What is a Holding Company?
A holding company is a specific type of company that owns and controls subsidiary companies. It can be structured as a limited liability company (LLC), parent company, or limited partnership (LP) that owns part of a majority of stock to gain managerial control. Holding companies can own assets and pay debts like any other incorporation.
A holding company functions as a parent company to form corporate groups through mergers and acquisitions rather than stock ownership. The company controlled by the parent company is called an operating company or subsidiary. The holding company can engage in business activities such as managing investments, providing financial services, and holding and leasing real estate.
This web page also discusses holding companies.
What is an Example of a Holding Company?
The most well-known example of a holding company is Berkshire-Hathaway, founded by Warren Buffett. It holds subsidiaries across a wide range of industries worldwide and is estimated at a worth of $102.8 billion. In addition, Berkshire Hathaway has made over 50 acquisitions and 60 investments.
Advantages of a Holding Company
Business owners form a holding company and subsidiaries to structure their business as it expands. A holding company can mitigate risk and maximize operational efficiencies for growing and diversifying a business. Keep in mind there are legal doctrines and regulations that can pierce the corporate veil and hold the holding company liable for certain obligations of its subsidiaries.
Here are the three advantages of a holding company:
- Safeguards Assets. A holding company can hold a business’s valuable assets, such as equity, intellectual property, and equipment. The subsidiaries then take over the business’s daily operations and trading responsibilities. As a result, the holding company’s valuable assets are protected from creditors and other liabilities. The holding company may still have a role in strategic decision-making and oversight.
- Minimizes Risk. When a holding company owns assets and operates independently from an operating company, losing assets is minimized if the operating company performs poorly or becomes insolvent. For instance, if an operating company declares bankruptcy, the holding company may also suffer financial losses. Creditors will not pursue the holding company legally, resulting in fewer financial obligations.
- Reduced Taxes. The holding company may be structured to qualify for lower tax rates. It’s possible to build a holding company in a lower-tax country. However, new laws enacted in 2016 to regulate tax or profit shifting to non-US counties have limited potential tax benefits.
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Disadvantages of a Holding Company
Holding companies are a great solution when you want to manage many corporations under a single “roof.” However, there are downsides to using a holding company as well.
Here are the three disadvantages of a holding company:
- Excessive Capital. Due to the possibility of pooling the holding company’s capital and its subsidiaries, overcapitalization may occur. As a result, shareholders would not receive a reasonable return on their investment in this situation.
- No Control Over Director Selection. Subsidiary companies may be compelled to appoint directors or other officers chosen by holding companies. Therefore, this strategy does not always result in resolutions in the company’s best interests.
- Subsidiary Exploitation. The holding company may profit from the activities of its subsidiary companies. Subsidiaries may be forced to purchase goods from the holding at inflated prices. They may be compelled to sell their produce at rock-bottom prices to the holding company. However, the relationship between a holding company and its subsidiaries should be based on fair and arm’s length transactions.
Difference Between an LLC and Holding Company
A holding company could be formed as an LLC. However, the most significant difference is that a holding company does not engage in operational activities, whereas an owned subsidiary LLC could. However, the choice of entity will depend on various factors such as tax considerations, liability protection, and governance requirements.
Holding Company vs. Operating Company
A holding company is the parent company of the operating company, which is its subsidiary. Operating companies are typically responsible for the day-to-day business management that the holding company controls. Additionally, the operating company is responsible for recruiting all employees and liable for all debts. The holding company may still be involved in hiring and financial matters.
How To Start a Holding Company
Forming a holding company is similar to creating any other type of business. The distinction is that a holding company does not manufacture or sell products. Instead, it owns one or more other companies. Still, it can help you protect your businesses from liability and safeguard your assets.
Here are the ten steps for starting a holding company:
Step 1. Select a Location
The first step is to determine the state in which to consider incorporating. Of course, most business owners choose their state of residence. However, Delaware is also an excellent choice for its favorable business services.
Step 2. Select an Organizational Structure
You have two structure options for a holding company, including an LLC, C corporation ( C corp ), or S corporation ( S corp ). LLCs and S corps provide better asset protection, reduce compliance requirements, and allow you to avoid double taxation through pass-through taxation.
Step 3. Your Holding Company’s Name
The third step is to select a business. Naming a company after yourself is nice, but it affords no privacy protection. Select a name that holds meaning to you but does not reveal your name or location.
Step 4. Establish Corporate Bylaws
Next, you create your governing documents in the form of corporate bylaws. Corporate bylaws are an essential governance document that establishes the rules of your holding company. For example, an operating agreement is required for an LLC, while bylaws are needed for a corporation.
Step 5. Establish Ownership Percentages
Establishing ownership percentages includes a description of the ownership percentage received by each member and investment amounts contributed. In most cases, the ownership percentage is proportional to the value of the initial contribution. Additionally, this section of the governing document should include any regulations or rules governing ownership changes. This should consist of the procedure for current owners to sell their shares and for new shareholders or members to join the company.
Step 6. Appoint Directors
Bylaws should also address how the business will be managed. For example, LLCs may be managed by a manager or members, whereas corporations appoint directors. The operating agreement should clearly define the structure you choose. This should also include the manager’s and members’ responsibilities and rights.
Step 7. File Articles of Incorporation
Now it's time to file your articles of organization with your secretary of state’s office. First, you complete a short form with relevant holding company information and pay a filing fee. After filing your articles, you will need to record meeting minutes and file an annual report to stay compliant.
Step 8. Get an EIN
Each business is assigned an employer identification number (EIN) from the IRS after receiving your certificate of incorporation. The EIN identifies your business on federal tax returns. While all corporations require an EIN, certain single-member limited liability companies may be exempt.
Step 9. Open a Bank Account
It’s relatively straightforward to open a business bank account. You must provide the bank with your articles of incorporation or organization, corporate bylaws or operating agreement, and EIN. This account can help you establish credibility and make company purchases.
Step 10. Form Subsidiaries
Generally, it is easier to establish a holding company first and then subsidiaries. This is because you will designate the parent company of the subsidiaries as the holding company for the initial documents to be properly drafted. However, suppose you already own businesses and wish to consolidate them under your holding company. In that case, you must amend each subsidiary company's operating agreement or bylaws to reflect the new owner.
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