Purpose of Holding Company: Everything You Need to Know
The purpose of holding company is to allow those who own several businesses a way to limit liability and maintain ownership over each business.3 min read
The purpose of holding company is to allow those who own several businesses a way to limit liability, create a streamlined management, and maintain ownership over each business. A holding company provides a central point of control over the businesses.
A corporation or limited liability company that maintains a controlling interest of ownership or the assets of other companies is a holding company. The holding company will typically hold equity interests or assets rather than actively being involved in business operations. A holding company is also called a parent company. Any company underneath the parent company is known as an operating company or subsidiary.
Advantages of a Holding Company
Three of the main advantages of using a holding company include:
- Centralized control.
- Limiting investment.
- Limiting liability.
Centralized control gives the owner the ability to maintain direction over the subsidiaries. Each subsidiary has the holding company as the owner. The owner can then choose an executive management team to help manage each company.
Limiting investment allows interested equity investors the chance to choose which company they want to invest in. If it was one large corporation, an investor would be investing in all divisions and segments of the company. With a holding company, they can focus on the business of their choice. By limiting investment, you can raise capital and create partnerships for each business on its own.
Limiting liability is an important advantage. Any assets of a subsidiary can be owned by the holding company, then leased to the subsidiary. If the subsidiary is the subject of any creditor or legal judgments, the subsidiary wouldn't lose the assets because did not own them. If needed, it is possible for the subsidiary to declare bankruptcy and close. The holding company can then establish a new subsidiary that leases the same assets.
Disadvantages of a Holding Company
There are also disadvantages to be aware of when using a holding company. They include:
- Each subsidiary must follow the formalities that come with being its own business. These includes:
- Having a separate business bank account.
- Having separate financial statements.
- Keeping a minute book of all meetings.
- Having its own employees, managers, officers, and directors.
- The business structure may be confusing or difficult to explain to partners, employees, or other interested parties. The confusion stems from not understanding the separation of entities and their purpose.
- In cases of infringement, an intellectual property holding company may not be eligible for lost profits that stem from issues with infringement. They may receive a royalty that is deemed reasonable, but not the full lost profits.
An Intellectual Property Holding Company (IPHC) is created to own and manage the rights of patents, trademarks, and copyrights. The IPHC will create a license arrangement with the subsidiaries to provide use of the intellectual property for a royalty fee. The license arrangements will be set for an agreed upon period of time.
How Do Holding Companies Make Money
A holding company can make money from:
- Any profits or dividends made from the subsidiaries of the holding company. This includes the interest and earnings of stock shares or bonds that pay dividends and/or interest.
- Offering services to the subsidiaries.
- The sale and purchase of assets, including buying and selling stocks.
The holding company will draft and sign an agreement with the subsidiary that states the following:
- How much the subsidiary needs to maintain their operations. This can be stated per year and per quarter.
- What the cost will be to purchase services from the holding company.
- The cost of selling to a sister company, if a sister company exists.
The holding company may be very involved in the management of the subsidiary's budget and operations, while others will only intervene if there are issues. The budget will be set before the start of the fiscal year and will state what is needed for investing, purchasing, and other budgetary concerns. By using a budget, this will allow the holding company to see which subsidiary is performing as expected. If there is excess cash, the holding company will decide whether they will keep it in the subsidiary or move it. This will vary by location.
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