Although not a common idea when first starting your business, a holding company is something that can provide a lot of benefits in the long run. Holding companies are businesses that do not sell products or services. Instead, they act as a business that owns other companies. This might include real estate, patents, or other units of ownership.
Holding companies exist to own other companies. Holding companies are considered the parent company, over the subsidiary, which it owns. Holding companies are usually corporations or LLCs and they do not conduct business other than owning stock in other companies.
Holding companies exist to operate with larger control and overall power, which would not exist as separate corporations. This can seem extremely helpful but does have a few disadvantages as well. You should be aware of these before pursuing this type of business.
Holding Company Benefits
The holding company also is known as Limited Liability Company or limited partnership, is the most popular corporate structure globally. The majority of conglomerates and multinational corporations throughout the world operate as holding companies. These corporations across the world employ almost thirty million people, generating yearly revenues exceeding $9 trillion.
Some of the most recognized holding companies on a worldwide basis include Walmart Inc, Berkshire Hathaway, Volkswagen AG, Ford Motor Company, BMW AG, and Tata Sons Ltd. Well-heeled individuals and affluent families incorporate holding companies mainly to transfer assets to their next generation, reduce tax liabilities, and gain greater control over subsidiaries. Individuals, partners or families form holding companies chiefly to take over other businesses which in due course become subsidiaries of respective holding companies.
The holding companies neither manufacture goods or offer services nor participate in the day-to-day business operations. Rather, the holding corporations exist exclusively for restructuring the different subsidiary businesses while keeping themselves insulated from risks and liabilities. In this blog, we take a close look at the distinct benefits enjoyed by a holding company or an investment holding company.
What are the Advantages of a Holding Company?
Creating a holding company is a great way to capitalize on the financial benefits and reduce risk of a parent company. Here are3 key advantages of creating a holding company.
Reduces Risk
One main holding company advantage is the fact that they reduce risk by providing asset protection. When holding companies go bankrupt, its assets can be pursued by creditors. This can be very dangerous when it comes to smaller corporations and businesses.
By setting up a holding company, it can reduce risk by keeping assets completely separate. Especially when it comes to real estate, you can protect the equity that has been invested into various assets by placing them in their own individually held companies.
Potential Tax Benefits
There are many types of tax benefits that come along with creating a holding company. Holding companies can allow the owners to defer and save on taxes, or even earnings on dividends from corporations. This is because they can flow between companies tax-free.
Another instance is that typically any earnings paid to shareholders are considered dividends. These will have taxes paid on them, as well as personal income taxes. When dividends are paid to a holding company they are not taxed in the same manner.
More Control With Less Money
Forming a holding company is possible with owning 51% or more of the stock in another company. This allows the holding company to spend less to purchase the stock but provides them with the same amount of control as if they own the company completely. This is also helpful for small businesses that have less capital but want to expand their business with less risk.
What are the Disadvantages of a Holding Company?
Although there are many advantages of starting a holding company, there are a few downsides. If you are going to start a holding company, make sure to know the disadvantages of holding companies as well as the advantages.
- High start-up cost: One holding company disadvantage is that, as compared to other business structures, holding companies carry a lot of costs.
- Less transparency for consumers: Because a holding company is not directly correlated with that of its subsidiaries it can be confusing for the consumer and leave less information for the consumer to understand.
- It is not easy for holding companies to sell shares:Holding companies sometimes need to jump through hoops in order to sell their shares in a company. Even placing a lot of their shares on the stock market does not mean that they will be sold.
- Reliant on the market: 60% of the income of a holding company must be from dividends, interest, or other areas that are not direct products or services. This means that it can make the company too reliant on the market.
Forming a Holding Company: How to Start a Holding Company
After you have decided to start a holding company you need to decide how you want it to be formed. You may want to consider using a corporation, an LLC, or another entity type. Corporations and LLCs are the most commonly used because they provide limited liability and tax advantages. These tax advantages typically depend on how the holding company will be taxed. Whether it is a separate taxable entity or, another option, a pass-through entity.
The next step in forming a holding company is to figure out where you want to form the entity. This will depend on the state that you wish to form in. You will also need to have a designated agent that has a presence in the state that you wish to form in. Finally, you can choose a name. This will need to be specifically based on the type of entity you form and needs to be completely unique.
Should You Start a Holding Company?
There are various advantages and disadvantages of forming a holding company. Whether or not you start a holding company will depend on the markets, and if you have a chance of being profitable. In some cases, it may not benefit you to begin a holding company, but in other cases, it can provide tax benefits, limited liability protection, and the ability to be more competitive in the marketplace.
If you are considering starting a holding company, speaking with a financial expert can help. We specialize in forming holding companies, LLCs, and corporations. Get in touch with one of our experts today to schedule a free consultation.
Risk alleviation
Perhaps the best benefit that a holding company enjoys is that it is shielded off from risks when one or more of its subsidiaries go bankrupt. Theoretically speaking if a subsidiary company performs poorly or is declared insolvent, the holding firm should be held responsible for the same. However, the holding company’s incorporation rules and regulations limit its liability to the degree it has staked in the subsidiary.
In other words, the creditors who’ve provided funds to the holding company for purchasing stakes in other companies cannot sue it for recovering their dues. The creditors cannot chase the holding company for retrieving their outstanding amount as it exists as a separate legal entity distinct from its subsidiaries. The holding company will not be liable to make good the losses incurred by its subsidiary or subsidiaries.
Another aspect worth noting is that the profit earned by the holding company and its subsidiaries is not subject to taxation in numerous jurisdictions. The capital gains or profits are paid out to shareholders as dividends are normally tax-free almost everywhere in the world. The organization of the holding company enables it to transfer proceeds from subsidiary companies as a secured debt or loan.
So, if one or more of the subsidiaries becomes bankrupt, the holding company can take over their assets which it held as collaterals. The structure of the holding company facilitates in safeguarding the interests of the shareholders, i.e., their investments. Put, the creditors cannot take the shareholders of the holding and subsidiary companies to court for retaking their advances.
Safeguarding assets
Another noticeable advantage of constituting a holding company is that it can maintain full control over its assets. Assets owned by holding companies generally include shares, stocks, copyrights, trademarks, real estate, mutual funds, intellectual property rights, and so on. Holding companies securitize their assets and collaterals for obtaining mortgages to buy out other firms which subsequently becomes subsidiaries.
Various assets held by the family holding companies stay under the firm control of the parent corporation, and cannot be seized by creditors. More often than not, families and individuals that own the holding companies form trusts for shielding their assets from the effects of estate and gift taxes, divorce, and bankruptcy. To put it in perspective, affluent individuals and families form asset protection trusts primarily to protect themselves from governments, courts, and creditors.
An asset protection trust comes in handy for holding companies, allowing them to make an out-of-court settlement with creditors, thus enabling both parties to steer clear of costly litigation. Nevertheless, a holding company has to fulfill several complicated regulatory stipulations for setting up an asset protection trust. It is worth noting here following the formation of a trust for asset protection, the provisos outlined in the manifesto become irreversible.
If at any time, the parties to the trust feel that they need to modify a specific clause, the proposal has to be approved by all signatories. On the other hand, the trust for asset protection contains a spendthrift stipulation. The spendthrift clause is inserted to thwart or discourage the beneficiaries from misusing the assets.
Alternatively, the spendthrift proviso shields the assets of the beneficiaries from being usurped or attached by creditors.
Centralized control
By and large, management and administration of the daily operations of the subsidiary companies and the holding company remain under the latter’s directors. Centralized control by the holding company directors allows for better management of all group companies, ultimately leading to enhanced performance and development. For instance, directors of the holding company could introduce a debt restructuring plan for making the most of the loans available on competitive interest rates.
Debt restructuring could also help the subsidiary companies or holding company to prevent or minimize the risk of defaulting on current debts. Subsidiary companies banking on holding companies stand a better chance of receiving loans on convenient terms and conditions compared to functioning as standalone entities.
Minimization of tax liabilities
Subsidiary companies under the control of a holding company may have to lower taxes compared to what they’d have paid had they operated as independent entities. One of the chief reasons behind constituting a holding company is to obtain relief from the burden of paying corporate taxes, which is quite steep in many countries. Many parent companies register their holding corporations in jurisdictions with relatively low corporate taxes.
Numerous states in the US charge lower commercial taxes in comparison to other states. Many corporations have registered their holding companies overseas or offshore areas regarded as tax havens such as the Channel Islands, Andorra, and Bermuda.
Flexible growth and development
When a holding company holds the assets of subsidiary companies, it has better leverage and control over the entire business. For instance, the holding company can venture into hitherto unexplored commercial segments and move out of loss-making businesses. The holding can make new strides in business without putting its assets at risk.
What is a holding company
A holding company is a corporation that owns shares in another company. It’s typically positioned between the operating company and the individual shareholder, and it owns the operating company’s voting stock and assets, and controls its management and policies.
It doesn’t usually produce goods or services itself
Why to use a holding company:
Asset Protection and Risk Reduction
Although there are a wide variety of benefits that can come from the use of a holding company, the most significant is the increased protection of business assets and the reduction of risk. Because a holding company is a separate legal entity than the businesses it owns, it is difficult for a creditor to pierce through a subsidiary company in order to access the holding company. This makes assets held by the holding company more secure than if those same assets were held in the operating subsidiary.
The use of a holding company limits liability to one subsidiary rather than allowing a creditor or lawsuit to negatively impact all of the companies owned.
A holding company is also generally safe from legal action if one of their operating subsidiaries faces insolvency. This minimizes the risk of losing assets beyond the scope of a specific lawsuit or financial failure, except in some unique cases where the holding company may be held partially responsible due to factors like negligence in the upkeep of the operating subsidiary.
Minimizing Taxes
Despite potential tax benefits from a holding company becoming more limited in recent years, there are still benefits to the use of the holding company structure. These benefits can stem from factors such as location or legal structure in ways that an operating subsidiary may not be able to take advantage of on their own.
Ease of Management
By consolidating all of a group’s business holdings under one holding company, the management of a variety of different business tasks and obligations can be streamlined. These optimizations can lead to improved efficiency within the management as well as increased profits when managed properly.
Growth Potential
Managing subsidiary companies under a holding company can also have benefits when pursuing new ventures and business opportunities. An operating subsidiary can take actions that may be considered too risky without a holding company, but with a holding company where the liability and risk are more managed, the operating subsidiary can act freely in a way that benefits future profits.
The existing structure offered by a holding company can also make it easier for new subsidiary companies to be added to the business structure without significant reworking of existing companies.
This same advantage offered by holding companies of making change easier also sets up the business for long term success. A successful company can be around for multiple generations and can change leadership and focus along the way. A bunch of independent companies can be difficult to manage and pass to new management due to the lack of a unifying structure. A holding company can act as that unifying structure, and optimize a business’ growth and future transitions, leading to a more successful company through changes of both leadership and operation.
