Every business owner wants to protect the assets of their company. There have been several strategies developed to help them achieve this goal over the years. Dividing a business into a number of commercial entities controlled by one holding company can be one of the most effective strategies. As a risk mitigation strategy, this article will examine this time-tested approach in greater detail.
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Defining a Holding Company
Holding companies are parent companies – usually corporations or limited liability companies – which do not produce anything, do not sell anything, and do not conduct any business operations. Holding stock or membership interests in other companies is its purpose, as suggested by the name. They are either involved in manufacturing, selling, or otherwise conducting business through some of their subsidiary companies. This type of company is called an operating company. Alternatively, the companies’ subsidiaries could hold real estate, intellectual property, vehicles, equipment, or anything else of value that they use.
A holding company can control a subsidiary with 100% ownership or with just enough stock or membership interest to have control. If it has control, then its stock or membership interests ensure it will get its way in the event of a vote of owners. Usually, 51% of the shareholders own the company, but it can be much lower where there are many owners.
The daily business of each subsidiary is handled by a separate management team. Managing the subsidiaries is the responsibility of the holding company’s management. Corporate or LLC managers and directors may be elected or removed, and major policy decisions, such as mergers or dissolutions, can also be made by them. Management at the holding company does not participate in day-to-day decisions made by the operating companies.
What Are The Financing Methods For Holding Companies?
As well as deciding where to invest the holding company’s money, the management makes those decisions. In addition to selling equity in its subsidiaries or itself, the holding company can borrow funds to finance its investments. A company’s revenue may also come from dividends, distributions, interest payments, rents, and payments for back-end services provided by its subsidiaries.
How Does A Holding Company Benefit You?
Holding companies are used for a variety of reasons. Some of them include:
1. Protection Against Liability
Companies that operate and the assets they use are placed in separate entities to shield their assets from liability. Subsidiaries are responsible for their own debts. The holding company or another subsidiary cannot be accessed by the creditors of a subsidiary.
We have a horse farm owned by entrepreneurs that is having trouble paying its trainers and veterinarians. In addition to the horse farm, they can also sue and reach the assets of the restaurant and apartment building that is owned by the subsidiary, but not those of the holding company itself.
2. Spend Less Money on Assets
Despite its holding company status, a subsidiary does not necessarily have to own all shares or membership interests in the subsidiary. Consequently, the holding company is able to acquire control over another company at a lower cost than if it had acquired its entire shareholding interest.
3. Debt Financing at a Lower Cost
Holding companies with strong financial strength are often able to obtain loans for lower rates than operating companies themselves, especially when the company is a start-up or other venture considered a credit risk. By obtaining a loan from the holding company, funds can be distributed to the subsidiary.
4. Promote Innovation
Investing in risky initiatives or startups is less risky because operating companies are separate entities. One of the reasons for Google restructuring and forming Alphabet as its holding company was that Google shareholders were worried about the company investing in areas like robotics, Google glasses, life sciences, and medical research. These investments were separated from its profitable core businesses, such as its search engine business and YouTube business, as a result of restructuring.