If you follow any type of financial news, you have probably heard the term “holding company” before. It often comes up, especially when discussing taxes or the assets of millionaires. But what exactly is a holding company?
Basics of a Holding Company
Traditional companies produce products or provide services. This is how the company makes money. However, a holding company isn’t a traditional company.
Most holding companies don’t produce anything or provide any services. Instead, the holding company owns only one type of asset: other companies.
But why would a company want to own another company? What advantages does this provide?
Decreased Investment Costs
One of the main advantages of a holding company is that it can decrease the investment costs involved in owning a normal company. This works because holding companies buy stock in other companies. As soon as a holding company owns over 50% of the stock, it has full control of the functions of that company at effectively half the cost of owning the entire company.
There are some additional costs for making a holding company, but they are drops in a bucket compared to the cost of owning the other 49% of a business.
Many holding companies own multiple subsidiary companies. Sometimes, holding companies even own 100% of the subsidiary companies. Even in a situation like that, though, the holding company gains an advantage.
If the holding company were instead a normal company producing the products of each of its subsidiaries, the costs and profits of the holding company would be similar. But the assets of the holding company wouldn’t be as well protected.
If someone sued the company for manufacturing a substandard widget, the entire company would be potentially liable. But when a subsidiary company is sued, only the assets of that company are at risk. The other subsidiaries of the holding company and the parent company are considered separate assets.
This advantage doesn’t just apply to lawsuits. It also applies to bankruptcy. If one subsidiary company goes under, that shouldn’t affect the other subsidiary companies. If your company is properly arranged, it probably won’t affect the holding company much either.
Tax law isn’t always consistent with litigation law. Holding companies are one example. The U.S. tax laws allow a holding company to combine the financial records of all subsidiary companies and use losses from one to offset profits from another. If both companies were treated independently, the net tax liability would be higher.
While this is not consistent with the previous advantage of independent assets, it is legal and one of the reasons that you might want a holding company.
Assume for a moment that you own a winery. Before you can sell your wine, you need to bottle it. This means you will probably want a business arrangement with a bottling company. If you have a holding company that owns both the winery and the bottling company, that arrangement is a lot more profitable for everyone.
It isn’t uncommon for holding companies to purchase companies that can support each other. This allows you to control multiple parts of the supply chain and decrease overall costs. If you have the necessary assets, you could potentially control the entire supply chain for a profitable company.
Talk to a Business Law Lawyer About Holding Companies
If you are considering investing in a business, starting a holding company might be more profitable. The Dallas, TX, business law attorneys at The Sul Lee Law Firm can help you determine the best investment strategy for you.