A holding company exists for the purpose of owning a controlling interest in other companies. (Reference 1) Holding companies typically do not provide services or produce goods themselves, but rather direct the actions of other companies. Warren Buffet’s company, Berkshire Hathaway, operates as a holding company. Holding companies offer both advantages and disadvantage.
Advantage – Limits Risk
The holding company and the companies it controls, called subsidiaries, operate as legally separate units. The legal separation shields the holding company from losses experienced by a subsidiary. The separation also provides the holding company the opportunity to make a business gamble though a subsidiary without jeopardizing its own continued survival. For example, a holding company may want to pursue a new solar cell technology. Rather than tie itself to the success or failure of that technology, the holding company purchases a controlling interest in an existing solar technology company and directs the solar company to pursue the new technology.
Disadvantage – Forced Dissolution
A holding company that buys up control of a group of companies that engage in the same or closely related business activities can find itself running afoul of antitrust laws. Antitrust legislation aims to prevent unsavory business actions, such as price-fixing, with a goal of protecting consumers and maintaining a competitive business environment. If the courts find a holding company guilty of violating antitrust laws, the government often forces the holding company to sell off its interest in some of its subsidiaries. The government’s decision to break up AT&T in the 1980s serves as case in point.
Advantage – Ease of Control
In theory, a shareholder needs to control more than half of a company’s stock to take control of the company’s actions or directions. The practical reality is that a far smaller amount of stock, sometimes as little as 5 or 10 percent of the voting stock, gives a holding company de facto control of a subsidiary. If a holding company only needs 5 percent of the stock of another company to take control, it can acquire a subsidiary for a minimal initial investment compared with purchasing a true controlling interest.
Disadvantage – Complex Taxes
The taxes that holding companies and subsidiaries must pay change depending on how much stock the holding company owns. If the parent company owns 80 percent or more of the subsidiary’s stock, the holding company can file a consolidated return. In other words, the holding company and subsidiary function as a single financial unit, even if they operate as legally separate units. If the holding company owns less than 80 percent of the subsidiary’s stock, it can only deduct a portion of the dividends from the subsidiary. The rest of the dividends are essentially taxed twice and at every level, from local to federal.