A holding company is a company that owns a big large percentage of common stock shares of a company or group of companies to exercise voting control over such business or businesses. Such voting control includes control over operations, management and boards of directors. Holding companies originated in 1889 in New Jersey, USA. New Jersey was the first state that made it legal to form a company with the single purpose of owning stocks in other companies.
The companies controlled by a holding company are called subsidiaries and holding company itself is called a parent company of such subsidiaries. If a holding company owns all the shares of the subsidiary than such subsidiary is called a wholly owned subsidiary.
The purpose of a holding company is usually only to own shares in other companies. However, if a holding company also runs the business operations then it is called a holding-operating company.
Liability of the holding company is limited to the value of the stock it has in particular companies. Acquiring control over the business via a holding company is much easier than to do so via leveraged buyouts or mergers.
Advantages of holding companies
One of the advantages of holding company includes isolation of risks.This occurs because each organization the holding company controls operates independently. If one of the organizations fails or becomes involved in a lawsuit then other organizations are not affected. This also allows the holding company to take on bigger risks at individual subsidiaries.
There are some exceptions to this. In certain circumstances the parent company may feel responsible for rectifying the problems in particular subsidiaries to maintain its reputation. Lenders may also require guarantee from the holding company when lending to subsidiaries. Therefore, this advantage is not always relevant for holding companies.
Holding companies are also able to control many assets with fractional ownership. Holding companies control a large amount of assets with a relatively small percentage of ownership and therefore relatively small investment. The percentage of shares required to obtain voting control differs from situation to situation. In smaller organizations it may be around 30%. However, if the holding company wants to obtain the voting control of a large company with widely distributed shares, than even 10-20% of the outstanding stock may be enough to have such control.
Disadvantages of holding companies
One of the disadvantages of holding company is double taxation. In the United States, if the holding company wants to obtains tax consolidation benefits such as tax free dividends than it needs to own at least 80% of the subsidiaries to do so. If it owns from 20% to 80% than it needs to pay taxes on 20% of the dividends received from the subsidiaries. If it owns below 20% than it needs to pay taxes on 30% of dividends received from subsidiaries. Such disadvantage is not relevant to mergers as no double taxation occurs in mergers.
Another disadvantage of holding companies is costly administration. This occurs because each subsidiary is maintained as a separate entity and therefore no economies of scale are possible as in the case of a merger.
A further disadvantage of holding companies is increased risk. If a holding company finances investments through debt than it needs to service the debt. If one or more of subsidiaries are not able to distribute dividends due to economic downturn or any other reasons then the holding company may not be in a position to be able to service debt and may be forced into bankruptcy.
It is also easier to request dissolution of the holding company if it is found guilty in breaking antitrust laws.
Another disadvantage is that due to the availability of voting control, the holding company may ignore interests of the minority shareholders.