A subsidiary company is a business entity whose controlling interest belongs to another company which is usually referred to as a parent or a holding company. The subsidiary operates independently from the parent company but under its control and direction. By owning subsidiaries, the parent company can enjoy various perks, such as paying less taxes, reducing risks, expanding its business, and reaching more customers. Subsidiaries can also have their subsidiaries, creating a complex corporate structure. To provide further clarity on the topic, we have prepared this comprehensive guide on a subsidiary company for you.
Who can Own a Subsidiary Company
Any entity can own a subsidiary company as long as the parent company has the dominant share of its ownership. This means that the parent company must own more than 50% of the subsidiary’s shares or have the power to appoint or remove its directors. A subsidiary company can be owned by another subsidiary company, creating a chain of ownership. Multiple parent companies can also own a subsidiary company, forming a joint venture. However, some industries or countries may impose legal or regulatory restrictions on the ownership of a subsidiary company. Subsidiary companies have their own financial statements but are also consolidated with the parent company’s financial statements. It can offer various benefits to a parent company, such as diverse expertise, tax benefits, cooperation, etc. However, they can pose challenges like limited control, workload, bureaucracy, complexity, and costs.
Key Aspects of a Subsidiary Company
Despite being owned by a parent or holding company, a subsidiary company has various aspects where its functioning differs. These aspects are:
- Decision-Making: The parent company can influence the decisions and operations of the subsidiary company through its ownership rights and board representation.
- Supervision and Direction: A subsidiary company is considered independent of its parent or holding company, but it still works under the parent company's supervision and direction, as required.
- Industry and Location: A subsidiary company has the freedom to operate in the same or different industry as the parent and in the same or different country or region.
- Subsidiaries of Subsidiary Company: A subsidiary company creates a complex corporate structure by owning subsidiaries.
- Support from Parent Company: The parent company can also provide financial support to the subsidiary company, along with technical and operational support.
- Consolidated Financial Statement: The parent company formulates its consolidated financial statements by combining the financial outcomes of all its subsidiaries.
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Steps to Establish a Subsidiary Company
Before creating subsidiaries for the business, it’s essential to examine all its aspects, including the potential advantages and disadvantages that accompany it. When there is a comprehensive and accurate understanding, the procedure to form a subsidiary can commence. The steps involved in establishing a subsidiary company are:
- Obtain Authorization. Obtain the rightful authorization from the parent company to create a subsidiary and then select the name, operation location, and business structure.
- Register Subsidiary. Then, register the subsidiary as a limited liability company (LLC) or a corporation with the secretary of state’s office in the same state. Pay the applicable filing fees and obtain the company's certificate of formation or incorporation.
- Apply for Unique Tax Identification. Obtain the Employer Identification Number (EIN), also called the Internal Revenue Service (IRS). It is a unique tax identification number for corporations to file taxes and other business purposes.
- Transfer Stock. Establish ownership and control over the subsidiary by transferring all or some of the stocks of the parent company to the subsidiary. A subsidiary company can be owned completely or partially by the parent company.
- Create a Bookkeeping and Accounting System. Create a separate bookkeeping and accounting system for the subsidiary that is distinct from the parent company. The subsidiary should have its own bank account, financial statements, and tax returns. The parent company should consolidate the subsidiary’s financials with its own on its consolidated financial statements.
Advantages of Creating a Subsidiary Company
There are many reasons to create one or several subsidiary companies. Some of them are:
- Raises Capital: By creating a subsidiary company, the parent company can drive large investments and offer stock for their company by selling a small fraction of the subsidiary company. This helps raise capital without the potential risk of adjusting the stock value of the main company.
- Adopts a Strategic Approach: By segregating the parent company's and its subsidiary's assets, the company can adopt a strategic approach in disclosing the desired aspects to the public. This can primarily assist those parent companies that operate in a competitive industry and are unprepared to reveal their new product line.
- Saves Taxes: When a parent company owns at least 80% of a subsidiary company, it can file a consolidated tax return while deducting any losses the subsidiary might incur from its total income. This way, while managing and selling the subsidiaries, the parent company's operations are unaffected. The parent company is also responsible for collecting subsidiary debt on the subsidiary accounts.
- Simplifies Brand Approach: Since a parent company may have multiple product lines when the subsidiary companies are separated, it facilitates the differentiation of the various brand identities and the company culture into a coherent structure. This tends to enhance vendor relations, marketing, and customer brand awareness.
- Limits the Legal and Financial Liability: When there are two separate legal entities, the legal and financial liabilities of both the parent and the subsidiary company are limited. Creating two separate legal entities can limit the liability of both the parent and the subsidiary company. When these companies are separated, the parent company can be shielded from possible legal or financial problems faced by a subsidiary company.
- Gains Diverse Expertise: Rather than investing substantially in internal research and development, parent companies frequently acquire companies with specialized domain expertise. For example, when a large corporation purchases a small firm that produces a specific technology or tool, it gives the parent company diverse expertise and recluses all its potential risks.
- Results in Flexible Operations: Typically, subsidiary companies are different brands or market segments in that a single parent business operates jointly. The subsidiaries benefit from the synergy among the various parts of the parent company but retain the advantages of independence. When the subsidiary and parent companies are separated, managing or selling the subsidiaries becomes easier.
Key Terms for the Subsidiary Company
- Synergy: This is the possible advantage of merging two or more companies, such as higher revenues, lower costs, or better efficiency.
- Parent Company: This company has the controlling interest in one or more subsidiary companies and owns them fully or partly.
- Liability: The legal obligation or responsibility is to pay debts or damages as mandated.
- Wholly-Owned Subsidiary: The company is 100% owned by the parent company.
- Partially-Owned Subsidiary: This is the company that is owned by the parent company between 50% and 100%.
Final Thoughts on the Subsidiary Company
A subsidiary company is a company that is wholly or partially owned by a parent or holding company. Establishing and acquiring subsidiary companies is common among publicly traded companies, especially in the real estate and tech industry. The parent or holding company needs to properly analyze and understand all the advantages and disadvantages of creating or acquiring a subsidiary company.
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