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A holding company is a special type of business that doesnt do anything itself. Instead,
it owns investments, such as stocks, bonds, mutual funds, gold, silver, real estate, art,
patents, copyrights, licenses, private businesses, or virtually anything of value. The term
holding company comes from the fact that the business has one job: to hold their
investments.
History is filled with examples of amazing holding companies, such as Allegheny, Loews,
Berkshire Hathaway, The Marcus Corporation, Cascade Investment, and Walton
Enterprises. Many modern day corporations such as General Electric or Bank of
America are really holding companies because they own a bevy of smaller businesses;
e.g., Bank of America is actually a bank holding company, owning control of the stock of
other private companies including the eponymous bank, insurance businesses, asset
management companies, securities underwriters, and more. That is, when you buy
shares of Bank of America on the New York Stock Exchange, the company you are
buying doesnt do anything itself. It is merely a conduit through which it controls and
owns the stock of underlying businesses.
Personally, I like to think of holding companies as coming in two forms:
1.
Holding companies that serve as investment vehicles for investors
2.
Holding companies that serve as risk management tools for large corporations
Although they have some similarities, they are different. It is important you understand
which you are thinking about and why both types are used.
costs less than a few thousand dollars (and it can even be done or less than $200 if
necessary).
There are 10 family members, each of whom writes a check for $1 million to the new
holding companys bank account in exchange for 10% ownership. Once everyones
contribution is received, the holding company has the simplest balance sheet in the
world:
Assets: $10,000,000
Liabilities: None
Member Equity (Book Value): $10,000,000
Im going to show you how the holding company could use that $10 million to control
$500 million or more without a lot of risk. This is an extreme over-simplification but
the idea is to teach you how holding companies work so we can ignore the details for
now.
The result is, the family is now controlling more than half a billion in assets, with very
little risk to itself, on only $10 million.
Now, to be perfectly clear: The rules are so incredibly complex that this is just a
theoretical, incredibly simplified broad overview example of how something like this
would work. It probably wouldnt be worth the effort to setup a structure that
complicated unless your business were generating massive annual profits. In most
cases, a guy running a little bakery in a small town is going to be covered by his
insurance policy. To him, the odds are good that a holding company would be an
expensive, mind numbingly painful paperwork nightmare.
With a conglomerate structure, you could just issue shares of the holding company to
your grand kids and they would indirectly own part of everything. They would only have
to deal with one tax filing, one stock, and one shareholder meeting. Plus, you could
write the holding company operating agreement so that you retained 100% voting
control.
Holding companies are as diverse as their owners. Some specialize in hotels and other
real estate, some own restaurants, some build coffee shops, some invest only in publicly
traded stocks, others focus on making investments in high-tech start-ups, some fund
movie projects, while still others acquire silver mines or mineral rights.
The point is, a holding company is worth too much effort and doesnt provide enough
benefits for most small investors. You should never add an extra layer of management
unless it is necessary. There are some expenses involved, such as preparing another set
of tax returns, that must be taken into account. If those are even a rounding error, you
probably should wait until it is going to be worth the expenditure. You should never
want a holding company simply for the sake of owning one. They have very specific
purposes. An exception might be a family who has a few hundred thousand dollars and
wants to invest together through a single entity.
Can be used to silo investment assets and protect them, such as Dunkin
Donuts putting its intellectual property into its own LLC.
Can permit you to structure deals so you control far more money than
you otherwise could afford. If you had $10 million and used it to buy control of a
$20 million insurance group that had $70 million in float, you would be controlling
$70 million from your holding company.
In essence, a holding company is in the business of providing capital and people. That
is it. Some dont even do that (Berkshire Hathaway refuses to provide management to
the subsidiaries it purchases; they dont run businesses. General Electric, on the other
hand, is one of the greatest machines of all time and can have someone else running a
company within 12 hours.)