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Advantages and Disadvantages of forming the Holding Company
Rather than a merger or an acquisition, the acquiring company may choose to purchase only a portion of the target’s stock and act as a holding company, which is a company that owns sufficient stock to a controlling interest in the target. Holding companies can trace their origins back to 1889 when New Jersey became the first state to pass a law allowing corporations to be formed to own stock in other corporations.
The company is a wholly-owned subsidiary of an acquirer who buys 100 % of the target. However, holding all of the company’s stock is not necessary to exert control over it. Companies with a widely distributed base can establish effective working control of a minor 10 to 20% of the outstanding common stock.
Holding companies have certain advantages that can make this form of control transaction preferable to an outright acquisition. Some of these advantages are listed as follows:
- Lower cost. With a holding company structure, an acquirer can attain control of a target for a much smaller investment that would be required in a 100% stock acquisition. A smaller number of shares permits a lower total purchase price. Since fewer shares are demanded in the market, there is less increased price pressure on the cost per share may be lower. The acquirer can attempt to minimize the increased price
- No control premium, Since the acquirer did not have 51% of the shares, the control premium associated with 51% to 100% stock acquisition would not have to be paid.
- Control with fractional ownership. Working control can be established with less than 51% of the target company shares. This may allow the controlling company to exert a specific influence on the target to further the controlling company’s objectives.
- Approval is not required. In the US, it is allowable under federal and state laws; a company may purchase shares of a target without having solicited the approval of the target company’s shareholders.
Holding companies also have certain disadvantages that make this transaction attractive only under the circumstances. Some of these disadvantages are listed here.
- Multiple taxations. The holding company structure adds another layer to the corporate structure. Usually, stockholder income is subject to double taxation. First, income is taxed at the corporate level, and some remaining income may then be distributed to stockholders as dividends. Stockholders are then taxed individually on this dividend income.
Holding companies receive dividend income from a company that has already been taxed at the corporate level. This income may then be taxed at the holding company level before it is distributed to stockholders. This amounts to triple taxation of corporate income.
- Antitrust problems. A holding company combination may face some of the same antitrust concerns that all at once face. If the regulatory authorities find the holding company structure anti-competitive, it is comparatively easy to require the holding company to divest itself of its holding in the target. Given the ease with which can accomplish this, the regulatory authorities may be quicker to require this compared with a more integrated corporate structure.
- Not 100% Owner. A holding company can be formed without a 100% share purchase may be a source of cost savings. However, it leaves the holding company with outside shareholders who will have some controlling influence. This may lead to disagreements over the direction of the company.
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