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Holding companies: Benefits & costs
for private equity investors
Holding company structure if designed appropriately can lead to synergies and efficiencies in the underlying
businesses
Darius Pandole
December 26, 2013 Last Updated at 15:54 IST
8
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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
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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 backend synergies to the group companies and efficient tax planning, but
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11/29/2016 Holding companies: Benefits & costs for private equity investors | Business Standard News
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 midsized 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 standalone 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 prequalification experience, facilitating bidding for additional projects. It also
provides flexibility to the lenders where holding companies can provide guarantees and their risks are diversified
visavis 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 Nonbanking
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 relatedparty transactions, intercompany
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 inefficiencies.
Darius Pandole is Partner, New Silk Route Advisors
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