The uses of holding companies

by International Wealth Marketing manager

What Can a Holding Company Be Used For?

Have you heard of Berkshire Hathaway Holdings? If you haven’t, you’ve certainly heard of Warren Buffett, a world-famous investor who is the owner of Berkshire Hathaway. This company ‘holds’ a large number of subsidiaries – other companies that make money for Buffett. He has fingers in many pies indeed.

This is essentially what holding companies are used for: to own other companies called subsidiaries. It may be a 100% ownership, a controlling interest, or just a minority stock. The key characteristic of a holding company is that it serves as a parent company for several other companies that are managed independently. The owner of the holding company does not usually get involved in direct management of the subsidiaries. He or she is in charge of strategic decisions related to overall business matters and the holding company owner may appoint the CEOs or the managing directors of the subsidiaries but he/ she does not normally take part in direct management of the holding company units.

What are the main reasons why a businessperson may choose to establish a holding company? First, a holding company serves the purpose of asset protection rather well. Imagine that you conduct business operations in two totally unrelated areas (you have two business units) under the umbrella of a single company that is NOT a holding company. If one of the units makes profits and the other one makes losses or debts, you will be answerable for the losses/ debts not only by the assets of the failing business unit but also by those used by the successful unit. Now, if you had a holding company and the two business units worked as separate legal entities, you wouldn’t face this problem. The failing company would be liable for its debts only by its own assets, not by the assets of the more profitable company that would be another part of your holding company.

If you have a holding company and you find yourself in the situation described above, you have two basic options that you can choose from. Either you can let the creditors have what they can of the assets of your failing subsidiary and go on with the more profitable line of business operations, or you can use the profits made by the successful subsidiary to compensate for the losses/ debts made by the not-so-successful one.

Warren Buffett, for example, owns a couple of newspapers. The newspaper industry has been struggling since the Internet became widely available. Many people have now stopped buying newspapers printed on paper because they can read all the latest news online. At the same time, newspapers still remain a rather powerful instrument of political influence, and Buffett is reluctant to let the unprofitable business units go. Instead, he uses the profits made by other subsidiaries of his holding company to make up for the losses made by his newspaper companies.

One more reason why you should consider setting up a holding company is the opportunity to save on taxes. Holdings are allowed to file consolidated tax returns if certain conditions are met. In particular, the holding has to have controlling interests in the subsidiaries if it is to be able to file a consolidated tax return. Now imagine that this condition applies to your holding company and you find yourself in the situation described above again: one of your subsidiaries has made a profit over the last fiscal year while the other one has made a loss. This will make your overall profit lower and thus, you will have to pay a smaller profit tax. Now, if you had two separate companies, you’d pay no profit tax on your loss-making company but you’d have to pay a higher profit tax on your profit-making company. This is how a holding company can help you save on taxes.

Besides, holding companies are often used to hold (or own) property such as real estate, trademarks, copyrights, or any other types of property. Suppose you register a business company somewhere in Nevis, for instance, and you make it the owner of the residential accommodations where you stay every time you come to the island. This is already a good idea but what if your Nevis-registered business goes bankrupt? In this case, you may lose your house to the creditors because it is part of the bankrupt company assets. If you had a holding company, however, and made the business unit one of its subsidiaries and the company owning your residential accommodations a separate subsidiary, you wouldn’t have to worry about the house. The two subsidiaries would be separate legal entities and the house-owning company would not be answerable for the debts made by the business-making company.

What are the downsides of having a holding company instead of a company with a less complicated ownership structure? Well, this is the major downside: the ownership structure of your company is going to be more complicated. This can give rise to certain issues that can make the company management a more difficult task.

First, if your holding has many subsidiary companies (like Warren Buffett’s does, for example), keeping even a general oversight of all the lines of business operations is going to be problematic if not impossible. Things are going to become even more challenging if your subsidiaries are engaged in dissimilar business areas. One person cannot possibly be an expert in all business fields. This means that you have to have subsidiary CEOs that you can trust and finding more than a few trustworthy people is not an easy endeavor.

Besides, some holding companies are used as intermediary companies. An intermediary holding company is one that owns subsidiaries but that, in its turn, is owned by another company. Managing a company with such a complex hierarchy can be a challenging task indeed.

At the same time, a holding company can serve as a highly efficient asset protection mechanism. Setting one up is worth considering especially if you do business in different fields or own different types of property.