“Holding company” is a common phrase you will usually hear when working with an accounting company to evaluate ownership structure or business incorporation. Many believe that it is mainly used in most corporate business structures.
Although you have heard “holding company” several times before, most of you might still be confused about what it is, how it works, or why everybody wants to have one. This post guides you to essential things you must know about a holding company.
So, without further ado, let’s get started!
Defining A Holding Company
If you are a complete beginner, you may be asking, what is a holding company? For starters, a holding company refers to any business element, such as an LCC (Limited Liability Company) or a corporation. In most cases, this type of business entity is not involved in conducting business processes, such as selling services or manufacturing products.
But instead, it is a business entity that holds, controls, and manages the stocks in other corporations. Like other corporates in the industry, a holding company can hold other companies’ assets, register IP (Intellectual Property), and pay debts.
On the other hand, it is worth noting that a holding company is not involved in other conventional business processes. But instead, many corporate groups consider it a parent company in the way of acquisitions and mergers instead of stock ownership. The corporate groups under the control of holding companies are called subsidiaries or operating companies.
What Is The Purpose Of A Holding Company
When you hear the word “Holding company,” what’s the first thing that comes to your mind? You are probably thinking of international institutions that will help you manage your business better using tax-efficient strategies.
Aside from large corporations, having a holding company is also a beneficial step among those with small- to medium-sized enterprises. If you have a business but manage different branches of the company, for instance, four small stores throughout the city, with each having an LLC, having a holding company will help you mitigate risks against potential losses when one of these stores fails.
Aside from that, a single holding company will also allow you to set up more than one subsidiary and hire an officer who will monitor your business assets. Doing so assures you that your assets are in a safe place against the creditors if financial problems happen.
In line with that, it is also worth noting that a holding company is not responsible for protecting a subsidiary against all possible losses. In such cases, a parent company may also be responsible for paying the debts caused by its subsidiaries. Moreover, it will also be liable for other crimes, such as financial fraud, done by the operating companies.
Advantages Of A Holding Company
As your business expands, establishing subsidiaries and a holding company becomes necessary. Having a holding company brings many advantages aside from maximizing operational efficiencies while minimizing risks.
After all, a holding company is designed for diversifying and growing your business. The following are some of the benefits of having a parent company:
Tax Benefits
One of the most significant advantages of a holding company is that it gives you countless tax benefits. For example, the operating company entrusted half a percent of its outstanding shares to a holding company. Doing so allows an operating company to save more from taxes.
Beyond that, the holding company does not require its subsidiary to pay tax on intercorporate dividends or assets. With that in mind, you can use your tax savings to invest in another corporate or property that will grow your profit over time.
A corporate without a holding company is more likely required to pay its shareholder by paying personal income tax or dividends. When that happens, the company would have little to no amount left to use for another investment.
Speaking of tax savings, it is worth noting that the amount may vary depending on different factors, such as your province, the type of income your business generates, and the personal income you are earning.
Considering the rules associated with how much passive income or investment a company can make, achieving these savings become more complicated. Despite that, it is still worth the risk because of the opportunities and benefits it offers.
It Protects Your Assets
Asset protection is another benefit that having a holding company offers. You can use holding companies to provide extra protection to your assets. You can do this by entrusting your business assets to a holding company.
Considering that these assets have a holding company, you can protect them against creditors if something wrong happens.
In addition, having a holding company is also an excellent way to have a separate barrier that distances an operating business from its ultimate shareholders. In such cases, this can be a great way of protecting assets separate from your business, including your personal property, in situations like litigation against your corporate.
Even if your business is established in a low-risk industry, there is still a high possibility of being exposed to several risks. Therefore, working with a holding company in your area can be a valuable part of adding an extra layer of protection to your business and personal assets.
It Minimizes Risks
A holding company is designed to manage and control the assets of an operating company. In other words, the parent company works differently from its subsidiary. Doing so is a practical way of minimizing or mitigating risks associated when the subsidiary declares bankruptcy or performs poorly.
The effects of the subsidiary’s bankruptcy will also affect its parent company. However, the impact would not be that significant, which leads to fewer financial responsibilities.
Drawbacks Of A Holding Company
Having a holding company is not all about the benefits. It is the biggest bet you can make for your corporation if you are trying to expand it. However, it also comes with a few drawbacks that you should be aware of to make a smart decision.
Here are some of the disadvantages of having a holding company:
Subsidiary Exploitation
Before you have a holding company, it is important to know that it may earn from the business activities done by subsidiary incorporations. In some cases, subsidiaries must buy products or avail services from the parent company at a higher cost. However, the holding companies may also force them to avail subsidiaries’ products at a meager cost.
Doesn’t Have Control Over A Director Selection
Another thing you should know before deciding on whether to have a holding company or not because holding companies may require the subsidiary corporations to select officers, such as company directors, according to their requirements.
Although the intention was good, this may often result in bad decisions that will not benefit the organization as a whole.
Expensive Capital Needed
In some cases, the pooling of the parent company’s subsidiaries and its assets is more likely to occur. When this happens can result in expensive capital. Considering this, the operating company’s shareholders may not receive enough ROI, which only shows that the corporation is functioning poorly.
Starting A Holding Company
Now that you have weighed the pros and cons of a holding company, it is time to understand how to have one.
Just like other corporations or LLCs, starting a parent company follows a simple and easy procedure. However, a legal guidance professional specializing in tax law may help you a lot, especially when it comes to effectively structuring the holding company and transferring the ownership of subsidiaries’ assets.
Aside from that, you will also need to hire more than two directors who will monitor and manage the subsidiaries and the operations done by the holding company. In general, building a holding company is easy but constructing everything that lies beneath it requires experienced advisers who are knowledgeable in this case.
Holding Company Example
A holding company is an organization that owns many different companies. The biggest advantage of holding companies is that they can bring together many different businesses under one roof to combine their strengths and maximize their efficiency.
They also help reduce the risk that a particular business will fail because they can diversify their holdings and protect their investments if one company experiences a downturn in the economy.
However, holding companies have also been criticized for limiting the autonomy of the individual businesses they represent, reducing the opportunity for the companies to grow and develop on their own, and having a tendency to become outdated as new technologies and business models emerge.
Sony Corporation is one of the most famous holding company examples. This name is associated with electronic products, including music, video games, and TV. Sony Corporation is a huge parent company that handles numerous subsidiaries, such as Sony Global Manufacturing Inc., Sony Electronics Inc., and Sony Interactive Entertainment Inc.
The Bottom Line
Having a holding company comes with some pros and cons that you need to weigh before deciding. Despite being popular, a holding company may not be a perfect fit for all business owners. In line with that, it is essential to work with a legal professional or accounting company such as JTT Accounting for further guidance that will help you make the right decision.