Irrespective of how big or small their business, any business owner is always seeking fool proof solutions to protect their wealth and business assets. Although there are several strategies that can help them achieve this objective, one of the most effective method is to divide the business into several business entities all owned and controlled by a single holding company. Let’s take a closer look at this time-tested and popular strategy that can help ‘’’mitigate risks.
What Is a Holding Company?
A holding company is a parent firm that owns the outstanding stock of several other companies. The holding company doesn’t manufacture anything, sell any products or services, or conduct any other business operations but owns the shares of other companies that produce goods and services. Holding companies are incorporated to protect the owner’s personal wealth and facilitate the ownership of multiple companies under a unified legal entity. A holding company can be used for the purpose of owning property such as patents, estates, trademarks, and other assets. Therefore, in the event of personal financial litigation, none of the owner’s assets can be attached as they are not the legal owners and the assets are registered under an independent holding company.
A subsidiary company within a holding company can manufacture, sell, or otherwise conduct business and are known operating companies. Similarly, several other subsidiaries can be incorporated for real estate, intellectual property, vehicles, equipment, or anything else of value that is used by the operating companies.
The holding company can own 100% of the subsidiary, or it can own just enough stock to have controlling stake in the subsidiary. Each subsidiary is independently managed although it is management of the holding company that is ultimately responsible for overseeing how the subsidiaries are being run. They have the right to elect and remove directors or managers, and are vested with the power to take major policy decisions regarding mergers, expansion, sale etc. It is interesting to note that the holding company does not participate day-to-day decision-making process of the operating companies.
How Is a Holding Company Financed?
A key function of the holding company’s management is deciding where to invest its money. The holding company is responsible for obtaining and organizing funds for its investments either by selling its own equity or that of its subsidiaries. The management can even opt borrowing funds to finance its investment. Moreover, the holding company is also allowed to generate revenue from payments it receives from its subsidiaries in the form of dividends, interest payments, rents, and charges for back-office services they provide.
How Is a Holding Company Used?
A holding companies is used by businesses of all sizes and in all industries. In Fact several publicly traded corporations are actually holding companies, and investors buying these stocks are seldom aware that they are investing in a holding company and not the operating company.
Usually large entities with multiple business operations in diverse sectors prefer to avoid having one corporation with different divisions. This is why they prefer to have one holding company having several subsidiaries, thereby allowing each business unit to be operated as an independent subsidiary in which the holding company owns a controlling interest.
Ideal for medium and small businesses too
A Holding company is ideal for any business. It can be used even by single entrepreneurs. Here is one of the ways this works, if an entrepreneur wants to buy an apartment building for earning rental income, he could opt for form two business entities: form an LLC that would own the apartment building and incorporate a holding company which owns the LLC.
In this manner if the entrepreneur is keen on expanding or diversifying his business, then the shares of the holding company can be sold to generate the capital needed for investing in the new business ventures. And each new investment can be added as a subsidiary of the holding company.
The Advantages of a Holding Company-Operating Company Structure are manifold
1. SEPARATION OF VALUABLE ASSETS
It provides a liability shield by placing operating companies and the assets they use in separate entities. Hence the debts of each subsidiary belong to that subsidiary and a creditor of the subsidiary cannot legally liquidate the assets of the holding company or another subsidiary to settle their debt.
2. STREAMLINED MANAGEMENT
As each subsidiary has its own management to run the day-to-day operations, a holding company can own businesses in a variety of unrelated industries. Even if the owners and management of the holding company are not well versed with the new business or sector they have invested in.
3. ENHANCED LIMITED LIABILITY
A holding company prevents the company from losing its assets in the event of a lawsuit or debt litigation.
4. LOWER INVESTMENT COSTS FOR CONTROL OF ASSETS
A holding company can drastically reduce the cost of running a diversified business. This is a practical and useful benefit of as it does not need to fully own a subsidiary and only needs to acquire a controlling in the subsidiary’s ownership.
5. REDUCED DEBT FINANCING COSTS
A holding company is helpful in using its overall financial strength to obtain loans for a lower interest rate as against what a new or smaller subsidiary will be able to negotiate. Typically, a startup venture or a smaller subsidiary is considered a credit risk. In such circumstances the holding company can be used to obtain the loan and distribute the funds to the subsidiary.
6. FOSTER INNOVATION WHILE CUTTING RISKS
A holding company helps in reducing the risk of loses in an investment as each operating company is considered to be a separate entity. Hence allowing for investment in startups or other ventures that may seem risky. A fine example of how this works is when Google restructured and formed Alphabet as its holding company. This was primarily done as a majority of Google shareholders were concerned about the company’s investments in risky areas like robotics, Google glass, life sciences, and medical research. The restructuring separated these new investments from its core and profitable functions such as its search engine and YouTube businesses thereby protecting shareholders’ interests.
To sum it up, holding companies and operating companies are used by businesses of all sizes and in all industries as it offers several advantages. Sanctuary Corporate Solutions can assist you with setting up of your holding company for your business and give you the primary advantages that come with it.