Holding Companies are complex in structure and can be difficult to understand. With companies increasing in size and getting more complex, they want to create a dominant position in the market by creating a monopoly.
This can be easily done if the large corporations, buy out smaller, fast growing rivals in order to maintain their market leadership.
Holding companies are created to buy shares of other companies, which it then controls. In other words, a Holding company is a corporate entity that owns enough shares in another company so that it controls it’s management and operations.
The aim of a holding company is not to operate a business, but to own assets and bring value to the investment. A holding company may hold various assets such as real estate, stocks, patents, copyrights etc.
The company owned by a holding company is called subsidiary. If the holding company owns 100% of the shares of its subsidiary, its called wholly owned subsidiary. On the other hand if the holding in subsidiary is less than 100%, its called partially owned subsidiary.
Why holding companies are formed:
Holding companies can serve different purposes for different needs. Some of the reasons why holding companies are formed are given:
Ease of Funding:
Holding companies, that are large in size can raise funds easily and cost-effectively for its subsidiary, which is otherwise, difficult for smaller companies. This is a win win situation for both holding and subsidiary company as Holding company receives regular interest income from its subsidiaries and subsidiaries get loans at lower which may otherwise not be available for a small size firm.
Since holding companies have multiple businesses in their portfolio, it provides diversification to the company. In case one of their subsidiaries does not perform well, the holding company is not badly affected.
How holding companies make money?
Okay, so holding companies does not operate a business but, hold significant stake in other companies, but every company has some expenses such as office rent, employee cost, etc. So how does a Holding company meet its daily expenses?. There are three major sources of revenue a holding company depends upon.
Dividend and interest from Subsidiaries:
One of the sources of revenue for a holding company is receiving dividends. Dividend is a part of profit, a company decides to distribute to its shareholders. Since Holding companies own significant stake in other companies, they receive regular dividends from them.
Secondly, holding companies sometimes provide loan to their subsidiaries, and charge interest against it.
Patents, Rights, Royalty:
Another source of revenue for holding companies is patents, royalties and copyrights. Many companies own valuable intangible assets(also called intellectual properties) such as a patented drug formula, a brand name, or a copyright to music.
The companies may charge other companies a royalty, which is a fee for using patent formula, or a brand name.
There are numerous examples of holding companies charging royalty against intellectual property.
Johnson and Johnson is a leading brand in baby healthcare products. Many smaller companies with great product may approach Johnson and Johnson, to market their product using brand name of Johnson and Johnson. This is a win win situation for both as company gets a brand that people trust, making it easier to sell the product, and Holding companies like Johnson and Johnson charge royalty fee against use of their name.
To understand further how Holding Companies work read the post linked below:
Also Read:How a Holding Company Works
Every coin has two sides, similarly, holding companies also has some advantages and some disadvantages.
Advantages of holding companies:
Some of the merits of holding companies are discussed below:
Ease of formation: It is quiet easy to form a company. The promoters of a holding company can buy shares of subsidiary company from open market, the consent of subsidiary companies is usually not needed in most of the cases.
Large Pool of Capital: Since holding companies own many subsidiaries, in case company has to take up a large project that requires huge capital, holding companies can pool the financial resources of all its subsidiaries in order to reach required capital.
Avoid Competition: If a Holding company finds a fast growing small company that can be a threat in the future, challenging its market position, holding company can simply avoid competition by buying smaller company.
Secrecy is maintained: The ownership and operations of a holding company is centralized, which means only few high managerial personnel have access to sensitive data and information. This helps in maintaining secrecy of the company’s operations and strategy.
Avoids Risk: One of the biggest advantages of a holding company is that it allows management to de-risk their business by diversifying in many subsidiaries. In case one of the subsidiaries takes a big risk and fails, the holding company does not lose its shirt.
Disadvantages of a Holding Company:
Some of the disadvantages of Holding companies are as follows:
Monopoly: A healthy competition is essential for economic growth, and better consumer experience. Holding companies kill the competition by buying out smaller companies that can challenge their market leadership. This may sometimes leaves consumer with no product differentiation and they may be forced to buy mediocre quality products.
Interference by Management: Since the management of the subsidiaries is centrally controlled by the holding company, there may be a lot of interference by the holding company in day to day operations of the subsidiary.
In such cases, subsidiaries are unable to take independent decisions which may be harmful for the business performance.
Exploitation of Subsidiary: Some holding companies may force their subsidiaries to buy raw materials at a high price. This increases the cost of operation for subsidiary, reducing margins, which may be harmful for the business.
Holding company is like a guardian angel for all its subsidiaries, as it provides funds, helps in critical decision making, protects rights of a business against internal and external threats, and allows easy decision making.
While analyzing financial statement of Holding companies, one should always look at its consolidated financial statements of the company as it portrays the real picture of the assets, liabilities.