What Is a Holding Company? The Complete Guide

A holding company (Holdco) is a business structure that doesn’t manufacture or sell products or services. Holdcos don’t conduct business operations; they hold the controlling stock or interests in other companies or subsidiaries.

While a holding company owns the assets of other companies, it only maintains oversight capacities. Holdco may oversee the company’s management decisions but doesn’t actively participate in the business’s daily functions. Sometimes, a holding company is also known as a parent or an umbrella company.

When done right, a holding company can make your business operations more competitive while helping to protect business assets and reduce taxes. Holdcos are more efficient, especially if the owner goes offshore.

If you’re interested in starting a holding company or want to know about the business structure, Incorpuk welcomes you to read this complete guide. We’ll discuss what holding company is, how it works, why it’s essential, and its roles.

Understanding a Holding Company

Typically, a holding company only exists for one purpose: to control other companies by holding stocks or interests on their behalf. Most holds operate under Limited Liability Company (LLC)) structures or Corporations. Holdcos can also own real estate, trademarks, patents, stocks, and other assets.

Running a holding company helps limit its subsidiaries’ financial and legal liability. The business entity may also reduce a corporation’s overall tax liability by strategically establishing some parts of the business in jurisdictions with lower tax rates.

The businesses wholly owned by a holding company are known as “wholly owned subsidiaries.” Hodlcos can hire and fire managers of their companies, but the managers are ultimately liable for their operations.

How Holding Companies Function

Corporations can become holding companies in two ways:

1. They can acquire enough voting stock or shares in another company, giving it the power to control.
2. A corporation can create a new corporation from the ground up and then retain the entire corporation’s shares or part of it.

Owning 50% or more of the voting rights in a company guarantees greater control, but a parent company with only 10% of the stock controls the decision-making process.

The companies under a holding company are known as subsidiaries, and they’re autonomous. All the assets a subsidiary owns belong to the holding company, which has no direct control over them.

An LLC or corporation holding company ensures excellent liability protection, allowing for lower overhead costs and fewer taxes. Holding companies is a popular way of holding and protecting a wide range of assets, including intangible assets or IP. Holdcos can leverage these assets to raise capital for business expansion or further acquisitions.

Types of Holding Companies

As we have established, a holding company owns the controlling shares in other businesses. The structure comes with a handful of benefits, which we’ll discuss, but first, let’s understand the different types of holding companies you may encounter. Holdcos can be structured as LLCs or Corporations under the following types:

1. Pure is a holding company formed for the sole purpose of owning stock in other companies. Typically, the entity doesn’t participate in any other business activities but only controls one or more firms.
2. Mixed is a mixed holding company that controls another firm but also engages in its operations, making it a holding-operating company.
3. Conglomerates are holding companies that participate in totally unrelated lines of business from their subsidiaries.
4. Immediate holding companies retain voting stock or control of another company, even when a different entity controls the company. In simpler terms, the holding company is a subsidiary of another.
5. An intermediate holding firm is a holding company for another entity and a subsidiary of a more significant corporation. The intermediate holding company of the smaller group might be exempt from publishing financial records.

Benefits of a Holding Company

Holding companies are protected from losses. However, if a subsidiary goes bankrupt, the holding company experiences a capital loss and a fall in net worth. The good for the holding company is that the bankrupt company’s creditors have no legal right to pursue the holding company for compensation.

Hence, a parent corporation can structure itself as a holding company to protect its assets while forming subsidiaries for every business line. For instance, a subsidiary can own a corporation’s brand name and trademarks while another owns its real estate.

Creating or changing holding companies makes it easy to leverage geographical variations in tax regimes. Simply put, a holding company can relocate to a different jurisdiction if its original jurisdiction has high business taxes and continues to operate there. Here are more benefits of a holding company:

1. More Control for a Smaller Investment

A holding company owner gets a controlling interest in another company without much investment. After a parent company purchases 51% of a subsidiary automatically gains control of the acquired firm. Even without 100% of every subsidiary, a small business owner gains control in numerous entities with minimal investment.

2. Independent Entities

Each subsidiary is considered an independent legal entity when several companies are under a holding company. This means that if any subsidiary were to face a lawsuit, the plaintiffs would not be able to touch the assets of other subsidiaries. The parent company can’t be held responsible if the subsidiary being sued acted independently.

3. Management Continuity

Every time a parent company acquires new subsidiaries, it almost always retains the management to ensure the owners decide to agree with the acquisition or not.

The holding firm has a choice not to be involved in the subsidiary’s activities except when making strategic decisions and performance monitoring. This means that the subsidiary managers will keep their previous roles and continue conducting business as usual. The holding company owner benefits financially without being part of the management tasks.

4. Tax effects

Holding companies that own over 80% of a subsidiary can enjoy tax benefits by filing consolidated tax returns. A consolidated tax return combines the acquired firms’ financial records with the parent company. In this scenario, if one subsidiary encounters losses, they’re offset by the profits of the other subsidiaries. The main impact of filing a consolidated return is the benefit of reduced tax liability.

Disadvantages of a Holding Company

Owning subsidiaries through holding companies comes with some disadvantages.

As investors and creditors, finding an accurate picture of the overall financial health of a holding company may be a challenge. It’s also not uncommon for unethical directors to hide their losses by distributing debt among their subsidiaries.

Holding companies sometimes exploit their subsidiaries by pushing them to appoint chosen directors. They can also force the subsidiaries to purchase products from each other at higher prices than the market offers.

Similarly, they can force subsidiaries to sell products to each other at lower prices than what the market is offering. The same force can be used by holding companies on their subsidiaries to lay off a large workforce. These strategies, known as vulture capitalism, can inflate the holding company numbers at the subsidiary’s expense. Here’s a summary of the downside of holding companies:

1. Subsidiary profits are taxed twice, which reduces earnings.
2. Controlling subsidiary companies may be challenging since subsidiary company shareholders can make conflicting decisions with those of the holding company’s interests.
3. The holding company may be liable for any debt or lawsuits a subsidiary company incurs.
4. Holding companies need significant capital to start and maintain.

How Holding Companies Make Money

Depending on the size of a holding company, it can have various income streams, especially for large holding companies. The simplest way for holding companies to earn revenue is through equity in their subsidiaries. Holcos can benefit from dividends in the subsidiary’s share price and selling equity in companies that gain value.

Holding companies can also benefit from synergies between the subsidiaries in their portfolio. Instead of having separate services for each subsidiary, a holding company can centralize and sell or lease them to their subsidiaries. The services include:

1. Information technology (IT)
2. Human resources (HR), or
3. Administration teams
4. Equipment
5. Assets

How to Register a Holding Company

Setting up a holding company is the same as all other limited companies. The holding company must be legally incorporated to ensure its compliance with the law. This information must be provided during incorporation:

1. The company's name
2. Apply for an Employer Identification Number (EIN)
3. A registered office address
4. At Least one director’s details
5. Standard Industrial Classification (SIC) codes
6. A minimum of one shareholder’s details
7. Details of share capital as issued to shareholders
8. Information of People with Significant Control (PSC)
9. Open a business bank account

If you provide all necessary documents per incorporation regulations, your application will be reviewed, and if it’s satisfactory, it will be approved. However, if more information is required, especially for offshore business owners, be ready to provide them for verification.

Different Ways to Transfer Assets to a Holding Company

After setting up your holding company, there are different ways to transfer assets to the holding company. Transferring assets to a Holdco is critical and might need an attorney’s guidance to help you understand what you’re getting into. Meanwhile, here are the different ways to transfer assets to your Holdco:

1. ‍Sale: The trading company sells its assets to the holding company at market value, and taxes might apply if there’s a gain in the assets being sold.
2. ‍ Contribution in Exchange for Equity: The assets owner contributes assets to the holding company in exchange for shares or membership interests. Sometimes, they can be structured to defer to avoid immediate tax consequences.
3. Loan or Capital Lease: The operating company lends assets to the holding company or agrees to a lease agreement. It ensures the Holdco can use the assets while the trading company retains ownership and receives rent or payment from the holding company.
4. Drop Down: A trading company drops its assets into a subsidiary holding company through a contribution, sale, or a merger of both.
5. Mergers and Reorganizations: Complex corporate reorganizations can be used to transfer assets to a Holdco. The process can be structured to defer tax implications.
6. Gift: Family businesses or assets can sometimes be gifted to the holding company, which can attract a gift tax.
7. Trusts: For estate planning purposes, trusts can be transferred into a trust, and the holding company becomes a beneficiary or operates it together with the trust.
8. Spin-off or Split-off: More complex corporate structures use this method to transfer assets to a holding company. A spin-off or split-off sets a part of the business from the parent company and transfers it to the holding company.
9. Asset for Asset Exchange: The holding company can trade assets of the same value as the operating company.

Transferring assets to a holding company may have potential tax implications, liability concerns, and other consequences. When transferring assets between related businesses, these implications may attract more scrutiny. Authorities scrutinise such transfers to ensure no one is evading taxes or trying to defraud creditors.

Frequently Asked Questions

What is the brief explanation of a holding company?

A holding company is a parent company that owns stock and controls interests in other companies without being active in their daily operations. Holding companies or Holdos don’t produce any goods or services. Holdcos can be used by businesses of all sizes and in any industry.

What is the primary role of a holding company?

The primary role of a holding company is to exercise control over other small companies they acquire, known as subsidiaries. Holding companies acquire a significant portion of the subsidiary to gain voting rights. Some benefits of running a holding company include tax benefits, risk management, asset protection, and streamlined control.

What business structure is ideal for a holding company?

The ideal business structure for a holding company is a limited liability Company (LLC) or Corporation. Regardless of the structure you choose to incorporate your holding company, ensure you adhere to formation guidelines in the particular state.

Do holding companies make money?

Holding companies make money in various ways, the most straightforward of which is through equity in their subsidiaries. Holdcos can also benefit from dividends in their subsidiary’s share price as well as through selling equity in companies that appreciate. Holding companies can also benefit from synergies where they centralise services and lease or sell them to their subsidiaries.

Can I form a holding company to protect my assets?

You can form a holding company to protect your assets by ensuring business longevity. If a day comes and your trading company goes bankrupt or is liquidated, your assets under a holding company are protected.

Do You Need Help Forming Your Company in the UK?

Incorpuk offers a range of fast and efficient online company formation services that makes it easiest and cost effective to take your business global. Kindly contact incorpuk if you need any help on company formation services today.

In summary

What is a holding company? A holding company is a business entity formed to fulfil a single purpose of owning other companies without participating in their daily functions. Business owners can acquire different types of holding companies by purchasing shares or assets in other businesses, known as subsidiaries.

To successfully manage a holding company, they consolidate all subsidiary accounts when making annual filings. Holdcos safeguards its assets from losses and benefits from lower tax liabilities by registering in business-friendly jurisdictions. Besides relocating to a different state, with lower business taxes, Holdco can still operate in its original location.