What is a holding company?
Holding companies are business entities, such as corporations or limited liability companies (LLC). A holding company may often be called an “umbrella” or a parent company. However, they typically do not manufacture, sell or conduct business operations. Instead, holding companies are used to control the stock of other companies.
Even though a holding company may own other company assets, it is often limited to only oversight responsibilities. It may review a business’s management decisions and not actively involve itself in running the company’s daily operations. The holding company holds assets for these other companies are referred to as subsidiaries.
Holding companies are not responsible for the debts of any of their subsidiaries. So, if a subsidiary goes bankrupt, the creditors cannot go after the holding company.
What is the purpose of a holding company?
The primary purpose of a holding company is to control other companies. They can also hold the property of their subsidiaries, including any trademarks, patents, stocks, or other assets.
If a holding company owns a business, that business is called a “wholly-owned subsidiary.” In this case, a holding company can hire and fire any of the wholly owned subsidiary managers. However, the managers are responsible for the operations of the company.
What are the benefits of holding companies?
As mentioned above, holding companies are not held personally liable for any losses that subsidiary companies have. Nevertheless, the holding company may still experience a capital loss and a decrease in its net worth. However, the bankrupt subsidiary cannot pursue the holding company legally.
This holding company's key characteristic protecting it from liability is often utilized as an asset protection strategy. This is done by having one holding company owning a subsidiary’s brand name and trademarks and another owning the real estate. This method prevents the exposure of the holding company and its subsidiaries. It also provides the added benefit of lower tax rates if parts of the business are located in areas with lower tax rates.
The holding company must be set up correctly so that any debt liability from one subsidiary does not affect the others.
Holding companies also help to protect an individual business member's assets. These assets are held by the corporation and not by the individual, thereby shielding them from debt liabilities, lawsuits, and other potential risks.
Holding companies lower the cost of operating capital for their subsidiaries. Through downstream guarantees, the holding company can pledge a loan for the subsidiary. This can aid companies in receiving lower interest rates for their loans. Using the financial strength of a holding company can decrease the risk of a subsidiary defaulting on its debts.
The general advantages of holding companies are further listed below.
- Protection from liability as mentioned above.
- Control assets at lower costs. The holding company doesn’t own all shares or membership interests. This allows the holding company to have control of another company and its assets at lower costs than if it had all of the subsidiary ownership interests.
- Lower interest rates for loans. As mentioned above, the financial strength of a holding company can be used to obtain loans for lower interest rates than if the subsidiaries were to take out the loans themselves.
- Improves innovation. By treating operating companies as separate entities, there is less risk with startups and other risky ventures. So for instance, Alphabet is the holding company for google. Alphabet helped restructure google so that business ventures seen as riskier such as google glass and medical research, would not jeopardize the more profitable components of google, such as the search engine and youtube.
- No need for daily management. Each subsidiary is responsible for its management and day-to-day operations.
What are some disadvantages of a holding company?
There are some disadvantages to utilizing a holding company, such as the following:
Costs for formation and compliance
When forming a holding company, each subsidiary needs to pay formation fees.
- Challenges for management. Conflicts can occur with subsidiary owners when they differ from the holding company.
- Complexity. There are more parts to keep track of holding companies, such as the associated subsidiaries.
What are the general steps to forming a holding company?
- Decide whether your holding company will be an LLC or a corporation.
- Select a name for your company.
Draft and sign an operating agreement (LLC) or bylaws
New Jersey does not require these documents, but they are recommended regardless.
- File paperwork to form the company. Submit the certificate of formation for an LLC or a corporation. The fee for submitting the certificate of formation in New Jersey is $125 for both a corporation and an LLC.
- Obtain an EIN from the IRS.
- Obtain any needed business licenses. You can see whether you need any by searching New Jersey’s Division of Revenue site.
- Set up any subsidiary companies or transfer the existing companies to the holding company.
How is a holding company financed?
The holding company's people are ultimately responsible for deciding where to invest their money. There are several ways holding companies can obtain funds by selling equity interests in themselves or their subsidiaries or by taking out loans. Another way it can obtain funds is by receiving payments from its subsidiaries through interest payments, rents, distributions, dividends, and payments for any other functions it provides.