Holding Company: Going Big

A holding company is one which maintains a strong, often controlling, interest in a number of different entities (known as subsidiaries) without unifying them into a single business. Perhaps one of the most renowned holding companies of the 21st century is Berkshire Hathaway, owned by billionaire Warren Buffet, which possesses a stake in multiple household brand names such as Coca-Cola, Duracell as well as Heinz.

So why set up as a holding company? Are there any tax advantages to be reaped? Could the immensity of the entity bestow benefits to both the holding company and its subsidiaries? Whilst the answers to none of these questions are straightforward, there are undoubtedly merits in setting up a holding company.

Firstly, the sheer scale of the business should enable it attain economies of scale at a relatively quick pace when compared to traditional start-ups or small businesses which lack the necessary financial backing and spending power often associated with a holding company. The subsequently increased negotiating leverage with suppliers could result in better credit terms being obtained, lower purchasing costs due to acquisition of materials in bulk quantity and perhaps greater willingness of suppliers to cater to requests of companies for fear of losing a valuable client if they refuse to do so.

Regarding taxation, it may be the case that the holding company is deliberately set up in a tax haven or country with a lower corporate tax rate than the subsidiary’s country of operations. Repatriating profits of the subsidiary to the holding company would as a result engender value creation for the shareholders of the entity. The augmented sum of profits retained can be reinvested to ameliorate the efficiency and competitiveness of the subsidiary such that prospective profits surge from the improved state of the subsidiary’s operations.

SSE can prove extremely valuable in situations where capital gains are large or the resulting tax saving makes the disposal of shares profitable.

In the same vein, holding companies with a stake of at least 10% or more might be entitled to the Substantial Shareholding Exemption(SSE). This enables companies who dispose of shares in the subsidiary to earn capital gains to exclude the gain from the clutch of corporate tax when submitting the statement of profit or loss and other comprehensive income to HMRC. Nevertheless, should a loss arise on the disposal of shares, these cannot be offset against corporation tax, i.e. they aren’t allowable to be claimed to reduce taxable earnings. Certain conditions must also be satisfied to determine whether an entity is eligible to SSE. A minimum stake of 10% must be held for a continuous period of 12 months, beginning no more than 6 years before the disposal date. Provided the aforementioned conditions are met, a holding company can also dispose of the shares gradually rather than in one swoop whilst still being able to claim the SSE.

However, there are drawbacks to such a structure with some stemming from the very nature of the manner in which the business is set up and its relationship with subsidiaries.

Consider a holding company with a stake in two businesses which are initially operating in separate industries or even the same industry but different markets. A decision by either firm to diversify and expand its operations could pit the 2 businesses against one another which leads to a conflict of interests for the holding company relating to how each firm should be advised and voting on decisions at annual general meetings(AGMs). The level of financial support and how to devise a strategy to capture the market could spur the performance of one entity to the detriment of the other.

Furthermore, management of the holding company may hold insider information regarding the state of affairs of the subsidiary and seek to profit from this data by engaging in speculative activities. Whilst this may augment the wealth of management, it harms the shareholders of the subsidiary through lower share prices if management become involved in short-selling the stock or create undue market panic.

Management speculation can prove costly to shareholders and raise the subsidiary’s cost of capital unnecessarily rendering it more expensive to raise new funds.

The holding company may also exploit its significant bargaining power and control over the resources of the subsidiary to impose trading conditions. Requirements such as purchasing inventory solely from the holding company, perhaps at an inflated price to flatter its financial performance whilst selling inventory to the holding company at an undercut figure will provide it with an unfair competitive advantage.

Whilst pooling the resources of the subsidiary and holding company can lead to the emergence of deep pools of capital, how effectively this capital is used to create value for shareholders and increase the earnings potential and free cash flow of the entity, key factors in determining share prices of entities, remains to be asked. Financial laxity and improper allocation of resources can undermine the synergies intended to generate the potential for success.

Thinking of commencing a holding company? Need trusted financial advisors who can guide you to optimising your business structure and availing all possible benefits. Then ring Cheylesmore Accountants today to discover a refreshing and unique accounting experience which is certain to deliver excellent quality and surpass your previous expectations and experiences with number-crunchers.