What is a holding company?
Simply put, a holding company is a type of company that owns a controlling interest in another company or companies, controlling their management policies and decisions.
Mostly, a holding company does not conduct any day-to-day operations or activities such as producing goods or providing services.
Besides the majority of shares of the company or companies that are controlled by the holding company, a holding company can also own various other types of assets, such as bonds, real estate, shares in public traded companies, and intangible assets like patents, brand names, copyrights, and trademarks.
Companies owned by a holding company
Companies that are owned by a holding company are called subsidiaries. The relationship between a holding company and its subsidiaries is called a parent-subsidiary relationship and the holding company is referred to as the parent company.
Companies owned by the same parent company are called sister companies. Sister companies operate separately and may have no association other than sharing the same parent company.
Basically, there are two types of subsidiaries:
- Wholly owned subsidiary
A company 100% controlled and owned by a holding company, is called a wholly-owned subsidiary.
- Partly owned subsidiary
When a holding company owns 51% to 99% of another company, then the company is a partly owned subsidiary, also referred to as a regular subsidiary. The holding company has only partial control over the subsidiary.
A holding company is allowed to have more than one subsidiary, but a subsidiary can only be owned and controlled by one other company, the holding company. However, a subsidiary can have one or more of its own subsidiaries.
Types of holding companies
Holding companies can be defined in different ways:
- Pure holding company: A company that was established primarily to own shares in other companies. The main activity of such a company is to own and control one or more other companies.
- Mixed holding company: A company that runs its own operations and also controls its subsidiaries. It is also known as a holding-operating company.
Holding companies are referred to as conglomerates when their activities and operations are completely different from those of their subsidiaries.
- Intermediate holding company: A company that is both a holding company of a subsidiary and a subsidiary of another holding company. Simply put, it is a company between a subsidiary and another holding company.
- Ultimate holding company (UHC): A company that has control over a group of subsidiaries in which some of the subsidiaries are themselves immediate holding companies of their own groups.
An ultimate holding company cannot be a subsidiary of another company.
- Immediate holding company: A company that maintains the controlling interest in a different company, despite the fact that the company itself is already controlled by another company.
Benefits of holding companies
- Limitation of risk
Holding companies can take risks through their subsidiaries, limiting the risk only to the subsidiaries and protecting the holding company against the risks. For example, the holding company would not be liable for the debts of a subsidiary, if it had not guaranteed the debts of the subsidiary.
A holding company is protected against losses incurred by a subsidiary. If a subsidiary fails and goes bankrupt, the holding company is not affected by the consequences. In other words, the holding company cannot be legally pursued by the lenders and creditors of the subsidiary for compensation.
However, a holding company may suffer a capital loss and a decline in net worth when a subsidiary fails.
Regarding legal issues, subsidiaries are considered independent legal entities. This implies that if a subsidiary were to face a lawsuit, the plaintiffs are not entitled to claim the assets of the holding company or the assets of any other subsidiary of the holding company.
- Less is more
The phrase less is more can also be applied to holding companies, meaning a holding company can gain control of another company without having to invest much. Hence, less capital is more control. Put differently, a holding company is allowed to control more companies with smaller amounts of capital.
When a company acquires 51% or more of the ownership of another company, it automatically obtains control of the acquired company, becoming its holding company. Therefore, a company is not required to purchase 100% of another company to control the company.
- Pooled resources
Financial resources
The financial resources of the holding company and its subsidiaries can be pooled together, enabling the company to undertake large-scale projects in order to increase its profitability and improve its net worth.
The combined financial power of the holding company and its subsidiaries can be used as bargaining power, negotiating favourable credit terms and quantity discounts with suppliers.
In addition, the combined financial resources of the group may be used to negotiate favourable financing terms regarding loans.
Human resources
A holding company and its subsidiaries may have managers and employees with different skills and know-how that could be used to the benefit of the holding company and its subsidiaries, increasing the value of all the companies involved.
- Tax benefits
Holding companies and their subsidiaries are subjected to the tax laws of the countries in which they are registered. The tax benefits for holding companies and subsidiaries differ from country to country.
Disadvantages of holding companies
Holding companies can also have disadvantages. Here are some of the disadvantages concerning holding companies:
- Over capitalisation
Pooling the capital of a holding company and its subsidiaries together may lead to overcapitalisation, affecting the returns of investors on their invested capital.
- Misuse of financial power
The financial power of a holding company may lead to irregularities, irresponsibility, and misuse of financial power.
- Exploitation of subsidiaries
There is a risk that a holding company can exploit its subsidiaries. For example, the subsidiaries may be forced to sell their goods and/or services to the holding company at exceptionally low prices. Conversely, the subsidiaries may be required to purchase products from the holding company at high prices.
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