The definition of an investment holding company is an extremely important one, whether you’re just starting up your own business, or looking to grow an established business even further.
For most businesses, the term investment holding company is a common sight when aiming to invest in a security that has been issued by a corporation, which can include: Common or Preferred Stocks, Corporate Bonds, or even performing a case study inside a private company.
So if you’re unsure about what an investment holding company is, what it does, what the advantages and disadvantages of an investment holding company are, and what the risks of using one are, then read on through this guide in order to gain a better understanding!
What Is An Investment Holding Company?
A holding company is a company that acts as a separate parent company that has been created to have a controlling interest in either a subsidiary company or companies.
As a general rule, a holding company won’t actually function itself, so it doesn’t trade, manufacture, sell products or services, or conduct any other form of business.
Instead, its singular objective is to hold the controlling stock of a company.
If you haven’t heard of the term “Investment Holding Company” before, then chances are you’ve heard another one of the terms that it is frequently given, with it often being known as an “Umbrella” company, or a “parent” company.
Whilst a holding company will own assets from multiple different companies, it very rarely does more than oversee the operations of each business, so yes it will often have an input into management or business decisions, it actually plays very little, or no, part at all in the running of the company.
Understanding Holding Companies
Whilst these companies exist solely to control other smaller companies, a holding company is also able to own forms of property, such as stocks, trademarks, patents, real estate, as well as other possible assets.
If a business is owned completely by a holding company, it can be known as a “Wholly-owned subsidiary”.
And whilst a holding company is able to fire and hire the managers of any company it owns, it is down to the elected managers to oversee and ensure successful operation of the company itself.
What Are The Benefits Of A Holding Company?
One of the biggest advantages of a holding company is the fact that they enjoy a lot of protection from potential losses.
For example, if one of the subsidiary companies goes bankrupt, then the parent company will experience a dip in net worth and a capital loss.
But, the creditors of the now bankrupt company are actually unable to chase the parent company for any remuneration.
This is what leads many parent corporations to turn themselves into holding companies, and then creating a subsidiary for each of the business lines it owns.
Usually in this scenario, each subsidiary owns a different aspect of the parent companies’ property, this might be the trademarks or the patents, or even some of the real estate.
Ultimately, this helps the parent company to massively limit both the legal and financial liability exposure of both the parent company as well as its various subsidiaries, and can also help by reducing the tax liability to, which is achieved by placing different subsidiaries in different jurisdictions.
In addition to all of this, a holding company is also able to help protect someone’s personal assets too.
Since with the use of a holding company, these assets are then owned by a corporation, and not an individual, it means that the person is then shielded away from any debt, lawsuits, and other potential liabilities or risks.
For a holding company to support their subsidiary, all they have to do is make use of their resources which will in turn help by reducing the cost of the operating capital required.
Furthermore, by utilizing a downstream guarantee, it allows the parent company to pledge a loan on behalf of the subsidiary company, which therefore leads to the subsidiary having access to financing with lower interest rate debt than would typically be achievable for a company of that size.
The strength of the financial backing by the parent company ultimately means that risk of the subsidiary company defaulting on the debt decreases massively.
Disadvantages Of A Holding Company
There are some disadvantages to the use of a Holding Company however.
Firstly, it can lead to some confusion amongst the various stakeholders in the parent and subsidiary companies as to what the true nature of the finances are.
The use of a holding company can also see the misuse of power, with the parent company appointing directors and other members of management staff forcefully.
The lack of financial liability and the prowess of financial power can often lead to rash decisions being made.
The parent company might also force the subsidiary company to sell its goods to them for a low price in order to sell them on for more money, which is a form of exploitation.
In general, the large concentration of such large economic power can actually be dangerous to the economy and lead to a monopolization of entire industries, which can lead to one company owning everything and dictating the prices for things purely based on their desire for profit.
In another form of misuse of power, it isn’t uncommon for directors to begin putting aside secret reserves of money or assets to appease different stakeholders to force different decisions or outcomes.
Summary
As you can see, holding companies can be extremely beneficial for those looking to help shake some of the risks and liabilities that come with owning a business.
However, holding companies as a concept can prove dangerous to economic welfare as a whole, so it’s important to consider it before using one.
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