We live in a globalized world where organizations are expanding in finance and operations. Companies typically seek to enter the global markets by setting up subsidiaries.
Subsidiaries are a company that works under a parent or holding company. A subsidiary is a kind of company where the majority of shares are controlled by a parent company or holding company. These shares can also be owned by a completely different company managed by someone else. For a company to be called a subsidiary, another firm must hold a minimum of 50% shares. However, if a company owns 100% of the other company’s shares, it is called a wholly-owned subsidiary.
The percent of holding decides the kind of control a parent company has over a subsidiary. While there are several advantages of a wholly-owned subsidiary, parent companies may have to bear certain disadvantages of wholly-owned subsidiaries too.
How does a wholly-owned subsidiary work?
In a wholly-owned subsidiary, minority shareholders are absent since the parent business owns all shares. Operations at a wholly-owned subsidiary are controlled and approved by the parent organization. These subsidiaries may or may not have direct input into its activities and management. Consequently, it could become an unconsolidated subsidiary.
For example, a wholly-owned subsidiary is located in a different country from the parent company. The subsidiary likely has its own management team, products, and consumers. With a wholly-owned subsidiary established in a foreign country, the parent firm may be able to sustain activities in other geographic areas, markets, or industries. These elements assist in adapting to market, geopolitical, and trade practice changes. This will increase the parent firm’s profits, which they can invest in other assets and entities.
Advantages of a Wholly-owned Subsidiary
There are several advantages of a wholly-owned subsidiary. A wholly-owned subsidiary allows tax benefits, has limited liability, and promotes diversification.
Knowing the advantages of a wholly-owned subsidiary will help you realize how to reap the optimal benefits of a subsidiary. Let’s have a look at these advantages:
- Easy reporting: The reporting procedure in a wholly-owned subsidiary is relatively straightforward. Generally, the parent company takes charge of consolidating all the subsidiary’s financial statements. Hence, the burden of creating different financial statements is not on the subsidiary. Further, all kinds of assistance are provided to the subsidiary when the parent company consolidates all the financial statements into a single one.
- Access to more resources: The financial resources at the company’s disposal increase as the parent firm can arrange for more financial resources as it receives all earnings from the subsidiary. Parent companies can use these funds to grow the company or invest in other businesses that can create value for it and improve ROI.
- Reduces cost: The subsidiary’s costs also go down as the parent company takes care of all pivotal overhauls. Also, there can be a mutual understanding between the parent company and the wholly-owned subsidiary where they mutually benefit from shared resources. This reduces the cost of procuring new technology and making changes in the financial systems as the parent company will already use its resources to understand the changes in the financial systems.
- Low tax liability: One of the most notable financial advantages of wholly-owned subsidiary is lower tax liability. Companies owning multiple subsidiaries can counterbalance the profits of one subsidiary with the losses of another, resulting in lower tax liability.
- Easy operations: The parent company has complete control over a wholly-owned subsidiary and can make any decisions concerning the subsidiary. The parent company can fully control all operations and strategically control the wholly-owned subsidiary.
- Better negotiations: When a parent company and wholly-owned subsidiary work together and share a business relationship, they gain more substantial negotiating power. This business relation gives them the authority to negotiate better with suppliers and other stakeholders that might impact these companies.
- Vertical integration: Vertical integration occurs when a strategic relationship exists between the parent company and the wholly-owned subsidiary. This increases the competitiveness of the companies that constantly try to outperform each other.
- Access to parent company’s resources: The best part of being a wholly-owned subsidiary is accessing all the parent company’s resources. However, this works the other way, too. Both companies can use each other’s resources which are not limited to assets and property. The two organizations can also utilize expertise in finance and marketing to grow. This, in turn, brings down any administrative overlap and promotes seamless integration between the two companies.
- Easy decision making: The decision-making process becomes easy and quick as the business model becomes flexible. The parent organization can give a direction to the wholly-owned subsidiary, and the subsidiary, in turn, can follow its footsteps and prioritize what seems necessary.
- Better synergy: Promotion of synergies between the two companies in different verticals like information technology, finance, marketing, etc., can benefit the parent company and subsidiary in terms of cost reduction and strategic positioning. Also, research and development become better when two companies come together. The strategic support lasts long, giving confidence to the wholly-owned subsidiary.
- Improved risk-taking ability: As a parent company backs the wholly-owned subsidiary, it can afford to take risks by diversifying business and entering new markets. Also, if the parent acquires a foreign subsidiary, they can use it to strengthen their foothold in that country.
- Limited liability of owners: A wholly-owned subsidiary is a separate legal entity. The parent-subsidiary structure helps the company strategize and mitigate business-related risks. The losses incurred by the subsidiary may not affect the parent company.
- Better risk mitigation: Parent companies can also use their data access and security directive for the wholly-owned subsidiary to mitigate the risk of theft of technology and intellectual property loss.
Disadvantages of a Wholly-owned Subsidiary
Despite having a lot of advantages, wholly-owned subsidiaries have a fair share of disadvantages. There is a possibility of multiple taxations, deviated business focus, and conflicting interests of companies and subsidiaries. Thus, while setting up a wholly-owned subsidiary, organizations must also be aware of the disadvantages of wholly-owned subsidiaries.
- More taxes on parent company: The tax levied on the parent company might increase as more taxes are levied on companies having subsidiaries.
- Complex documentation: Owning a wholly-owned subsidiary comes with a lot of paperwork and legal formalities, which will increase the cost structure of the parent company.
- Increased cost for parent company: A parent organization must buy into the company’s assets, making a total investment. This is practically impossible if the aspiring parent organization is a small or medium-sized firm with limited resources.
- Overvaluation: The parent company might pay too much for the subsidiary’s assets if the assets are overvalued and multiple businesses are bidding for the same company.
- Higher reporting risk: A minor execution error in financial reports may disturb the parent company’s fiscal performance.
- Increased impact of losses: Suppose the wholly-owned subsidiary has to bear any losses. Those losses will directly impact the parent organization, and the parent organization must intervene to help the subsidiary recover.
- Onboarding additional resources: Every country sets its own rules and regulations for running a business. Managing a wholly-owned subsidiary based out of a foreign country can be challenging as you may not know the country’s laws and industry regulations. Hence, you might hire additional resources for managing your wholly-owned subsidiary in a foreign country. This can create an additional financial burden.
- Dependency: Suppose there are any disruptions in the working of the wholly-owned subsidiaries. In that case, it will directly impact the flow of work in the parent organization; hence, the entire atmosphere gets disrupted.
- Legal restrictions: Certain countries hesitate to allow foreign companies to set up a wholly-owned subsidiary.
- Technological and intellectual risks: The parent company with foreign-based subsidiary is at high risk of losing technology and intellectual property to other companies that can affect operations. Specific protection directives and data access regulations are required to avoid theft-related risks.
- Challenges in diversification: When a parent company focuses on diversifying the operations of the wholly-owned subsidiary, it might lose focus on its function, which will hamper the company in the long run.
- Increased cultural differences: With diversification, the central issue of cultural difference arises, disrupting the day-to-day operations of the subsidiary and organization.
- Rise of conflicts: There are high chances of conflict between the management of the parent company and the wholly-owned subsidiary, which might directly affect the working of both companies.
- Reduced privacy: When a wholly-owned subsidiary and a parent company work closely, there is a possibility of disclosing corporate secrets and sharing confidential techniques. This may create problems since sharing technologies with a domestic entity in a foreign country may reveal sensitive information causing the subsidiary to lose its competitive edge.
- Impact of dynamic business environment: Several cultural and political challenges might affect the dynamics between the two companies, affecting the success of both these companies. For instance, if there is a recession in the country where the wholly-owned subsidiary is located, the parent company’s performance is directly impacted.
Understanding the disadvantages of a wholly-owned subsidiary is crucial if you plan to buy stakes in a company or acquire it.
Along with several wholly-owned subsidiary benefits, it becomes time-consuming for parent organizations to go through the process. Organizations must undergo the registration process and take care of legal requirements and other processes. This is time-consuming and also demands financial support.
Multiplier can help you set up your business when you have a new wholly-owned subsidiary in a global market. Here at Multiplier, our team of experts helps businesses bypass setting up a business entity when companies try to enter the global market.
You can reach out to our experts today, and they will help you understand how the entire system of wholly-owned subsidiaries works. They will also assist you in onboarding new talent to help you sail through the process.
Q. Is a wholly-owned subsidiary a disregarded entity?
A wholly-owned subsidiary must pay taxes, but the parent company looks after the financial statements; therefore, it is not a disregarded entity.
Q. What kind of control does a parent company have over a wholly-owned subsidiary?
A parent company has financial, operational, and strategic control over a wholly-owned subsidiary.
Q. What are non-performing assets?
Non-performing assets generally refer to the loans and advances given by the company to individuals and other companies, but there is no chance for the money to return.