What is a Holding Company?

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Definition:

A holding company is a corporation, company, or other legal entity that owns one of more businesses entirely or owns enough shares in another company to control it.

🤔 Understanding holding companies

A holding company is a legal entity that has ownership over another company. Typically, holding companies don’t produce goods and services themselves. Instead, they own enough of a share in other businesses to control them and provide oversight over their operations. Each firm that a holding company owns remains separate from the others, and the holding company is independent of each business it owns. Large conglomerates often use holding companies with one parent business owning many smaller businesses. Holding companies can provide a variety of tax and legal benefits that can make them attractive to business owners.

Example

Perhaps the best-known holding company in the United States is Berkshire Hathaway — which is both a holding company and a conglomerate. Berkshire Hathaway purchases large stakes in other companies, influencing their behavior and reaping the profits of their success.

Berkshire Hathaway holds large stakes in some companies — It wholly owns others. Some of the businesses that Berkshire Hathaway holds non-majority stakes in as of February 2020 include:

  • American Express
  • Kraft Heinz
  • Delta Airlines
  • Bank of America
  • Southwest Airlines
  • Coca-Cola

In addition, Berkshire Hathaway owns other companies outright, including Geico, Berkshire Hathaway Reinsurance Group, and PacifiCorp.

Takeaway

A holding company is like a pair of cargo pants…

When you put on a pair of cargo pants, you can hold many different things in all of the pockets. One pocket might hold your wallet. Another pocket might hold your cellphone and a charger just in case. A third could hold a sandwich for lunch. In a similar way, a holding company can hold many different businesses.

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What is a Holding Company?

A holding company is a business designed to own multiple other companies. Most holding companies don’t operate their own businesses, like manufacturing or retail. Instead, holding companies usually serve as a legal entity that can own multiple other companies while allowing them to remain separate from each other.

Holding companies usually own a significant enough stake in the businesses they own to influence their actions. This can mean the holding company owns half or more of each business’s shares, or merely a large percentage.

What are some examples of a holding company?

One of the most famous examples of a holding company is Berkshire Hathaway. The holding company owns significant stakes in dozens of different businesses — and owns some businesses outright.

Another example of a holding company is Alphabet. Alphabet is the parent company of Google. It also owns Google Fiber, Calico, Verily, Sidewalk Labs, GV, CapitalG, JigSaw, DeepMind, X, Waymo, and Project Wing.

Sony is another well-known holding company, owning Sony Electronics, Sony Global Manufacturing & Operations, Sony Interactive Entertainment, Sony Mobile Communications, Sony Music Entertainment, Sony Network Communications, and Sony Pictures.

What is the purpose of a holding company?

Holding companies have many purposes, including earning money for their owners and providing legal protection to subsidiary businesses.

One of the most common uses for holding companies is dividing different business operations into independent businesses. This provides significant legal protection to businesses.

For example, imagine business XYZ works in two different industries, manufacturing widgets and operating shipping vessels that transport goods across the ocean. If one of the company’s shipping vessels sinks, it will need to compensate the businesses that paid it to ship their products.

Because XYZ is one business, all of its assets, including the manufacturing assets, will be at risk if a court orders it to pay back the companies that hired it to ship their goods.

If XYZ instead established a holding company and split its business into two independent units, one that focused on shipping and one on widget production, each firm would be insulated from the other. The widget business cannot then be held liable for the shipping business’s debts, and the shipping business is free to declare bankruptcy without affecting the widget company.

Holding companies also provide for centralized control of the subsidiary businesses. The owners of the holding company can influence the management of the subsidiaries. If the holding company owns enough stock, its owners can even pick the management team for each subsidiary without input from anyone else.

What are the types of holding companies?

There are many different types of holding companies. Each operates differently and offers various benefits.

Pure holding companies

A pure holding company has no purpose other than holding shares in other businesses. It doesn’t produce goods or services.

Mixed holding companies

Mixed holding companies operate their own business, producing goods or services for other companies or consumers, and hold shares in other companies. If a mixed holding company operates in an industry unrelated to that of its holdings, it is called a conglomerate.

Immediate holding companies

An immediate holding company owns stock in another business that is already owned by a third company.

Intermediate holding companies

An intermediate holding company is a holding company that exists under a larger company. If holding company A owns holding company B, which owns business C and D, company B is an intermediate holding company. It is the intermediary between company A and business C and D.

Offspring holding companies

An offspring holding company is a new business that formed for the express purpose of taking ownership of a different, existing business.

How do holding companies make money?

Holding companies make money when the businesses they own make money. You can think of a holding company like an investor.

When you invest in a stock or mutual fund, you’re hoping that the value of your investment will increase or that the investment will pay dividends that you can use or reinvest. When a business owned by a holding company performs well, the value of that business should likely increase. The holding company could sell its shares in that business for a profit. If the firm pays dividends, the holding company receives cash dividends that it can use for other investments.

If a holding company wholly owns its subsidiaries, it may set requirements for how much money it must receive from the subsidiary. For example, a holding company may demand $100 million in payments from its subsidiary every year, allowing the subsidiary to retain the rest for growth. Others take all of their subsidiaries excess cash.

Holding companies that offer their own products or services can also make money through the sale of those products and services.

What are the advantages and disadvantages of a holding company?

One of the most significant advantages of a holding company is that it reduces risk and provides legal protection. If one subsidiary business loses a lot of money, goes into debt, or has a legal judgment against it, the other subsidiaries typically cannot be held liable. That means that one subsidiary can go bankrupt without affecting the others. If each subsidiary combined into one business, the actions of each unit could affect the others.

Many holding companies also have large amounts of capital that their subsidiaries can use. If one business wants to start a large project, the holding company may be able to take cash from each subsidiary and invest it into the project, giving each access to more money than they would otherwise have.

Holding companies are also relatively easy to form. Almost anyone can start a holding company as long as they own multiple businesses or have the funds to purchase large stakes in various companies.

One disadvantage of holding companies from a public perspective is that they can contribute to monopolies. One holding company buying out multiple businesses in the same industry could consolidate power in that industry and reduce consumer choice.

Holding companies can also lead to mismanagement of subsidiaries. Because the owners of the holding company can influence the management of its subsidiaries, too much negative interference can negatively affect the subsidiaries’ performance.

Finally, holding companies can be exploitative, especially if they acquire businesses through hostile takeovers. If a holding company owns a significant enough stake in its subsidiaries, it can force them into bad business deals, for example, buying raw materials from another subsidiary at a high price. This benefits some of the holding company’s holdings, at the cost of others.

How do you form a holding company?

The first step in forming a holding company is deciding on its business structure. For example, you could create a holding company as a corporation or a limited liability company. Each business structure has its own tax benefits and drawbacks.

Once you have your business plan, you can file the paperwork to form your company. Filing requirements vary by state but typically require a name for the business, an address, its ownership structure, and how the owners will make business decisions.

Once you’ve formed the business, you can deposit assets in its accounts. If you’re creating a holding company to own assets you already have, you’ll want to transfer ownership to the holding company, possibly by selling your ownership share to the holding company. You could also lend or give capital to the holding company if you plan to purchase other businesses. Your holding company will need to have a bank account of its own and maintain financial records separate from any of its owners’ records.

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