By definition, 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.
This structure lends several advantages to either the corporate group
or the investor.
Firstly, a holding company can gain control over its subsidiaries without
investing the entire equity requirement. Thus,a holding company
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.
Secondly, 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. 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 ringfences
each business from the risks of the other, by preventing the business performance of one business from affecting the
performance and valuation of another.For investors, this offers the option to gain an exposure
to any preferred business along with the flexibility to structure the
investment (as debt, equity etc.) to meet their investment objectives.
Holding companies created by PE firms typically hold majority stakes in the underlying portfolio
companies. A common platform not only provides
back-end synergies to the group companies and efficient tax planning, but also maintains the identity of individual brands under its
subsidiaries. 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.
The consolidated revenue of the holding company, being larger than that of the stand-alone
firms in its portfolio, makes them more attractive in
initial public offerings (IPOs) of shares, an important route for PE firms to sell their investments. A holding company could also be an
attractive target for strategic acquisitions, wherein these companies could be sold individually
or collectively, thereby facilitating an exit for the investor.
In India, in the infrastructure sector, individual project companies called special purpose
vehicles (‘SPV’) are set up to undertake Infrastructure
projects. Groups of such SPVs are then held by a single holding company. A holding company structure becomes necessary, since
relevant regulatory authorities are required to award concessions relating to the infrastructure
projects in specific SPVs. A holding company structure
also enables each individual entity to gather pre-qualification experience, facilitating bidding for additional projects. It also provides
flexibility to the lenders where holding companies can provide guarantees and their risks are
diversified vis-a-vis the project SPVs.
As per the regulatory framework in India, holding companies which do not undertake any
operations and are engaged only in the business of
holding investments in other companies, may be classified as Non-banking Financial Companies (‘NBFC’). There are a separate set of
regulations applicable to NBFCs in India, which need to be complied with. Also, foreign
investment in such investment holding companies is subject to
approval from the Foreign Investment Promotion Board of India. According to the new Companies Act 2013, a company
will be regarded as a holding company of another, if the former holds or controls more than
50% of the total share capital of the latter, i.e., equity (voting and
otherwise) and preference share capital. This is significantly wider than the test under the Old Act and will have an impact
on the determination of related-party transactions, inter-company loans, etc.
In addition to a cumbersome regulatory framework, the holding company structure has certain
inefficiencies that need to be recognized. For
instance, in cases where the holding company is not the sole owner of its group companies, distribution of dividends is accompanied by two
layers of dividend distribution tax. Secondly, there is a requirement for a holding company to
transfer a part of its profits to its reserves which
may result in trapped cash that is difficult to upstream to the ultimate shareholders. Thirdly there is limited liquidity for minority
shareholders in a holding company as the promoters can retrieve profits from the subsidiaries
disproportionately through mergers and demergers; due to which
minority investors often seek fall back options along with related structures to secure an exit. As a consequence, the capital
markets have often attributed a ‘holding company discount’ when valuing such companies.
In conclusion, if the holding company structure is designed appropriately in light of the
objectives and scale of its businesses, it can lead to
synergies and efficiencies in the underlying businesses and the commercial benefits therefrom can outweigh the tax and regulatory