Holding Company: What It Is, Advantages and Disadvantages

What Is a Holding Company?

A holding company is a business entity—usually a corporation or limited liability company (LLC)—that typically doesn’t manufacture anything, sell any products or services, or conduct any other business operations. Rather, holding companies, or “holdcos,” hold the controlling stock in other companies.

Although a holding company owns the assets of other companies, it often maintains only oversight capacities. So, while it may oversee the company’s management decisions, it does not actively participate in running a business’s day-to-day operations of these subsidiaries.

A holding company is also sometimes called an “umbrella” or parent company.

Understanding Holding Companies

A holding company typically exists for the sole purpose of controlling other companies. Holding companies may also own property, such as real estate, patents, trademarks, stocks, and other assets.

This structure serves to limit the financial and legal liability exposure of the holding company (and of its various subsidiaries). It may also depress a corporation’s overall tax liability by strategically basing certain parts of its business in jurisdictions that have lower tax rates.

Businesses that are completely owned by a holding company are referred to as “wholly owned subsidiaries.” Although a holding company can hire and fire managers of the companies it owns, those managers are ultimately responsible for their own operations.

Advantages and Disadvantages of a Holding Company

Advantages

Holding companies enjoy the benefit of protection from losses. If a subsidiary company goes bankrupt, the holding company may experience a capital loss and a decline in net worth. However, the bankrupt company’s creditors cannot legally pursue the holding company for remuneration.

Consequently, as an asset protection strategy, a parent corporation might structure itself as a holding company, while creating subsidiaries for each of its business lines. For example, one subsidiary may own the parent corporation’s brand name and trademarks, while another subsidiary may own its real estate.

Holding companies are also relatively easy to create or change. This makes it easy to take advantage of geographical differences in taxation regimes: If a certain jurisdiction has high business taxes, the holding company can simply relocate to a more business-friendly environment while continuing operations in the original location.

Holding companies support their subsidiaries by using their resources to lower the cost of operating capital. Using a downstream guarantee, the parent company can make a pledge on a loan on behalf of the subsidiary.

Disadvantages

There are some disadvantages to owning subsidiaries through a holding company. For investors and creditors, it may be difficult to find an accurate picture of the overall financial health of the holding company. It is also possible for unethical directors to hide their losses by moving debt among their subsidiaries.

Holding companies can also exploit their subsidiaries, by forcing them to appoint chosen directors or forcing the subsidiaries to buy products from one another at higher-than-market prices. They may also force subsidiaries to sell products to one another at below-market prices.

In some cases, holding companies can even force their subsidiaries to lay off a large section of the workforce or plunder their acquisitions for saleable assets. Known as vulture capitalism, these strategies can have the effect of inflating the holding company’s overall numbers at the expense of the subsidiary.

Types of Holding Companies

Holding companies fall into different categories, depending on their business operations. Some only exist to hold a single subsidiary, while others may be engaged in other business operations. The different types of holding companies are explained below:

• Pure: A pure holding company is one that only exists as a vehicle for ownership of other firms. These companies do not participate in any other type of business.
• Mixed: A mixed holding company is one that has its own business operations, in addition to managing its subsidiaries. Another word for this is a holding-operating company.
• Immediate: An immediate holding company is a company that owns other companies, but is itself owned by another entity. In short, these are holding companies that are owned by another holding company.
• Intermediate: Similar to an immediate holding company, these are holding companies that are also subsidiaries of a larger corporation.
  

How Holding Companies Make Money

Large holding companies may have several income streams, depending on the companies in their portfolio. The most straightforward way to make money is through equity in their subsidiaries: Holding companies can benefit from dividends in the subsidiary’s share price, as well as by selling equity in companies that gain value.

In addition, holding companies can also profit from synergies between their subsidiaries. Rather than have separate information technology (IT), human resources (HR), or administration teams for each company, a holding company can centralize these services and then sell them to the subsidiaries. Holding companies can also centralize equipment or other assets for lease by all of their companies.

Example of a Holding Company

An example of a well-known holding company is Berkshire Hathaway, which owns assets in more than 100 public and private companies, including Dairy Queen, Clayton Homes, Duracell, GEICO, Fruit of the Loom, RC Wiley Home Furnishings and Marmon Group.

Berkshire likewise boasts minor holdings in The Coca-Cola Company, Goldman Sachs, IBM, American Express, Apple, Delta Air Lines, and Kinder Morgan.

The Bottom Line

A holding company is a type of business entity that has a single purpose: owning other companies. Some holding companies are large conglomerates, with arms in many different industries; others only exist to manage a single subsidiary. Holding companies can help protect their owners from losses, or they can also be used to reduce tax burdens.