One of my readers, Anshul, has been asking me, “Why do companies have a Holding Company? Why don’t they do direct business? A case in point is Balmer & Lawrie Investments Ltd vis a vis Balmer & Lawrie Ltd.
Before I elucidate upon the holding companies, Balmer & Lawrie Investment is an example of a company which has no business. It only owns approximately 10 million shares in Balmer & Lawrie Ltd. If Balmer & Lawrie pays a dividend, that becomes a tax free income for Balmer & Lawrie Investments. So, it is simply holding the shares of another company.
The best example of a holding company is the ultra famous Berkshire Hathaway of Warren Buffet.
A holding company is a company organized with the intention of acquiring equity ownership in other companies. Holding companies are popular in India, mainly in two forms – (1) corporate groups running multiple and varied businesses; and (2) private equity funds looking to create platforms to consolidate multiple assets within specific sectors or verticals, in which there are not many companies of the required size and scale.
When a family owns too many businesses with cross investments across those companies, it becomes an ideal control tool. In India, Birlas, Ambanis, Jindals, Mittals, Bajajs….. the list is a long who’s who of Indian family managed business owners, each started single businesses. Thanks to the LPQ Raj i.e License , Permit, Quota Raj of the 1960s to 1980s in India, all these Industrialists took permits and licenses for various businesses. So , the Birlas had paper, cement, sugar, shipping, aluminium, steel…..can you find a pattern? They were mostly commodity businesses with trading ideas inherited from the British Raj, with lots of money to be made as the licensee was a monopoly for a limited period.
This structure reduces risk to owners and provides for the ownership and control of a number of different companies. In doing so, a holding company can obtain certain tax-free dividends, based on ownership percentages, along with voting rights and value held by the company.
The holding company generally produces no products or services and is simply a vehicle for owning shares of other companies. Another benefit is the reduced risk exposure. The only risk the holding company has is the capital invested. The holding company also benefits from the subsidiary’s goodwill and reputation, while being sheltered from risks faced by the subsidiary in the case of legal issues, tax liabilities and lawsuits.
Structuring a holding company also makes sense from a number of other perspectives. When raising capital a larger holding company has more diversity of assets than an individual company, which makes raising capital easier. In addition, if the holding company loans the subsidiary money, the holding company can secure the loan with the assets of the subsidiary, thereby creating a collateralized loan that places the company in first position in the event of bankruptcy. Furthermore, the holding company can set corporate policies over all subsidiaries without interfering with individual management of the subsidiaries.
A holding company also, allows for structural leverage due to its ability to control the business of its subsidiaries by holding majority (just over 50% shareholding), but at the same time allowing for fresh external investment for the balance stake.
Tax can be saved by splitting income, and a holding company can enable this—-something especially beneficial for a family-owned business. By paying dividends to the holding company, the shareholders can ultimately determine who receives the income.Family members can subscribe for shares in the holding company, and tax can be minimized by splitting the income amongst individuals in different tax brackets.
Another advantage a holding company provides, is asset protection. If an operating company goes bankrupt or faces liability issues, creditors and litigators can go after its assets. For a small to medium size business, one claim can put a lifetime of accumulated profits at risk.
If excess earnings, investments and other assets have been separated to a holding company they are beyond the reach of creditors and liability claims originating from the operating entity. It can assist in raising capital based on the consolidated financial strength of its subsidiaries, which otherwise could be difficult for each individual subsidiary company. Thus, Flexibility to reorganize and structure finances is also available for individual businesses. Another key advantage of a holding company structure is that while it allows investment in multiple businesses under one parent company, it also ring fences each business from the risks of the other, by preventing the business performance of one business from affecting the performance and valuation of another.
In India, for instance New Silk Route PE has set aside US$100 million to invest in mid-sized food and beverage firms via its ‘Gastronomy’ platform, with two investments complete – Bangalore based Vasudev Adiga’s and Mumbai based Moshe’s.
Since, the query started with Balmer & Lawrie, I will finish with the same. The Government of India owned IBP, an oil company. IBP held shares in Balmer & Lawrie Ltd. When the government deregulated the oil and gas sector, it divested in view of globalisation of the economy to a strategic partner with management control. In consequence to such disinvestment, the shareholding of IBP Co. Limited in its erstwhile subsidiary, Balmer Lawrie & Co. Limited, was decided to be de-merged in favour of Balmer Lawrie Investments Limited. So, the erstwhile shares of IBP in Balmer & Lawrie are held by Balmer and Lawrie Investments thus, protecting the control of the government and making it a PSU.
Dear Sir,
Apologies for the late reply, spl when I have been the one pestering you for the post. Kudos to a great post, very well researched. I could have not asked for a better explanation of the complexities of the subject. I will just highlight the key take aways –
1. Better Structural Control. This structure reduces risk to owners and provides for the ownership and control of a number of different companies. In doing so, a holding company can obtain certain tax-free dividends, based on ownership percentages, along with voting rights and value held by the company.
2. Reduced Risk Exposure. Another benefit is the reduced risk exposure. The only risk the holding company has is the capital invested. The holding company also benefits from the subsidiary’s goodwill and reputation, while being sheltered from risks faced by the subsidiary in the case of legal issues, tax liabilities and lawsuits.
3. Ease of Raising Capital. When raising capital a larger holding company has more diversity of assets than an individual company, which makes raising capital easier. In addition, if the holding company loans the subsidiary money, the holding company can secure the loan with the assets of the subsidiary, thereby creating a collateralized loan that places the company in first position in the event of bankruptcy. Furthermore, the holding company can set corporate policies over all subsidiaries without interfering with individual management of the subsidiaries.
4. Asset Protection. The holding company can have all the advantages of the business, without the risk of bankruptcy ie the max loss is limited to the capital invested. The assets of the holding company can’t be called in by the creditors of the operating company.
5. Flexibility. Another key advantage of a holding company structure is that while it allows investment in multiple businesses under one parent company, it also ring fences each business from the risks of the other, by preventing the business performance of one business from affecting the performance and valuation of another.
However, being the contrarian that I have become, after following you, May I ask further few questions:-
1. With so many advantages, is it correct to say that one may be better off in investing with Balmer Lawrie Investments rather than Balmer Lawrie & Co?
2. What about the operating costs of the holding company ie if i intend to hold 200 shares of a company Y which holds 1000 shares of coy X, will I not be paying a ‘middleman’ for holding these shares of company X?
3. Growth. Growth of both the companies are tied together, but if operating coy X grows its PAT at 20%, the growth of the holding company Y is limited to growth in dividends, which may or may not be in line with growth of PAT.
Finally, thank you sir, for introducing us novices to such an interesting subject.
Regards
Anshul Gaur
You are bang on. Buying Balmer & Lawrie Investments is a better bet than B&L. But price appreciation in holding companies is sometimes subdued.Look at BF Investments also.