Why a holding company model is good for business

If you venture into a business seeking equity capital or partnership - perhaps to enter into a new line, expand the size of your business or venture into new geographies, then you ought to understand the concept of a holding company as an investment partner.

It may also be that you have been approached by entities that are interested in acquiring a controlling stake in your business.

It is however important to seek sound legal and financial advice on what such an arrangement will mean for your business before making any decision, especially as to your company's place in a broader structure.

Holding companies are becoming more common in the Kenyan market today than they probably were ten years ago.

Still, many businesses, especially in the small and medium enterprises (SMEs) sector, look at them as a preserve of big corporations.

That is however not the case. To understand how holding companies may be beneficial even for businesses in the SME sector, we need to first understand what holding companies are and how they benefit the businesses under them.

Controlling stake

The primary business of a holding company is to hold a controlling stake in other companies. In and of itself, a holding company does not engage in the production of goods or services.

Holding companies may however own property, such as real estate, patents, trademarks, stocks, and other assets that may be beneficial for their subsidiaries.

The companies under a holding company are called subsidiaries.

These are either wholly owned by the holding company (wholly owned subsidiaries), or companies in which the holding company has a controlling stake.

While larger corporations often have diversified holding companies with investments spanning various sectors, it is typically advisable for smaller companies to focus on related sectors, so that they can benefit from group synergies and shared technical expertise.

One of the most important roles a holding company performs is sourcing capital and strategically deploying it to subsidiaries.

Holding companies exist to pool and deploy capital to their subsidiaries, offer strategic management support and provide platforms for synergies.

The advantage that a holding company has when it comes to capital sourcing and deployment is that it can utilise a diverse pool of options that is not limited to equity capital or credit from banks.

Additionally, holding companies, by virtue of their deeper engagement with subsidiaries, are better placed as capital providers due to their enhanced understanding of their subsidiaries' operations and business cycles which enables them to be more supportive and flexible.

However, this relationship needs to be managed as underlying businesses can destroy value if the relationship is not objective, making return and risk expectations unenforceable.

Often, the holding company may also raise funds to acquire a new business that will complement the activities of the already existing subsidiaries.

For example, a holding firm that owns an electrical transformers manufacturing company may acquire an electrical conductors manufacturing company to produce conductors for its transformers or bundle them together for joint sales to mutual clients.

In most cases under a holding company structure, the holding company also owns strategic assets like land or buildings which can also be deployed to the subsidiaries to meet strategic objectives and keep value in-house.

Governance levels

A holding company's investment in a subsidiary is in most cases usually accompanied by strategic representation at various governance levels for better alignment, quicker decision making and oversight of management.

Subsidiaries can also leverage the holding company's resources to expand their capabilities, especially in areas where specific technical expertise may be lacking.

A holding company has teams with specialised skills and operational expertise to support subsidiary businesses and offer critical support services as well as provide strategic direction.

As part of offering strategic support, a holding company may also be directly involved in the decisions relating to recruiting key personnel in the subsidiaries in line with set strategic goals.

These include some C-suite-level personnel.

Additionally, a holding company structure could produce value accretive synergies across its platform from commercial collaborations to infrastructure sharing and skills and expertise in identified areas in a shared services model.

The costs of centralised teams could then be shared across various businesses, saving costs and most importantly standardising key services.

The writer is the Group CEO of TransCentury Group Plc