tax on the dividends paid to the holding company and instead reinvest them into other ventures.
How are holding companies formed?
A holding company is a business entity set up for the exclusive purpose of holding shares in other firms supervising other businesses. Establishing a holding company is similar to registering any other private company limited by shares. A holding company can be created exclusively for the purpose of owning shares in and supervising other, already existing businesses; or a holding company can be formed and have its subsidiaries then created from scratch, immediately owning all shares of the subsidiaries.
How do you structure a holding company?
Holding companies can be structured many ways. The larger the subsidiaries, the more complex the structure. As previously mentioned, large companies will break up various assets into multiple subsidiaries to decrease liability. One holding company might have a separate subsidiary company for human resources, equipment, real estate, manufacturing, and to hold intellectual property. This way, if someone attempts to sue the company after being injured in one of its buildings, only the subsidiary that leases office or retail space to holding company would be liable, protecting the holding company and its profits.
JP Morgan Chase and Co. is one example of this kind of holding company structure. Its dozens of subsidiaries focus on specific businesses ranging from a state-wide insurance company in Kentucky to a realty leasing company in New York City, all under the JP Morgan Chase and Co. name.
Large holding companies focus less on dividing assets and more on diversifying their holdings. Another large holding company, Johnson & Johnson, owns subsidiaries one might mistake for independent companies including Splenda, Tylenol, and Aveeno.
What does a CEO of a holding company do?
While holding companies themselves do little business, they still have a board of directors and CEO. These positions manage current investments, such as deciding who should be the new CEO of a subsidiary and choose whether to invest in new companies.
Holding company examples
One of the most popular examples of a holding company is Berkshire Hathaway, run by famed investor Warren Buffett since 1970. The multinational conglomerate was founded in 1839 and has dozens of subsidiary companies including GEICO and Dairy Queen.
What is the largest holding company in the world?
The largest holding company in the world is the Industrial and Commercial Bank of China (ICBC). The company provides a bevy of financial services through its subsidiaries and uses the structure to separate its organisations based mainly on location. As of May 2021, it is ranked highest in the Forbes Global 2000 with 4914.7 billion in assets.
Can one person own a holding company?
Yes, small business owners will often set up a holding company for one or only a few operating companies to separate assets and avoid tax liabilities. A single entrepreneur who wants to buy an apartment building may set up an LLC to own the building and a holding company to own the LLC. They could then purchase more apartment buildings and establish individual LLCs for each, protecting each building and themselves from financial liability while still easily maintaining control of every building.
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