What is the Purpose of a Holding Company?

A holding company, as the name implies, is usually an entity formed exclusively for the purpose of “holding”, i.e. owning something.  Holding companies typically do not conduct business in the same way an operating company does. The specific purpose of a holding company depends on how it is used and what potential problems a holding company is intended to solve.  In this article I will discuss two popular types of holding companies: (1) the parent company, and (2) the intellectual property holding company.

The Parent Company

A parent company typically owns other companies and not much else. One of the most common situations in which a parent company is used is when a common group of owners want to have equity in multiple related companies. For example, rather than giving an investor 20% of an operating company and an IPHC and three real estate holding companies, the investor could simply take 20% of a parent company and the parent company could own 100% of the subsidiary companies.  It essentially accomplishes the same objective with fewer complications.

The Intellectual Property Holding Company

Intellectual Property Holding Companies (IPHCs) are formed exclusively to own and manage intellectual property (patents, trademarks, and copyrights). IPHCs almost always involve a license arrangement with a related company under which the IPHC earns royalties in exchange for allowing the related company to acquire rights in the IPHC’s intellectual property for a period of time.

Example

One common structure our law firm has used with clients is a three-company structure: (1) a parent company, (2) an IPHC (wholly owned by the parent company), and (3) an operating company (also wholly owned by the parent company).

Consider the example of a medical device business.  The purpose of the operating company is to conduct business.  In other words, the operating company is responsible for research, product design, sales, marketing, hiring, training, and managing employees, entering into strategic partnerships and other contracts, and the other typical types of conduct one would expect from a company transacting business in the modern medical device marketplace. The purpose of the IPHC as you probably have guessed by now is to own and manage the company’s intellectual property.  This would likely include any patents covering the business’s medical devices, registered trademarks protecting the company’s brands, logos or slogans, and copyright registrations on the company’s works of authorship. There would be one or more intellectual property license agreements between the operating company and the IPHC under which the operating company pays a royalty to the IPHC in exchange for certain rights relating to the intellectual property owned by the IPHC. As mentioned above, the operating company and IPHC are both 100% owned by the parent company.  

Advantages of a Holding Company

⁃ Separation of the management of the holding company(ies) from the management of the other parts of the business. Sometimes the same management team is not well suited to run all aspects of your business. Allowing a specialized management team to focus on a single purpose rather than trying to handle everything often produces better results.

⁃ Isolation of assets and liabilities. In most cases, a creditor of one company may not reach the assets of a different company (even if the two companies are related or have common ownership) to satisfy that company’s debts. Using our three company structure as an example, if an adverse party obtained a court judgment against the operating company, the assets of the IPHC and the parent company should be unaffected.

⁃ IPHCs can bring enforcement actions.  If a third party is thought to be infringing the business’s intellectual property, the IPHC can sue to enforce its rights and stop the infringing activity. This avoids having to create a distraction for or drain on the operating company.

⁃ There may be tax advantages. A discussion of the tax implications of utilizing a holding company is beyond the scope of this article, but suffice it to say that holding companies are frequently formed in tax-friendly jurisdictions for this purpose.

⁃ Cleaner exit options.  Sometimes a business might want to sell off a particular business unit, but keep the rest of its operational structure intact.  If a holding company is utilized to isolate a certain type of asset (such as intellectual property) it makes it easier to carve it out and sell it to a third party if everything relating to that business category is already segregated into its own entity.

Disadvantages of a Holding Company

⁃ Must maintain typical formalities for each entity. Each company in this structure must conduct itself as its own separate, viable legal entity with its own operations.  In other words, each company should have its own bank account, financial statements, minute book, and preferably independent directors, officers, managers, and employees.

⁃ Can be confusing for partners and employees. It is not always easy (or desirable or necessary) to explain to third parties or employees the reasons for a particular business structure.  Individuals may become confused as to the purpose of each entity, which risks (particularly with employees) the entities being incorrectly treated as being one in the same.

⁃ IPHCs may not be entitled to lost profits in cases of infringement. Case law suggests an IPHC may be awarded a “reasonable royalty” in a case of patent infringement, but not “lost profits”.  Lost profits are generally considered a preferable measure of patent infringement damages as compared to a reasonable royalty.

Final Considerations

In considering whether the structure described in this article is right for your business, ask yourself what problems you are trying to solve or prevent, and whether a holding company structure will help you solve them. If a structure involving one or more holding companies seems like a good solution, ask yourself whether the additional cost and administrative burden is outweighed by the added legal protection and operational advantages.  If the answers to both questions are yes, or if you need help figuring it all out, our law firm would welcome the opportunity to assist.