What is a Holding Company?
A holding company has a controlling interest in other companies which are called subsidiaries. An operating company is often a subsidiary of a holding company that conducts the regular management of the business under the holding company’s control. The holding company usually owns all the shares in the operating company but doesn’t participate in the day-to-day decision-making, sell any goods or deliver any services.
Also known as a ‘parent company’, a holding company has some management oversight and control when it comes to the operating company’s policies. This structure is often called a ‘dual company structure’ and it allows the holding company to own the business’ valuable assets. These assets may include intellectual property, cash, property and equipment which are held separately from the subsidiary operating company.
What is an Operating Company?
The operating company conducts the business under the control of its holding company and is responsible for the business’ day-to-day trading responsibilities. This includes entering into contracts with clients and taking on all associated risk and responsibility. The operating company also manages the recruitment of all employees and contractors for the business. Further, it enters into all agreements with suppliers and will be held accountable for any payments and debts.
Key Benefits of the Dual Company Structure
The dual company structure adds a layer of complexity because it involves the formation of two corporations which entails additional compliance obligations and costs. However, this company structure has some key benefits including protecting valuable assets, streamlining operations and providing flexibility for the business’ growth.
1. Asset Protection
The operating company is exposed to risk in undertaking the trading responsibilities of the business. However, if the operating company goes bankrupt, creditors are prevented from pursuing the assets held by the holding company to meet the operating company’s debts. Additionally, if a customer has a claim against the business, the claim lies against the operating company. Therefore, the business’ valuable assets are protected against any liabilities which the operating company might incur.
2. Streamlined Operations
Generally, the holding company and operating company will have the same directors. This enables the business to be centrally managed and for the company directors to focus on the business’ overall growth and performance. Also, when an operating company requires capital, a holding company with financial strength can achieve favourable financing terms. A holding company can often obtain loans for a lower interest rate than its operating company would receive, especially if the operating company is a type of venture considered a credit risk such as a start-up. After obtaining the loan, the holding company can distribute the funds to the operating company.
3. Flexibility for Growth and Development
Since the holding company holds the business’ valuable assets, there is less risk associated with the operating company investing in new ventures and diversifying. The holding company holds key assets which are not affected by the operating company entering into new contracts and taking on risk. For example, Google restructured and formed Alphabet as its holding company to have the flexibility to make investments in areas such as robotics and medical research. Google’s restructure enabled it to separate those new, riskier investments from its core and profitable functions, such as its search engine.
When is a Holding Company Liable for an Operating Company’s debt?
A holding company can be liable for an operating company’s debt if the following criteria are met:
- It was a holding company of the operating company at the time the debt was incurred;
- The operating company was insolvent when the debt arose or became insolvent from taking on the debt;
- The holding company had reasonable grounds for suspecting that the operating company was insolvent, or would become insolvent, and;
- One or more of its directors were aware, or should have been aware, that there were reasonable grounds for suspecting insolvency.
A dual company structure is something to consider when establishing a business as it offers considerable asset protection, streamlined management and opportunities to grow your business. It is worth considering if your business has valuable assets that require protection against risk.
If you need assistance with establishing a business, you can contact the team of commercial lawyers at OpenLegal on 1300 997 337 or by filling out the form on this page.