Let’s suppose someone starts a business that meets its goals and is expanding. If the stakeholder, i.e., a business owner, doesn’t divert the available cash flow in that business, it’s prone to several litigation policies.
But, when that operational unit has a central authority, its working and profits both stay safe. That intermediate unit is called a holding company that supervises multiple businesses without facing any liability.
In this guide, you’ll know what a holding company is, how it makes money, and how it is established from the ground up. So, read on, and clear your doubts.
Definition of a holding company
A holding company is the parent organization that oversees different businesses and controls its policies. This company doesn’t run the day to day activities but supervises them and ensures that a business meets its set target.
Simply put, a holding company owns the highest rank in a business tree, which controls its shafts, i.e., subsidiaries. It owns stocks in several companies at once and can shift their management to achieve its long-term goals. The holding company lets you invest your profits elsewhere with minimal risk.
Mitsubishi UFJ is an Asia-based leading holding company which owns many subsidiaries and is balancing their operations.
How does a holding company work?
There are two answers to this question:
- First, a company buys shares/stocks from any business. It earns the power to control its policies, ultimately becoming its supervisor.
- Second, a business owner develops his own holding company to use as the anchor between his smaller branches.
When a company has above 10% shares in a business, it becomes an absolute authority. So, it doesn’t matter if a holding company is an external body or owned by the same person who runs the subsidiaries; its role will stay the same.
Types of holding companies
Following are the four main types of holding companies depending upon their participation in the operational units:
Pure holding company
This company is solely developed to buy and own assets in other businesses, without participating in their production/development process. When someone deposits a considerable sum in their holding company’s account and buys shares/stocks through it, they operate a pure holding company.
ATCO is a Canada-based pure holding company that owns assets in several electricity and gas companies. It dictates their managerial decisions and ensures a smooth cash flow in the subsidiary companies.
This one has some participation in the business handling and shares of its subsidiaries. When a stakeholder designs a holding company to leverage his business, he takes an interest in the profits, losses, and taxes of the subsidiaries.
When a company becomes an equity partner in another organization, it oversees funding and profits simultaneously, making it a mixed holding company.
When an operational company directly reports to a holding company, which is also a subsidiary of another group, it’s termed immediate. A business that supervises another and has its operational units is called an immediate holding company.
Business cycles are vast and include multiple layers of supervision. An intermediate holding company is put in place to record a circle of companies’ financial status so that the main stakeholder doesn’t stress over these matters.
Instead, he can deploy several intermediate hands to track smaller businesses and maintain a sustainable model.
Benefits of holding companies
A holding company is an anchor between your business and the state authorities. It collects the money trail from an organization’s smaller branches and lets the owner track them with no loophole.
When a business grows, its taxable amount also increases, eventually drying up the free-floating cash.
However, business conglomerates incorporate a holding company that works as an intermediary between the tax-claiming authorities and an operational unit.
Here are the main benefits of holding companies:
When a holding corporation buys above 50% stocks in a subsidiary, it gains authority over it. It can decide about the smaller counterpart’s funding, management, and business model without having to buy its 100% shares.
Let’s suppose a holding company owns several businesses, each with its separate entities, goals, and management.
If any of those subsidiaries fails to achieve the goals or goes bankrupt, the holding company won’t be accountable for refunding the creditors.
This reduces the risk and lets investors divide their cash in smaller chunks with minimum liabilities. A holding corporation implies that even when a subsidiary fails, the capital owner won’t face a setback. Although its net worth would decrease, there won’t be any legalities or claims included in the recovering phase.
Running multi-layered companies requires efficient and well-controlled management at each level. One authority controls all steps of a business, the liabilities, and risk increase.
However, when a large organization divides its assets and checks its business at multiple levels, it’s more manageable. The sole owner can put his trusted people in higher positions and reduce the chances of failures to a great extent.
Money trail management
When the holding company owns operational units, it means the revenue doesn’t belong to an individual but a corporation. The shareholder can withdraw money from its subsidiaries in the holding company as an inter-organization cash flow and avoid a few tax rules.
Similarly, when a business has a steady cash flow, its creditors may cause different litigation hurdles. The holding company works as a shield for the owner and subsidiaries by holding the cash flow for the time being.
A holding company provides you with tax-free dividends, which might cost a lot for personal money withdrawals.
When the investor/intermediator, i.e., a holding company, backs a loan procedure, the subsidiary companies get debt at lower interest rates, which is beneficial for both parties.
The holding company provides its branches with low-liability money. The subsidiary gets the debt at lower interest rates when a significant stakeholder backs it.
What are examples of a Holding Company?
Alphabet Inc. is the holding company of Google, aimed to manage Google’s subsidiaries without creating havoc in the company.
Sony is a Tokyo-based holding corporation that is there to control Sony’s expansive business. This holding company holds assets of different sub-branches of Sony, eventually shifting them to the central command.
Johnson & Johnson
JNJ is one of the oldest holding companies which still hold a considerable share in the business world. It has a few world-famous subsidiaries like Neutrogena, McNeil Consumer health, etc.
How does a holding company make money?
A holding company receives dividends from its subsidiaries based on the contract terms. The holding company’s profit margin is decided before buying the stocks in a subsidiary so that its money stream isn’t disturbed.
Most holding companies own intellectual business properties, i.e., brand names, formulas, and copyrights, which allows them to claim a fair share in the operational unit’s earnings.
For example, Johnson & Johnson is a well-known baby product brand and a holding company. If a smaller manufacturer buys the brand’s royalty from JNJ to sell its products, the holding company will earn through it, without participating in anything.
You start a grocery store that suffices your initial investment within a few years and has now become a high-value property. If you only own that one high-paying store, you don’t grow beyond a limit.
But, when you take out funds from it and invest them somewhere else, a business conglomerate starts to develop.
However, it’s never that simple. You need some surety and guarantee that if a portion of your income becomes a deficit, you don’t go bankrupt.
That’s when a holding company plays its role. It works as a third party that holds your collective funds and allows you to distribute them in multiple businesses.
You may be interested in opening an ice cream franchise or a spa, we never know. What you do is, you collect your capital in the holding company, and buy new businesses through it.
You invest some amount in the stock market and some in an operational unit without losing it all.
For example, Berkshire Hathaway is a well-established holding corporation in the US, according to its total revenue. This company owns shares in over 100 public properties, landmarks, and stocks, which gives it a net worth of around 210 Billion USD.
How to start a holding company?
As I mentioned above, there are two ways to start a holding company, but the procedure to register and deposit assets is the same.
- You have to register your holding company in a state and provide your business name and the person who runs the operation company.
- If you are building the holding company from the ground up, you can be the operational and holding company agent simultaneously.
- Open a bank account for your holding company, which will track the money trail associated with it.
- The last phase is to deposit the assets in your holding company’s account. This amount/credit can be used for either of the two companies upon the owner’s consent.
Registering and starting a holding company isn’t a tricky task, but marinating the balance between its subsidiaries is. For example, when a holding company is associated with MNCs and business chains, it has to ensure a fair distribution of money.
A holding corporation can also become the equity partner with an operational unit by buying its shares and co-signing the debt contracts. However, that’s not advisable for a real estate holding agency as it’ll be exposed to several liabilities in the process.
What is a parent company?
As the name suggests, a parent company is the head of any business corporation. It can either belong to the same stakeholder who owns the smaller units or someone else.
This parent company votes and selects its subsidiaries’ CEOs, eventually becoming the high almighty in any organization.
A parent company doesn’t bear the loss when one of its subsidiaries/branches goes bankrupt or faces a significant setback.
BAJAJ FINSERV LTD is India’s biggest parent company, which owns 19.66 Billion USD in many real estate holding companies in the country.
Since the managers are responsible for operating their respective branches, a parent company doesn’t get affected by any losses or redemptions.
Difference between a holding company and a parent company
Most people question what a holding company is and its significance in a business model being inactive. A holding corporation owns an idle position and doesn’t directly participate in services or product development. It selects the board of directors, CEOs, budgeting, and withdrawals from its subsidiaries while ensuring smooth operation.
On the other hand, a parent company can be active and have interests in a company’s production unit. The parent company is the sole owner and head of any conglomerate, mostly run by a single stakeholder. It implements several changes and holds the managers accountable for not achieving specific goals.
Despite that, the parent organization also ensures balanced cash and tax flow in its smaller branches like a holding company.
What is the difference between a holding company and an investment company?
An investment company manages all the financial needs of a newly established business and is responsible for filing any shortcomings. In return, it claims a share in the profits and losses of the firm. This parent company may entirely own a smaller business or have a percentage in its shares.
On the other hand, a holding company is mainly developed for owning assets. It takes managerial decisions and ensures an interrupted cash flow in its subsidiaries with no control over the profit or loss margin.