What is a holding company?
A holding company is a business entity, usually a corporation or an LLC, that holds a controlling share of stock or assets in a company. Holding companies typically do not sell goods or services, manufacture any products or parts, nor perform other business functions. The main purpose of a holding company is to act as a parent company to another business and hold majority shares. This ownership allows the holding companies to have decision making power in the businesses structure, including the power to buy and sell their shares to generate income as well as being able to sell or dissolve the business.
What is the purpose of a holding company?
Holding companies are set up to be the controlling interest of another company. They only have to own enough stocks or assets to have final say in major company decisions. This can be 51% ownership, though a holding company can also own real estate property, intellectual property and trademarks, patents, and any other asset.
Many companies choose to form their own holding companies or merge with existing ones to limit their liability, open up access to capital and borrowing, and diversify their scope of business. By separating parts of your business into a holding company and its subsidiaries, it can allow your business to grow and innovate.
Different types of holding companies
Because so many business models can benefit from using a holding company, there are different types available. Depending on the size and functions of your company, you’ll want to know all your options before deciding upon one.
- Pure: Pure holding companies are the simplest of the bunch as they are formed with the sole purpose of holding the majority share of a company. They typically do not perform any other function than to hold this ownership and keep it separate from its subsidiaries.
- Mixed: A mixed holding company (also known as holding-operating company) not only owns the controlling share in another company, but it also performs its own business functions and operations.
- Immediate: An immediate holding company is also a subsidiary of another holding company, yet still holds a controlling share in its subsidiary’s stock, but is overseen by another parent company.
- Intermediate: Like an immediate company, an intermediate holding company acts as both a subsidiary of a larger holding company, and the parent company and interest holder of a smaller subsidiary.
Advantages of holding companies
Though holding companies are most often seen with larger companies, even smaller businesses can benefit from teaming up with a holding company or forming their own.
One major draw of using a holding company is the liability protection it offers. Many larger businesses who have multiple divisions may choose to form one holding company, then split up the remaining divisions into subsidiaries under it. This is why holding companies are sometimes called “umbrella companies.” This allows the subsidiaries to operate on their own and if they are subject to loss or litigation, only that subsidiary can be held liable, not the larger holding company or other subsidiaries.
Control Assets for Less Money
Because holding companies only have to own the controlling share of the companies they parent, they are able to control the operations and assets of its subsidiaries while only owning 51% of the stock.
Lower Debt Financing Costs
Businesses that use holding companies are able to leverage the power of this to their advantage when seeking financing. Oftentimes smaller businesses may not be able to qualify for the terms or amounts that a larger company can. The holding company can back the smaller subsidiary and use what’s called a downstream guarantee to obtain better financing for them.
Disadvantages of holding companies
Setting up and using a holding company is definitely a more complex business model than a simple corporation or LLC. Also, while the holding company does not participate in the day to day operations, it can make decisions about its lower subsidiaries that can be very consequential like selling or dissolving the company.
Holding companies also cost more to maintain, especially when they are coupled with the division of the rest of the company into subsidiaries. Each separate entity will have to pay for and comply with all state and federal regulations, filing, and renewal requirements.
Manipulation or Coercion
In some cases the holding company can exert too much power and it can bridge into manipulation or coercion of its lower subsidiaries. Because the holding company exercises majority rule in decision making, this can put the lower tier companies in an unfair spot.
How to set up a holding company
If you are considered setting up a holding company within your business or working with an existing holding company, it is highly recommended you consult with a financial planner or business lawyer. Holding company structures will add complexity and cost and you need to know exactly what you are doing.
You will first need to decide which business structures you want to use and how many subsidiaries you’ll want to create to be under the holding company. You’ll then need to decide if it’s more advantageous to be taxed as a corporation or as a pass through entity, which state or states you want to file formation papers in, as well as business names. If you are merging with an existing holding company it will require shareholder approval.
The process is more complicated than setting up a single corporation or LLC and should be done with the help of an advisor. Learn more about how to set up a holding company and New Mexico LLC benefits here.