A holding company is an entity usually a Limited Liability Company (LLC) or a corporation that owns other companies’ outstanding stock. It usually refers to a company that does not produce goods or services itself. Rather its purpose is to own shares of other companies for business, financial, or tax advantages.
A holding company is a great way to manage multiple business entities under the umbrella of a parent company while taking advantage of the benefits that come with it:
- Legal protection,
- Transfer of ownership,
- Tax savings, and
- Access to capital.
Holding companies can be used for a variety of purposes, including managing a diverse portfolio of businesses, simplifying the ownership and management of multiple companies, and creating a separation between the assets and liabilities of the subsidiaries and the holding company.
Let’s dig deep into what a holding company is, its types, advantages, and disadvantages so that you can decide whether you should form a holding company or not.
What is a Holding Company & Structure
A holding company consists of a parent company (LLC, S corporation, or C corporation) that owns the stock of other companies, which are known as subsidiaries. The holding company may have operational control over the subsidiaries, or it may simply hold the stock or membership units as an investment.
The holding company is typically a separate legal entity from the subsidiaries, and it is often created to manage the ownership and control of multiple businesses. Holding companies may also be used as a means of tax planning or to facilitate the transfer of ownership of a group of companies.
Holding companies are used to keep control of smaller business entities with some of their collective power. Assets owned by a holding company are generally better protected against lawsuits than those owned by individuals or smaller associated entities.
Features of a Holding Company & Structure
Some of the main features of a holding company include:
- A holding company can be a corporation or an LLC (limited liability company) and offers the same liability protection to its owners as these business entities do.
- It also provides Limited Liability Protection to all subsidiaries against the obligation of any subsidiary within the umbrella of the parent company.
- A holding company does not typically produce goods or services itself but instead derives its income from the profits of its subsidiary companies.
- It has ownership and control of multiple subsidiaries (often in different industries).
- It ensures the consolidation of operations and financials across all companies in the corporate group.
- It creates an overall business strategy to advance the interests of all companies in the conglomerate.
- It offers additional services, such as financial planning, estate planning, and tax preparation.
- It has financial benefits, such as consolidated income taxes and shared costs among the subsidiaries.
Types of a Holding Company
Depending on the operational activities, a holding company has the following two types:
1. Pure Holding Company
This is a holding company that does not have any operations of its own and exists solely to hold the stock of other companies. It may receive dividends or profits from the subsidiaries, but it does not generate any revenue through its own operations.
2. Mixed Holding Company
It is also called a holding-operating company. It may hold the stock of one or more subsidiaries and have operational control over them, but it may also have its own operations and generate revenue through its own business activities.
Depending on the level of ownership and control, a holding company falls into the following 3 categories:
1. Ultimate Holding Company
It is the highest level holding company in a holding company structure. It is the company that owns the major stock of one or more holding companies or other business entities. An ultimate holding company is not a subsidiary of any other business entity.
The ultimate holding company typically has the highest level of ownership and control within the holding company structure.
2. Immediate Holding Company
It is a holding company that owns the stock of one or more subsidiaries but is itself owned by another holding company, known as the ultimate holding company. An immediate holding company may have operational control over the subsidiaries or it may simply hold the stock as an investment.
It is typically one level down from the ultimate holding company and has a lower level of ownership and control than the ultimate holding company.
3. Intermediate Holding Company
This is a holding company that is owned by another holding company, which is known as the immediate holding company. The intermediate holding company may hold the stock of one or more subsidiaries, and it may have operational control over them.
An intermediate holding company is typically one or more levels down from the immediate holding company and has a lower level of ownership and control than the immediate holding company.
Example of a Holding Company
Here is an example of how a holding company acts:
- ABC Corporation is a holding company that is owned by a group of investors.
- ABC Corporation owns the outstanding stock of XYZ Corporation, a manufacturer of auto parts.
- ABC Corporation also owns the membership unit of KLM LLC, an auto repair shop.
- XYZ Corporation operates independently, producing and selling auto parts to car manufacturers. The same KLM LLC works independently and provides auto repair services.
- The profits generated by XYZ Corporation and KLM LLC are distributed to ABC Corporation as dividends.
- ABC Corporation uses the profits from XYZ Corporation and KLM LLC to invest in other companies or to distribute profits to its investors.
In this example, ABC Corporation acts as a holding company by owning the stock of XYZ Corporation and KLM LLC and receiving the profits from these companies.
This structure provides liability protection for the investors in ABC Corporation and allows them to manage and control the operations of XYZ Corporation and KLM LLC without being personally responsible for its debts or liabilities.
XYZ Corporation and KLM LLC act as independent companies despite being subsidiaries of ABC Corporation. They are also protected against the liabilities of each other. If KLM LLC is sued, XYZ Corporation will not be liable and have no obligation for the liabilities of any other subsidiary under the ABC Corporation.
How To Create a Holding Company LLC or Corp?
To create a holding company, you need to decide whether the holding company will be a corporation or an LLC. After Deciding, you can follow our DIY guide on How to start an LLC or How to form a corporation.
Tip of the Day: Forming an LLC or corporation by yourself is mostly hectic, costly, and time taking. Hiring a professional and legit corporation or LLC Service online like ZenBusiness or IncFile not only saves your time but is also budget-friendly. Therefore we recommend you to:
Advantages of a Holding Company
There are several advantages to using a holding company structure:
- Simplification of ownership and management: A holding company can simplify the ownership and management of multiple businesses by centralizing control and decision-making at the holding company level. This can make it easier to manage and coordinate the activities of the subsidiaries and to make strategic decisions about the overall direction of the group.
- Separation of assets and liabilities: A holding company can provide a separation between the assets and liabilities of the subsidiaries and the holding company. This can provide a level of protection for the subsidiaries in the event that one of them experiences financial difficulties or becomes involved in legal proceedings.
- Tax planning: Holding companies can be used for tax planning purposes, such as to take advantage of lower tax rates or to facilitate the transfer of ownership of a group of companies.
- Flexibility: A holding company structure allows for flexibility in terms of the ownership and management of the subsidiaries. The holding company can hold a controlling stake in the subsidiaries, or it can hold a minority stake while still maintaining some level of control through voting rights or other means.
- Potential for growth: A holding company structure can provide a platform for growth, as the holding company can acquire additional subsidiaries or invest in new businesses. This can allow the group to diversify and expand its operations over time.
Disadvantages of a Holding Company
While holding companies can offer a number of benefits, there are also potential disadvantages to consider:
- Complexity: Holding company structures can be complex and may involve multiple layers of ownership and management. This can make it more difficult to understand the relationships between the various companies and to make informed decisions about the direction of the group.
- Increased costs: Setting up and maintaining a holding company structure can involve additional costs, such as legal and accounting fees. These costs may be passed on to the subsidiaries or may be borne by the holding company itself.
- Lack of control: If a holding company does not have operational control over the subsidiaries, it may be limited in its ability to influence the direction and performance of the businesses.
- Reduced transparency: A holding company structure can make it more difficult for outsiders, such as investors or regulators, to understand the financial and operational performance of the subsidiaries. This can reduce transparency and make it harder for outsiders to assess the risk and potential return of investing in the group.
- Potential for conflict of interest: If the holding company has operational control over the subsidiaries, there may be potential for conflicts of interest to arise. For example, the holding company may prioritize its own interests over those of the subsidiaries, or it may make decisions that are not in the best interests of the subsidiaries.
While creating a holding company can provide several potential benefits, it’s not always the right choice for everyone. Ultimately, forming a holding company is a decision that should be weighed carefully and discussed at length.
It is important to have a clear understanding of the goals the company wishes to achieve and how forming a holding company will help reach these goals.
Knowing what type of benefits you want out of reorganizing your ownership structure is key in deciding if a holding company better suits your needs than another structure such as a series LLC. You can compare series LLC vs holding company before taking the final decision.
Aisha Noreen is an owner of a small business with more than 9 years of experience in the marketing industry. With the wisdom of an old soul, she always seeks innovation and mind-blowing ROI techniques. Her unique approach helped many small businesses thrive and she can surprise you in many ways as well. Believe it or not, her energy, passion, and creativity are contagious enough to transform your business and take it to another level.