Definition of holding company: A legal entity with a primary purpose of owning an equity stake in other companies.

What is a holding company?

A holding company in the UK is usually a private limited liability company (Ltd), although occasionally it may be a public limited company (plc).

The primary purpose of the holding company is not to generate revenues or incur costs. In fact, some enter into virtually no transactions each year.

The primary purpose is to own all, or a proportion of ordinary shares in another company, or a group of companies.

Why do groups use holding companies?

In this way, a holding company represents a ‘layer’ in an organisational structure which can simplify the ownership structure and provide an easy way to transfer ownership from one party to another.

Holding companies exist at all levels of group structures, and not just at the very top. Holding companies in the middle of a group structure are known as ‘intermediate holding companies’. As their name implies, they own stakes in other companies but are not the ultimate parent company of the group.

Reasons why a holding company can be useful

Imagine a shareholder who owns 100% of the ordinary shares in a holding company, which in turns owns 100% of the shares of two trading companies. Let’s consider the advantages to this structure compared to if the shareholder simply owned 100% of the shares in each trading company.

Segregation of the group

By dividing trade into multiple subsidiaries and forming a group, legal risks can be segregated.

Limited liability companies are treated as completely separate entities. If a company enters into administration or becomes insolvent, its creditors cannot claim on the assets of other companies in the group.

This structure can allow a group to continue trading as a whole rather than be taken down by the knock-on impact of one business unit failing.

Control over personal tax

If the shareholder directly owned the trading companies, then any transfer of cash out of the company would be treated as dividend income, and would therefore become taxable.

It makes sense to have as little cash as needed inside the trading businesses due to the risk of lawsuits/bankruptcy, which would result in this cash being lost. Therefore the shareholder is forced to choose between taxable income or unnecessary risk.

With a holding company, dividends could be paid up from the trading companies to the holding company (tax-free), and then be held in the holding company until it is advantageous for the shareholder to withdraw it as income.

Ease of ownership changes

With a holding company sat above trading businesses, changes in ownership can be easily executed by issuing new shares in the holding company to a third party, or by transferring the ownership of the existing shares across. It’s like handing over the reins to another.

The trading company would be completely unaffected in this scenario and would be able to continue trading like normal, as it continues to be owned by the holding company.

Convenience & filing efficiencies

By adding a holding company above multiple businesses, this forms a group, which may allow the group to submit VAT returns and other tax returns as a collective rather than as completely separate entities.

This can allow the gains and losses from one business to offset another, which can lead to an optimal outcome.

How is the phrase holding company used in a sentence?

“The holding company has nothing on its balance sheet except an investment in the subsidiary.”

“The holding company does not report a gross profit or net profit as it did not trade during the accounting period.”

What else you should know about holding companies

Holding companies are sometimes incorporated in a different jurisdiction to the companies it owns.

An multinational group listed on a stock exchange will usually have a parent company registered in the country of the listing, and this parent will then own stakes in various trading subsidiary companies.

Using holding companies domiciled in nations with banking secrecy laws have been one of the ways in which unscrupulous individuals have made it difficult for tax authorities to follow income and ownership back to the true owner.

The use of holding companies in a group structure is completely legal and commonplace in most large groups for the reasons listed above.

However, some unscrupulous individuals have used convoluted group structures which include multiple holding companies domiciled in nations with banking secrecy laws, to hide their taxable income from tax authorities. This is an example of illegal tax evasion.

How does the definition of holding company relate to investing?

Venture capital trusts and private equity groups tend to make liberal use of holding companies to invest in private businesses. In doing so, they allow for simple exit transactions at a later date and protect the wider fund from the bankruptcy of any of its equity investments.

Read more about this in the best venture capital books and the best private equity books.