A subsidiary is a company that is owned or controlled by a parent or holding company. Usually, the parent company will own more than 50% of the subsidiary company. This gives the parent organization the controlling share of the subsidiary. In some cases, control can be achieved simply by being the majority shareholder. When a parent organization owns all common stock of a company, it is known as a “wholly owned subsidiary.”
A subsidiary and parent company are recognized as legally separate entities. This means tax and debt are paid by the individual organizations, limiting shared liabilities between the companies. Subsidiary companies will have independence from the parent company, and in many cases are individual brands. However, the parent company will naturally influence how the subsidiary company operates. As the major shareholder, the parent company can elect the board of directors and drive the overall business strategy.
Subsidiaries are a commonly used structure for both national and international corporations. Tiers of subsidiaries can be used to group a range of industries within a multinational conglomerate. The structure can also be used to bring together companies from within one sector in a corporate group. This guide will explain what a subsidiary company is, how they work, key definitions and the benefits they bring to corporations.
What Is the Purpose of a Subsidiary Company?
The main benefit of subsidiary companies draws from the fact that they are different legal entities to their parent company. This means the two companies can limit shared liabilities or obligations and will be separate in terms of regulation or tax. In practice, this limits the legal and financial liability of both the parent and subsidiary company. Keeping companies separate can help to insulate the holding company from potential financial or legal issues faced by a subsidiary company.
In the case of multinational corporations, subsidiary companies will be aligned with local regulations or laws. As an incorporated company in its own right, a subsidiary company can take advantage of more favorable corporate tax rates compared to where the parent company is based. Subsidiary companies are a common way for corporations to expand into international markets. As independent entities, the risk for the wider corporation is minimized.
Subsidiary companies are often distinct brands, positioned under an overall holding company. These brands can benefit from the synergy between different parts of the larger corporate group, but also retain the benefit of independence. Subsidiaries can be experimental brands or products, as financial liabilities are contained. As separate legal entities, subsidiary companies are more straightforward to manage or sell too.
Instead of investing heavily in internal research and development, parent companies often acquire companies with specific area expertise. An example would be a larger company purchasing a small firm that produces a specific technology or digital tool. Subsidiary companies allow parent corporations to diversify their business but isolate the potential risks involved.
Setting Up a Subsidiary Company
A parent company can either create the subsidiary company or purchase the majority shares in an existing company. If founding a new subsidiary, parent companies will need to complete the process of incorporation as with the creation of any new company. The subsidiary will need to be registered within the state or country it is to be founded. The parent company will be recorded as owners of the subsidiary during the incorporation process.
As the majority owners, a parent corporation will elect the subsidiary’s board of directors, including the chairman of the board. In many cases, certain members will sit on the board of both the parent and subsidiary companies. They can help to represent the wider group’s interests when making strategic decisions.
As a legally separate entity, subsidiaries function as normal independent companies. They will produce their own independent financial statements. All transactions between the parent company and subsidiary will need to be recorded. Parent companies are also required to include financial statements from its subsidiary companies within a consolidated financial document. Corporate documentation is vital across the whole business life cycle, from initial incorporation until the potential closure of a subsidiary.
The Benefits of a Subsidiary Company
Subsidiary companies bring clear benefits in certain circumstances when it makes sense to keep companies separate as opposed to merging them. As separate legal entities, parent companies can limit financial liabilities and keep businesses apart.
This legally recognized separation is a key difference between a branch and a subsidiary company. It is useful when a company may benefit from favorable corporate tax rates or local regulations. A subsidiary company can also be a straightforward way to enter new international markets.
A subsidiary company that has been acquired can benefit from increased investment and expertise from the wider parent company. But at the same time, subsidiary companies can keep a degree of independence as a separate brand.
Benefits of a subsidiary company include:
- The potential for favorable tax rates in a separate setting to the parent company.
- Limited financial liability for the wider holding corporation, containing potential losses within the subsidiary company.
- Keep a specific brand or product as its own legal entity to maintain independence and make selling straightforward.
- Subsidiaries focusing on specific product or technology development can strengthen the corporation as a whole.
- Maintain an acquired company’s independence whilst exerting managerial control.
Who Owns a Subsidiary Company?
Subsidiary companies will be owned by either a parent company or a holding corporation. A wholly owned subsidiary company will be entirely owned by the parent or holding corporation. In other cases, parent companies will hold the controlling share of a subsidiary company. In practice, this means owning more than half of a company’s common stock. So, by definition, parent companies have majority ownership or control of a subsidiary.
As the major shareholder, parent companies will have the deciding vote when electing the directors in the boardroom. In many cases, a member sits on the board of both the parent and subsidiary company. Because of this, parent companies will have a huge influence on the strategic direction of subsidiaries, including any steering committee groups.
What Is a Holding Company
A holding company is a corporation that has one purpose: to manage subsidiary companies. The holding company usually won’t produce products or provide services in its own right. Its business is to oversee the operation of the subsidiary companies.
Holding companies are also known as umbrella corporations, as they group together a range of different subsidiary companies. Alongside companies, it may own a range of diverse assets such as property or stocks. Holding companies will generally deal with the strategic aims of the corporate group, selecting the board members across the subsidiary companies. Corporations can keep track of governance decisions across the group by using board portal software.
The subsidiary structure protects the holding company and corporate group as a whole from individual subsidiary liabilities. Any potential legal and financial issues will be contained within the affected subsidiary as individual entities.
What Is a Parent Company?
A parent company is an organization that has control of another company (or companies). It may hold the majority of shares in a subsidiary company, allowing it to control and manage the organization. Parent and holding companies are often used as interchangeable terms, but there are key differences.
Unlike holding companies, parent companies provide services and products themselves. In essence, it is a fully functioning business that has majority control of at least one other company. Parent companies will generally be large organizations that either fund a new subsidiary business, or purchase majority control of another company.
A common example is a large company buying a smaller company which might offer a specific product or service in their sector. This way, a parent company can acquire processes or products to strengthen its overall operation. By keeping the company independent as a subsidiary, the parent company lowers financial risk. It will also be more straightforward to sell the company as a subsidiary if it becomes unprofitable.
What Is a Wholly Owned Subsidiary Company?
If the entire subsidiary company is owned by the parent corporation, this is known as a wholly owned subsidiary. This means all common stock is held by the parent company. This is generally achieved through a parent company acquiring full control of a company, or by founding the subsidiary company itself. The wholly owned subsidiary company is still legally recognized as its own entity.
In contrast, a normal subsidiary is usually when anything more than half of the common stock is owned by the parent or holding corporation. A wholly owned subsidiary company has no other shareholders. This gives the parent corporation a major influence on the company’s ongoing operations. Direct control of who sits on the board of directors helps define the aims and strategic decisions made by the subsidiary company.
Wholly owned subsidiary companies are often international operations for a multinational corporation. With full control of the company, it can be better aligned with the corporate structure of the parent company. It also allows the parent company to retain full ownership over processes and products.
It’s worth noting that as the sole owner of the subsidiary company, there are heightened risks for the parent corporation. Without public shares or affiliated shareholders, it may be difficult to raise capital. The parent company may be the only avenue for financial support or investment.
What Are Tiered Subsidiary Companies?
There can be multiple layers or tiers of subsidiary companies within a wider corporate group. A company owned by a parent corporation is a first-tier subsidiary. But this subsidiary company may hold majority shares of a subsidiary company of its own. The second subsidiary company can be described as a second-tier subsidiary of the overall parent corporation. The tiers can continue depending on the complexity of the corporate group.
The parent company will have a degree of control over both tiers of subsidiary companies. As the major shareholder, it will hold direct control of a first-tier subsidiary. It can elect the board of directors and influence strategic business decisions when required. Using this influence, the parent company can exercise indirect control of the second-tier subsidiary.
What Is a Conglomerate?
A well-known use of the subsidiary corporate structure is within multinational conglomerates. This is usually one vast parent corporation that owns a range of smaller independent companies. Conglomerates often have diverse portfolios of companies from across many sectors. They can also focus on gaining controlling shares of companies within one specific industry.
By definition, a conglomerate will own a diverse group of businesses. The overall structure might see different holding companies covering different sectors, all under one parent company. The subsidiary companies can often be unrelated to each other within the conglomerate. By being invested in a diverse range of industries and businesses, the parent corporation can mitigate the risk of financial downturn and upheaval.
Conglomerates can benefit subsidiary companies by helping to unlock better funding. With improved access to capital, companies can grow their facilities and market share. In many conglomerates, subsidiaries are left alone as individual entities to manage their day-to-day operation. But by being part of a much larger group, they can benefit from the economy of scale.
What Is an Associate Company?
When a corporation owns a minor share of another business, the company is known as an associate or affiliated company. In this case, a corporation owns a portion of a company, but not enough to have full ownership. Usually, this is when a parent corporation owns less than half of a company’s common shares. To be considered a subsidiary, the parent corporation would need to own the majority of a company.
With a minority share of common stock, a parent corporation will have no direct control over strategic decisions. In most cases, a larger company will invest in a smaller associate company. The value of this investment will usually be recorded on the parent company’s financial statements.
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