In this edition of our Finance 101 series, we will study the concept of holding companies.
A holding company is a company that exercises control over another company. The company that is being controlled is known as a subsidiary company.
A holding company is said to exercise control over its subsidiary in two cases:
- When the holding company has majority voting rights in a subsidiary through ownership of common shares; or
- It has the power to control the composition of the board of directors of subsidiary companies. This means that the holding company may appoint or remove the majority of directors of the subsidiary company.
Here is a glimpse of the contents of this article:
- Example of Holding Company
- Creation of Holding Company
- Types of Holding Companies
- How Does a Holding Company Work
- Benefits of Creation of Holding Company
Let’s get started!
Example of Holding Company
You may have heard recently that Alphabet Inc. owns Google, but you probably always thought Google was its own company. The fact is that Alphabet Inc. acquired the entire controlling stake (i.e. 100% shareholding) in Google. That’s why Alphabet Inc is now the holding company of Google.
There are a lot of corporate restructuring arrangements like this one going on in the world constantly. Websites such as Easymarkets.com, Motley Fool, and One Billion Signals are great ways to stay updated about important restructuring deals like this one. These resources will help you keep track of essential restructurings.
Creation of Holding Company
Bringing a holding company into existence is a very easy process. There are two ways in which a holding and subsidiary company relationship can be developed.
- A company can acquire common stocks of another company carrying the majority (more than 50%) voting rights and become a holding company of another such company.
- If a company acquires the power to control the composition of the board of directors of another company, either by way of agreement or otherwise, then the company acquiring this power becomes the holding company.
Thus, either of the above two scenarios would lead to the creation of a holding company.
Types of Holding Companies
Holding company may be of different types:
Parent Holding Company
An existing company acquires majority voting rights in existing companies or incorporates new companies under its ownership.
Pure Holding Company
A holding company which has been formed principally to manage and control the subsidiaries. A pure holding company is formed to unite all the individual subsidiaries in a large business group.
Offspring Holding Company
A new company is incorporated to take over the majority shares of an existing company.
Intermediate Holding Company
A holding company that controls its subsidiary but it is also being controlled by a holding company.
For example, XYZ Ltd controls ABC Ltd and thus XYZ Ltd is the holding company of ABC Ltd. In the same example, PQR Ltd is the holding company of XYZ Ltd. Here, XYZ Ltd is the intermediate holding company which has PQR Ltd as its holding company and ABC Ltd as its subsidiary company.
Proprietary Holding Company
A company that has control over the entire common stock of its subsidiary company.
Operating or Mixed Holding Company
A holding company that carries out its business activities in addition to controlling the activities of its subsidiary.
Primary Holding Company
A holding company that is the head of a whole group structure and is not being controlled by any other company.
How Does a Holding Company Work?
Generally, holding companies are formed with a purpose to own shares in subsidiary companies. The holding company is entitled to receive dividends o these stocks from its subsidiary companies. Holding companies are usually not involved in the production of goods or rendering of services. They own and protect the valuable business assets of the business group. These assets could include immovable property, investments, intellectual property rights, and so on.
Holding companies may also be managing the affairs of subsidiaries and supervise their activities. Sometimes, a holding company may be involved in business activities also. Such a holding company is known as an operating or mixed holding company.
Benefits of Creation of Holding Company
The structure of holding-subsidiary companies is being followed worldwide. It offers a range of benefits to the companies.
- Holding companies are sometimes formed to own valuable business assets. The subsidiary company can focus on its business operations and the valuable assets remain safe with the holding company in the sense that no creditor can claim any amount from such assets in case the subsidiary company faces financial stress.
- In some jurisdictions, the corporate tax rate is less for holding companies that own a prescribed percentage of share capital in its subsidiary. Thus setting up holding companies in such jurisdictions such as the UK would offer you tax benefits as a result of which tax expenses of the overall business group would be minimized.
- When the scale of operation of a group is large, they prefer the holding-subsidiary structure so that the holding company can’t be held responsible for the risks of operating losses of the subsidiaries. Even if the subsidiaries go bankrupt, the creditors can’t file a suit against the holding.
- The group of holding and subsidiary companies, as a whole, gains economies of scale. The group as a whole can negotiate better deals and terms.
- Holding and its subsidiaries coming together to work in a partnership help them attain a greater market share in the industry.
- The creation of a holding company structure is a very easy process as the same involves purchasing the majority shares in the company that you wish to set up as a subsidiary company.
If you want to create a holding company, first understand the need for the same. Finalize a structure that you are looking for and go through the legalities for the creation of a holding company in a jurisdiction.