The purpose of holding company is to allow those who own several businesses a way to limit liability and maintain ownership over each business.3 min read updated on February 01, 2023
The purpose of holding company is to allow those who own several businesses a way to limit liability, create a streamlined management, and maintain ownership over each business. A holding company provides a central point of control over the businesses.
A corporation or limited liability company that maintains a controlling interest of ownership or the assets of other companies is a holding company. The holding company will typically hold equity interests or assets rather than actively being involved in business operations. A holding company is also called a parent company. Any company underneath the parent company is known as an operating company or subsidiary.
Advantages of a Holding Company
Three of the main advantages of using a holding company include:
- Centralized control.
- Limiting investment.
- Limiting liability.
Centralized control gives the owner the ability to maintain direction over the subsidiaries. Each subsidiary has the holding company as the owner. The owner can then choose an executive management team to help manage each company.
Limiting investment allows interested equity investors the chance to choose which company they want to invest in. If it was one large corporation, an investor would be investing in all divisions and segments of the company. With a holding company, they can focus on the business of their choice. By limiting investment, you can raise capital and create partnerships for each business on its own.
Limiting liability is an important advantage. Any assets of a subsidiary can be owned by the holding company, then leased to the subsidiary. If the subsidiary is the subject of any creditor or legal judgments, the subsidiary wouldn't lose the assets because did not own them. If needed, it is possible for the subsidiary to declare bankruptcy and close. The holding company can then establish a new subsidiary that leases the same assets.
Disadvantages of a Holding Company
There are also disadvantages to be aware of when using a holding company. They include:
- Each subsidiary must follow the formalities that come with being its own business. These includes:
- Having a separate business bank account.
- Having separate financial statements.
- Keeping a minute book of all meetings.
- Having its own employees, managers, officers, and directors.
- The business structure may be confusing or difficult to explain to partners, employees, or other interested parties. The confusion stems from not understanding the separation of entities and their purpose.
- In cases of infringement, an intellectual property holding company may not be eligible for lost profits that stem from issues with infringement. They may receive a royalty that is deemed reasonable, but not the full lost profits.
An Intellectual Property Holding Company (IPHC) is created to own and manage the rights of patents, trademarks, and copyrights. The IPHC will create a license arrangement with the subsidiaries to provide use of the intellectual property for a royalty fee. The license arrangements will be set for an agreed upon period of time.
How Do Holding Companies Make Money
A holding company can make money from:
- Any profits or dividends made from the subsidiaries of the holding company. This includes the interest and earnings of stock shares or bonds that pay dividends and/or interest.
- Offering services to the subsidiaries.
- The sale and purchase of assets, including buying and selling stocks.
The holding company will draft and sign an agreement with the subsidiary that states the following:
- How much the subsidiary needs to maintain their operations. This can be stated per year and per quarter.
- What the cost will be to purchase services from the holding company.
- The cost of selling to a sister company, if a sister company exists.
The holding company may be very involved in the management of the subsidiary's budget and operations, while others will only intervene if there are issues. The budget will be set before the start of the fiscal year and will state what is needed for investing, purchasing, and other budgetary concerns. By using a budget, this will allow the holding company to see which subsidiary is performing as expected. If there is excess cash, the holding company will decide whether they will keep it in the subsidiary or move it. This will vary by location.
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FAQs
A holding company is a financial vehicle for owning and controlling other assets, such as real estate, stocks, or companies. Using a holding company creates legal separation between the assets and the owners, and reduces the liability for the owners if one of the holdings encounters financial trouble.
What is the primary purpose of a holding company? ›
Their sole purpose is to hold the controlling stock or membership interests in other companies. This type of holding company is called a pure holding company. Some holding companies, in addition to owning and controlling subsidiaries, do have their own business operations.
What is the point of holding companies? ›
A holding company is a parent company—usually a corporation or LLC — whose purpose is to buy and control the ownership interests of other companies.
What are the objectives of holding a company? ›
The primary aim of a holding company is to manage other companies, whether they be other companies, limited liability partnerships, or limited liability companies. Holding companies can also own properties, such as immovable objects, patents, trademarks, securities, etc.
What is the purpose of a parent company? ›
Also known as a parent corporation, a holding company owns a controlling interest in other companies but does not engage in operational activities. They exist solely to manage and oversee a subsidiary company, providing it with resources, support, and guidance.
Why use a holding company for LLC? ›
If your business engages in legally or financially risky activities, you might consider using a holding company to keep valuable assets separate from potential liabilities. Setting up a holding company can be costly. In addition, a holding company needs to be well managed in order to maintain its legal protections.
What are the tax benefits of a holding company? ›
The main tax advantage of a holding company is that it does not have to file different tax returns for each subsidiary company. Generally, subsidiaries can pay dividends to the holding company without creating a tax liability.
What is the downside of holding companies? ›
Limited control: As a holding company, you may not have direct power over the operations of the companies you own. It can make it challenging to implement changes or make decisions that affect those companies. 3. Increased risk: As a holding company, you are exposed to the risks of your own companies.
Does a holding company need to make money? ›
Revenue Generation in a Holding Company
A holding company generates revenue through various channels, including dividends from its subsidiaries, income from its assets, and royalties from patents or copyrights it holds. This diverse income stream contributes to its financial stability and growth.
Does a holding company have value? ›
The Net Asset Value (NAV) method calculates the value of a holding company by considering its net assets. This method is particularly suitable when the company's primary function is to hold and manage various assets, such as real estate properties or investment securities.
All corporations must have a federal tax ID number to do business, and there are only rare situations (a holding company that does not pay tax of any kind) where an LLC wouldn't need an EIN. Your tax ID number will be required to fill out payroll reports, pay taxes, open a business checking account, etc.
When to create a holding company? ›
When should I set up one? When deciding whether you should set up a holding company, you must first consider what your objectives are with creating one. If your operating company is earning excess cash and you want to invest it while potentially delaying some tax, it may be worth it to have a holding company.
What is the best jurisdiction for a holding company? ›
1. - Luxembourg: Often considered a favorable jurisdiction for holding companies due to its extensive double tax treaty network, low withholding taxes, and flexible corporate laws. Luxembourg is also known for its political and economic stability.
What is the role of a holding company? ›
A holding company typically exists for the sole purpose of controlling other companies. Holding companies may also own property, such as real estate, patents, trademarks, stocks, and other assets.
How do parent companies make money? ›
Increased revenue: Parent companies frequently receive a percentage of their subsidiaries' profits. These payments can allow a company to increase its profits through its subsidiaries' operations. Additional guidance: Subsidiary companies usually benefit from working with larger and more established parent companies.
What is the cost of control in a holding company? ›
COST OF CONTROL (COC) is the amount paid by a holding company, sometimes at a premium, for shares in its subsidiary company over and above the value they would command as an investment, in recognition of the particular benefit, which the company gains through control.
What is the duty of holding company? ›
The fundamental duties of a holding company include maintaining control over its subsidiaries, protecting assets, providing strategic direction, and managing financial risks. These duties ensure the holding company effectively manages its portfolio of businesses while safeguarding its assets.
What is the primary goal of the personal holding company tax? ›
The main purpose of the PHC is to avoid capital gains tax. As it prevents the companies to accumulate the its earnings and distribute them as a dividends. The dividend paid by these companies is totally tax-free if the company is a subsidiary company.
Is it necessary to have a holding company? ›
Holding companies can offer advantages, like letting you own multiple companies through one entity, protecting your personal assets from business debts, and keeping business liabilities separate.
What is the purpose of a holding company for real estate? ›
A real estate holding company is a legal entity designed to protect business owners from the risks that come with owning investment properties. Real estate holding companies, also known as limited liability companies (or LLCs), do not participate in business operations themselves but own different assets.
