Inside an Investment Holding Company

May 31, 2018 HospitalityEconomyBusiness

What is a Holding Company?

A holding company is a parent corporation, limited liability company or limited partnership, that is a vehicle for owning other companies. Its existence is to hold investments, such as property like real estate, trademarks, patents, stocks and other assets.

It is a majority shareholder of other companies(subsidiaries), with ownership of 10% or more of shares. Holding companies oversee the businesses but are passive; Holding companies provide support services to the various investees.

This form of set up reduces the risk of liability as it is legally considered a separate entity not entangled with each of its subsidiaries. The Holding company is therefore liable for only the amount of capital invested and not more.

For example, the holding company may be a trademark which creates and funds a design company, a manufacturing factory, and logistics company to design, create, and ship a product. Let’s say the manufacturing factory is liable for losses or is handed a law-suit, the holding company will bare capital loss of its subsidiary to the extent of its ownership percentage and can be sued directly in case of 100% ownership.

Strategy

Diversification

A Holding company’s objective is to make profit through the ownership of other companies, or parts of other companies. When it comes to investments, diversification is a well-known to investment companies as a risk-management strategy.

Investing across different industries, sectors of the economy, asset classes, geographical locations, helps to increase the rewards and keep risks at a minimum. As it is not possible to always pick a winner, having eggs in different baskets ensures that if one investment falls short due to various factors, the rest balance the overall ability to make profit.

Combined cost

Holding companies lower the costs and improve revenue by owning several companies that complement and complete the overall business. For example, a building construction company, a concrete factory, and a heavy machinery company make for three subsidiaries worthwhile of a holding company’s investment within the construction industry.

8 Tips to Start

How do successful holding companies go about picking an investment? There are a few initial key points that are important to look at before further decisions are made. According to the mammoth of an investor Warren Buffet of Berkshire Hathaway, one of the largest multinational companies in the world by revenue, the following is advised:

1. Figure out what a good business is for you personally and ask where there is room for growth?  You do not want to get stuck in a business where there is no room for advancement, by product or in the market.

2. Not everything that comes your way must be invested in. When it comes to investing there are countless opportunities. Successful investment is about the knowledge and understanding of the company and industry of choice, and it only takes 1 to make a lot of money, one to build a name.

3. It can be a better bargain to go for components or partly-subsidized instead of wholly-subsidized (100% owned). Look at what is the most profitable way about the investment.

4. Invest in productive assets, not a stick of gold that “sits and looks pretty”. Investments that actively produce profits such as a farm, agriculture land, can continuously produce products and profit, are the way to go.

5. Evaluate the business first. Look into its history, do your research, and if it is possible go see the business in person. If the valuation you give matches the price of the shares or is higher (undervalued stock), it is considered a good investment.

6. Look at the financial reports; First, whether the net income is positive, second if there has been growth over time through revenue and earnings, and third, whether the operating cash flow is positive. Past performance can be indicative of what is to come but not predictive.

7. Look at the P/E ratio. This is the ratio of the company’s price of stock to the company’s earnings per share. If it is low it can indicate that you are getting a bargain, however it may not be the full story as it can fluctuate depending on different factors. It is never-the-less, a good first valuation when considered against the company’s past performance and in comparison to the industry and market.

8. Accept mistakes, cut your losses and move on. How do you know you have a bad business and when to call it quits? If you have a bad business with a good manager, you probably have a bad business. If you have a bad business with bad manager, put in a good manager and see what happens. If that doesn’t improve the standing of the company, it’s probably time to cut the losses and move on.

Advantages

  •  Depending on the percentage of shares owned, holding companies benefit from tax reductions, in the sense that it becomes more about moving money between the same company. If 80% or above is owned, the holding company can benefit from tax-free dividends – depending on where it is based.
  • A Holding company is sheltered from the risks faced by the companies it owns in the case of legal issues, tax liabilities and lawsuits, depending on ownership.
  • This structure can use its own selection of subsidiaries to do business, thereby cut down costs and increase overall revenue.
  •  Raising capital for subsidiaries becomes easier as the holding company is a safe guarantor with larger finances for creditors.  Holding companies can therefore secure loans for subsidiaries and lower interest rates than they would get as stand-alone entities. (This reduces interest expense and, in turn, increases both return on equity and return on assets.) 

 

Disadvantages

  •  Management of holding companies may not be sufficient with industry knowledge to run new subsidiaries.
  •  Subsidiaries may face difficulties with the new change of control as new board of director and management may be put in place.
  •  Shareholders pay taxes on dividends received from the holding company. To begin with though, at the corporate level the subsidiaries have already paid tax on profits, and the holding company on dividends received from its subsidiaries.
  •  As a larger company it can be more difficult to maneuver in volatile markets.

The structure of a Holding company is beneficial for the legal purpose of protection, reduction of risks, tax, and allows for management and profit. It is a great choice for wide spectrum of investments with the use of diversification as a strategy to keep overall profit up even if one sector drops. Looking at the words of advice coming from a top investor, before deciding on an investment there are short hand methods used to get the feel for whether or not an investment opportunity is worth taking seriously. These strategies used by holding companies and top investors are similar to those an individual can apply to help in choice of investment.

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