Holding companies aren’t the type of business that someone traditionally pictures. Instead of producing goods or services for consumption, these companies simply hold onto shares of other companies. This unique type of structure has some definite benefits to it, but there are some unique disadvantages which must be addressed as well. Here are some of the top holding company pros and cons for your consideration.
The Pros of a Holding Company
1. Any dividends that are received by the holding company are tax free.
This helps the holding company be able to have a local economic impact with less overall risk. Although workers aren’t making goods and services, they are still contributing by earning money based on their investment strategies and spending it locally.
2. There is a reduced level of legal risk.
Because holding companies are essentially just a shareholder in an organization, they don’t run the same legal risks as if they produced goods and services. Their ownership stake may be financially affected should one of the companies in which they hold shares loses a lawsuit for some reason, but they won’t have a direct legal responsibility that could be even more costly.
3. It doesn’t limit a company from having some traditional functions.
In the United States, a business can qualify as a holding company if 60% of its adjusted ordinary gross income comes from dividends, royalties, interest, and/or rent. This allows a company to be involved in a diverse range of business opportunities and still potentially make and sell products for consumption if they recognize an opportunity exists.
4. Holding companies have access to more secure loan opportunities.
Because the shares a holding company typically owns are considered a tangible asset, secure loans based on their value can be secured at much lower interest rates. If the holding company defaults on the loan, the asset simply transfers to the holder of the loan. It’s low-risk for everyone involved and allows a holding company to expand their investments when it makes sense without costing them current revenues to do it.
The Cons of a Holding Company
1. Company management isn’t very transparent.
Warren Buffet is the exception to the rule instead of being a good example of what a holding company does. Most holding companies have their board of directors, their shareholders, or both in the dark when it comes to how the company is managed. Instead of having a direct input on the day to day operations of the company, these entities act more as a sounding board for advice and consultation. In many ways, outside of the primary individuals involved, there is much which may not be known.
2. It can be difficult to liquidate assets when necessary.
If a bull market quickly transitions into a bear market, a holding company may find themselves in a difficult situation. They may have a diversified portfolio in place, but certain shares may need to be dumped so financial losses on an investment can be limited. There may be fines and penalties which may also need to be paid, but not much cash available to make that happen. Buying is easy for a holding company. Selling is a bit more difficult.
3. Market volatility brings company vulnerability.
A holding company is only as strong as their investment strategy and the economy which supports it. This means there is less predictability in the year-to-year profits that a holding company receives when compared to a more traditional business. Holding companies can’t introduce new products or try new services as much as a traditional company can do to create new revenue streams either.
4. Shareholders may have competing interests.
Whenever there are competing interests for a holding company, it is going to affect the share prices involved. Shareholders may hold stock in a company that the holding company decides to make an investment in already. The holding company may also choose to sell some of their equity in a business. There is a lot of up and down when it comes to the financial stability of everyone involved if a holding company is very active, which can make it difficult to plan for the future for some of the folks involved.
A holding company can provide a stable source of revenues. It can also be a very volatile business entity that affects many others on its road to profitability. The holding company pros and cons mentioned here are just a few of the key points to consider. Before starting any company or getting involved with an investment, it is best to seek legal and business advice to make sure you are protected as much as possible.