The purpose of a holding company is to own stock in another company, which is called the subsidiary. Holding companies do not produce goods or services themselves, but rather focus on controlling their subsidiaries and on reducing risks for the owners. The purpose of a subsidiary is to own property such as real estate, patents, stocks and other assets. Similarly to the holding company, also known as the parent company, subsidiaries do not produce goods or services either. The main goal of a subsidiary is to reduce risks for its owners and to pay interest on the loan issued by the parent company.
1. Holding companies are used to reduce risk
Shareholders create holding companies to decrease the risks they can face when a subsidiary experiences losses. For example, when a subsidiary goes bankrupt, the holding company suffers capital losses and decreases in net worth. Nonetheless, the total loss does not exceed the investment in the subsidiary and the subsidiary’s creditors cannot claim additional compensation from the holding company.
Subsidiaries act as silos within a holding company. The losses experienced by one subsidiary do not affect the other subsidiaries. Therefore, shareholders create holding companies to compartmentalize risk.
Shareholders also create holding companies to safeguard their personal assets. When the holding company goes bankrupt, the loss is limited to the company’s assets, thus protecting the shareholders’ personal assets from debt and from potential lawsuits.
2. Holding companies have control over their subsidiaries
A holding company can own one or more subsidiaries. A holding company who owns 100% of the shares of a subsidiary has operational and strategic control over the subsidiary. The holding company has the ability to direct how to invest the assets of its subsidiary, also known as a wholly owned subsidiary.
The overall control is usually less when the holding company owns only a portion of the shares of a subsidiary, or when the subsidiary has overseas operations. Nonetheless, the holding company may still benefit from owning subsidiaries in various geographic markets or from only partially owning a subsidiary.
3. Holding companies are used for the issuance of loans to subsidiaries
Shareholders invest money in the holding company and expect a payout. Along the same lines, a holding company invests money in its subsidiaries in the form of a loan, and expects a payout in the form of interest.
The subsidiaries invest the money from the loan in real estate, stocks and other revenue-generating assets. Investing in subsidiaries limits risks since placing assets in independent subsidiaries limits losses. When a subsidiary suffers losses, the other subsidiaries are not affected and the total loss of the holding company is limited to the investment in that subsidiary.
The subsidiaries then pay interest on the loan to the holding company. It is much simpler for shareholders to oversee one holding company with several subsidiaries, than to oversee multiple holding companies.
It is important to note that the financial information provided in this blog is for informational purposes and not for the purpose of providing specific financial advice. You should contact a financial advisor to obtain specific advice tailored to your needs.