What Is a Holding Company and How Does it Work? Advantages and Disadvantages

Fintech Harbor Consulting | What Is a Holding Company and How Does it Work? Advantages and Disadvantages
Reviewer: Bohdan Popovchenko
Reviewer: Illia Ivanko
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In today’s business environment, among the many types of entities, holding companies play a significant role. Most seek to create structures aimed at optimizing operations and achieving higher efficiency. Holding companies are one of the most common forms of organizational structure. They allow to unite several firms under common management, simplifying management. At the same time, they reduce the tax burden and provide a convenient strategic orientation.

What Is a Holding Company?

So let’s find out what a holding company is. Here’s a look at what sets it apart from other types. You can find a large number of holding company definitions. A holding company, also known as a parent firm, is established to maintain control over one or multiple subsidiaries. Unlike engaging in the production or direct sales of goods or services, its primary role is to hold controlling interests in various companies. To put it simply, it is a company that owns other companies. The term “umbrella” or parent company is also used to describe it.
To better understand their significance, we must explore their functions, mechanisms, and also we will look at the holding company benefits.
Fintech Harbor Consulting | What Is a Holding Company and How Does it Work? Advantages and Disadvantages

How Does a Holding Company Work?

The holding company operates through the management supervision of its subsidiaries. Each subsidiary has a separate administration that manages its day-to-day affairs.
The holding company can make important decisions, such as mergers or dissolutions, as well as elect and dismiss directors or managers. The day-to-day activities made by the operating company are not discussed by the management of the holding company.

The Holding Company and Subsidiary

In the relationship between a holding company and its subsidiary, the subsidiary functions as an independent company owned or controlled by the parent company, often holding more than fifty per cent of its shares. Subsidiaries maintain independence in legal, tax, and governance aspects. In the scenario where a parent company owns a subsidiary in a foreign jurisdiction, the subsidiary must conform to the laws of that specific country.

The Parent and Holding Company

A parent is a firm that operates its own business and controls the business operations of one or more subsidiaries. A form becomes a parent firm by either:
  • Acquiring a controlling stake in an existing firm; or
  • Starting a new firm under its control.
Individuals and partners who form or invest in a variety of different types of companies usually own them under one umbrella. Holding companies are established in the same way as any other business entity.

What is the purpose of a Holding Company

The main reason for the emergence of entities as a form of association of business entities is obvious. It is a desire to get more profitability at lower costs. Specific objectives and benefits of a holding company may vary depending on the objectives. Also from strategies of the parent company and the nature of its subsidiaries. The holding company structure and operations of a firm depend on the jurisdiction in which it operates.
Fintech Harbor Consulting | What Is a Holding Company and How Does it Work? Advantages and Disadvantages

How to start a holding company?

Start with a focused business plan outlining goals and strategies. Choose a legal structure, register your entity, secure initial capital, and ensure legal compliance. Understand tax implications, form a board of directors, and identify potential subsidiaries for investment diversification. Implement asset protection, hire professionals for guidance, invest in subsidiaries, stay compliant, report regularly, and consider insurance for risk mitigation. So the way how to create a holding company can be complex, so seeking professional guidance is crucial.

Advantages and Disadvantages of Holding Companies

Advantages of holding companies include asset protection during subsidiary financial troubles. They structure with subsidiaries for different business lines, providing flexibility and leveraging tax differences. Properly established holdings shield subsidiaries from each other’s debts and reduce capital costs through downstream guarantees. This is a frequent reason why having a holding company is a common practice.

However, holding firms have drawbacks, such as a complex financial position and the risk of directors concealing losses by reallocating debts between subsidiaries. Some may exploit subsidiaries to inflate their financial performance, resorting to aggressive measures like layoffs or asset divestment, known as “vulture capitalism.” Ethical governance is crucial to ensure fair treatment of subsidiaries.

Holding Company Structure

In a typical firm structure, subsidiaries produce, sell, or otherwise conduct business. They are called operating companies. A holding company may own 100% of a subsidiary or own shares. Or units to control the subsidiary. It can be 51%, or it can be much lower if there are many owners. Each subsidiary has its own management to manage day-to-day operations. The management of the holding firm controls the management of subsidiaries.
In a typical holding structure, there are two main types of subsidiaries. Operating companies. And those that own assets like real estate, intellectual property, vehicles, or equipment.

How does a Holding Company make money

A holding corporation may receive revenue from several sources, such as revenue from affiliates. Through its subsidiaries, a company can make money by getting a cut of the profits made.
Real estate and assets. Businesses may possess their own property and assets. which can be used to create revenue, for as through leasing them to subsidiaries or other parties or renting them out.
Consistent dividends. Its subsidiaries might pay them on a regular basis in dividends or interest.

What Do Holding Companies Do?

It usually exists for the sole purpose of controlling other firms. They may also own property, such as real estate, patents, trademarks, shares and other assets.
Subsidiaries held by a holding firm often span diverse industries. They allow for strategic diversification and risk mitigation. It can influence key decisions like mergers and acquisitions.
Fintech Harbor Consulting | What Is a Holding Company and How Does it Work? Advantages and Disadvantages

Tools To Manage a Holding Company

  • Financial software should be used for regulatory compliance and processing.
  • Hire legal and compliance professionals.
  • For oversight, a diverse board of directors should be established.
  • Manage and assess risks.
  • Put succession planning into practice, especially for family-run firms.
  • To maximize results, investment management should be optimized.

FAQs

Holding corporations aim for increased profitability and cost efficiency. Their specific goals vary based on the parent corporation’s strategies, the nature of subsidiaries, and the jurisdiction of operation. The formation of holding firms is driven by the desire to achieve financial benefits through strategic business associations.
A company that owns and manages other businesses is known as a holding company. It typically stays out of its subsidiaries’ day-to-day business affairs. Among these, limited liability companies (LLCs) are increasingly prevalent. Owners (members) benefit from flexible management options and minimal responsibility. They can be applied to different kinds of businesses. and have made the reporting needs simpler.
if you appreciate flexibility and lower taxes and your company does not need a complicated financial structure. Select an LLC holding company structure in these situations. If you intend to raise further funds and require greater legal protection for your assets. A C-corporation might be a wiser option.
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