What is a Subsidiary?
The subsidiary, or a daughter company, is a company controlled by a different firm. The company that manages the subsidiary is the parent or holding company. The parent corporation owns at least half the voting stock, and both are different firms from a legal point of view.
Why do Businesses Form Subsidiaries?
Usually, a subsidiary business is an individual part of a vast organization. There are multiple reasons to start a subsidiary company, including the legal benefits, separate taxes, regulations, international markets, expansion, and others. With the effective use of a subsidiary business model, the parent company can achieve greater strategic and business flexibility.
To create of two Legally different firms
When both the parent and subsidiary firms are legally separate entities, they share limited liabilities, financial and legal. They don’t need to follow the same regulations or tax rates.
Furthermore, if the subsidiary company faces financial or legal issues, the parent company is protected.
To enjoy tax beneficial
When it’s a multinational organization, the subsidiary follows laws and regulations set by local authorities. Since it is an independent entity from a legal standpoint, it also enjoys more beneficial tax rates from where the parent firm is based.
To Expand into international markets
International markets are a different playing field altogether. So, to reduce the risk factor, a subsidiary company is a favorable choice as it is easier to set up than other entities. Often, subsidiaries are a brand on their own under the holding company’s control. So, they enjoy the combined benefits of being an independent part of a vast organization.
Moreover, when it comes to international markets buying and selling must be simple, and selling or controlling a company is more manageable.
To save on research and development cost
Let’s say a large corporation is looking to expand its scope in a specific sector. It requires a new research and development section. Along with a hefty financial commitment, it comes with hassles and time consumption. Instead of investing resources in the research process, acquiring companies that are experts in the given field is more straightforward.
So, acquiring a subsidiary business working in that field makes sense if someone is looking for a digital tool or service. The parent company can expand and shield itself from risks simultaneously.
The Structure of a Subsidiary Company
A parent company controls the subsidiary company owning a specific portion of voting stocks. However, even when the parent company manages the subsidiary, it is a legally separate entity.
The percentage of stock a company owns in another business decides whether the company will become an associate firm, a minor passive investment, or a subsidiary. Here is how it is determined.
- <20% ownership makes it a minority passive investment.
- 20-50% ownership makes it an associate company.
- >50% of the voting stocks owned to make the company a subsidiary.
We will take a look at a subsidiary management plan as an example. For instance, A is a parent company, and B is a subsidiary business. Let’s see how it can influence company B. That is, what aspects a parent company can and cannot manage for a subsidiary with its majority voting shares.
How A manages B:
- Company A can decide to dissolve B.
- Company A can merge the two corporations.
- Company A can appoint the board of directors for B.
- Company A can claim B’s assets as its own
- Company A can receive synergies of B, such as tax benefits and diversified risk.
How A cannot manage B:
Parent company A cannot do all of the above if tax, legal, and/or marketing reasons restrict them.
For example, the local authorities have specific laws and regulations the subsidiary abides by. The subsidiary business will not uphold the decisions if they clash with these regulations.
While enjoying all benefits, parent company A must abide by all the rules if a subsidiary is opened in a foreign land.
Here are some ways a company can get control rights for other companies through various methods other than a subsidiary.
- Consolidation: It occurs when two companies are combined to form a completely new one.
- Mergers: Here, there is a small and a large company. The large company buys the smaller one. After that, the smaller firm doesn’t exist anymore.
- Special purpose entities: These companies are created and sponsored for a specific purpose or project, usually by large companies.
What are Tiered Subsidiary Companies?
A subsidiary, in essence, is an independent company whose majority voting stocks are owned by a parent firm. Now, the subsidiary company can own majority voting stocks in other companies, having subsidiaries of its own.
Now consider company A acquired company B as its subsidiary. And company B acquired company C as its subsidiary business. Company B has become a first-tier subsidiary, and C is a second-tier subsidiary company. Company C can now acquire company D as a subsidiary, making company D a third-tier subsidiary in this chain of corporations.
A colossal conglomerate is a giant web of subsidiaries. There is a parent company that has several subsidiaries. And these subsidiaries further have their own subsidiaries. It allows the parent company to diversify its business and minimize risks.
It brings forth an intriguing question: Does parent company A control companies C and D, and does B get to control company D?
To a certain degree, company A can control all the tiers. Now, it directly influences the decisions of company B and can make business decisions and elect board members, and so on, owing to the major shares it holds. With this power, it can indirectly control the second and third-tier subsidiaries.
How do Subsidiaries Record Financial Statements?
A subsidiary is an individual entity, so it records its own financial statements. It can make financial statements just as done by the parent company. Typically, the subsidiary business forwards these statements to the parent company.
The parent company then makes a consolidated statement containing words from all its operations. These consolidated financial statements show how the corporation is managed and operated.
The financial statement must reflect any transaction between the parent and the subsidiary company. Moreover, since the subsidiary has an employer identification number (EIN), it can also pay its taxes.
Most public companies prefer a combined financial statement covering the balance sheet and the income statement. These consolidated income statements must provide an overview of all the subsidiary expenses. If a parent company holds 80% or more voting stock, it can submit a consolidated tax return. It means the subsidiary tax is included in the parent company’s tax.
So, if the company has more than one subsidiary business, then it can benefit from neutralizing a company’s profits with other subsidiary’s losses. However, every subsidiary must consent to this consolidated tax return.
The Ownership of a Subsidiary Company
A holding or parent company owns the subsidiary business. It means that they have more than 50% of the common stocks. That is, they have primary ownership or control over the subsidiary.
Now, the holding company and the parent company are two separate entities. Both have different functions starting from the ownership of subsidiaries to management. Let’s see what differentiates the two.
The sole purpose of a holding company is to control the subsidiary’s ownership rights. The holding company is responsible for looking after the business strategies, board decisions, and governing of the subsidiary businesses.
The holding company is also known as the umbrella corporation, as its business governs the subsidiary companies. They do not provide any services or tools. Apart from owning companies, they also have assets like real estate or stocks.
The holding company is protected from any financial or legal issues and liabilities of the subsidiary company since they are individual entities.
If a holding company looks explicitly into the ownership, it is recognized as a ‘pure’ holding company. If it participates in business operations, it is called a ‘mixed’ holding company.
A parent company is a company that provides some service and has its own business operations outside of running a subsidiary. Unlike holding companies, they are involved in other businesses.
Usually, acquiring a subsidiary business means expansion into other business opportunities. They also own subsidiaries that may help them on their current ongoing projects.
The parent companies are also protected from their subsidiaries’ legal and financial liabilities. Since a parent company owns a subsidiary for expanding their business, it is also easy for them to let the company go if it incurs losses.
Affiliate vs. Subsidiary
- When a company owns less than 50% of another business, the partially-owned business is known as an affiliate or associate company. Since it does not own a majority of the associate company, it cannot control the latter.
- Hence, it is different from a subsidiary company, as the stocks owned by the parent company are more than 50%, and they can control it.
Branch vs. Subsidiary
- A branch or a subsidiary are used almost synonymously. They are different terms having no connection.
- A branch is a part of a company situated in a different location. It functions as an extension of the owner company. For example, various companies have branches in other cities to get more profit. The branch is an individual entity. It does not function individually on its own.
- Moreover, branches do not have a parent company – they have headquarters. The first-ever office of that company is usually the headquarters.
- A subsidiary is an entirely different and independent legal entity. However, another corporation controls it.
- Usually, branches of a company are involved in the same business as the owner company. However, in the case of a subsidiary, it may or may not be involved in the same service as the parent company.
Division vs. Subsidiary
- A division is a part of a company dedicated to one specific activity within the company. For example, several divisions in insurance companies tackle various types of insurance.
- Since they perform a specific task, it is not considered a separate entity. They are a part of the company, not an individual entity. Even if a division functions with a different name other than the company, it is still a part of the company. However, a subsidiary is a legal entity that functions independently from its parent company.
- Now, when a larger company wants to increase its business scope without spending a lot of resources on research and development, they acquire a smaller company providing that specific service.
- In this case, the smaller company becomes a subsidiary.
A Wholly Owned Subsidiary Company
A wholly-owned subsidiary is one entire subsidiary company owned by the parent company. This means that 100% of stocks are bought or held by the parent company. Whereas in a regular subsidiary business, the parent or holding company owns more than 50% of the stock. They have the controlling rights for the subsidiary.
The difference between a subsidiary and a wholly-owned subsidiary is that a wholly-owned subsidiary company is recognized as an entity of its own. However, the subsidiary company is still a separate entity.
This scenario occurs when a parent company acquires the entire corporation and becomes a subsidiary. It means they have 100% voting stocks of the company with no other shareholders. They hold all rights to elect the board of directors, make strategic decisions for the company, etc.
Also, when a corporation wants to own a subsidiary, it can set it up and make it a wholly-owned subsidiary. It is beneficial for multinational corporations as it helps keep the structure of the parent company uniform throughout.
A question may arise: Is it still an individual entity in itself?
The answer is yes. Like any other subsidiary, this is a distinct legal entity.
Real-world Examples of Subsidiary Companies
Now that we have understood what a subsidiary company is, let’s look at a real-world subsidiary example of infamous holding and parent companies.
The first name on the list is Meta Platforms, Inc. This company was in itself a social media platform. Then, it acquired Whatsapp, Instagram, and Oculus. Though Instagram has separate management, Meta owns the entire company. It has become renowned by obtaining multiple social media platforms and other tech companies like Oculus.
The next name on the list is P&G. This holding company has several highly successful subsidiaries in its portfolio. Various production companies in niches like haircare, menstrual hygiene, healthcare, dishwashing, household, skincare, etc. Here are some of the names you might have heard – Tide, Ariel, Pampers, Vicks, Oral-B, Pantene, and Tampax. Sixty-five different brands are subsidiaries of P&G.
Another well-known holding company is PepsiCo. The Gatorade Company, Frito-Lay, Tropicana, Lays, Pepsi, Mountain Dew, and Doritos are some of PepsiCo’s subsidiaries. Twenty-three brands under PepsiCo generate a sale of more than $1 billion.
Apart from this, other examples of parent companies like Nestle, Alphabet, etc., have popular subsidiary businesses. Notable FMCG subsidiaries like Frito-Lay and Tropicana belong to PepsiCo’s holding company. Entertainment channels like Marvel, ABC Television Group, and ESPN, Inc. are subsidiaries of the Walt Disney Company.
The Advantages & Drawbacks of Subsidiaries
Having a subsidiary business is not without its benefits and drawbacks.
- The parent company is shielded from the subsidiary company’s liabilities, including tax liability, as they are independent of each other. Moreover, the parent company faces limited financial or legal issues.
- For multinational corporations, when a subsidiary is based in different locations, it is bound by varying regulations. It has to pay taxes only for itself and not the parent company’s profits.
- Suppose a company is looking to expand and experiment. In that case, it is easy to set up or acquire a subsidiary for that service or product as it is easy to sell and/or establish a subsidiary business.
- Setting up subsidiaries helps split the activities, making the function of the parent company with working on respective services manageable.
- The parent company is still liable for criminal actions, corporate malfeasance, etc. It also has to look after the debts of the subsidiary.
- The subsidiary company must maintain clear account records, which must be reported to the parent corporation for transparency. Sometimes, this process can get lengthy and tedious.
- The legalities and work related to it significantly increase when two separate legal entities work together.
- A parent company may also have limited control as other entities also own the subsidiary.
What is the Best Alternative to a Subsidiary?
A subsidiary company conducting its business in countries other than the domicile country of its parent company must comply with local laws and regulations. With the presence of local entities in over 100+ countries, Multiplier offers a revolutionary solution.
We help businesses eliminate the need to set up a subsidiary when entering global markets. Our SaaS-based global Employer Of Record (EOR) solution includes international payroll, compliance, and benefits, among other things.
Q1. Are franchises and subsidiaries the same?
No, a franchise differs from a subsidiary. A subsidiary is an independent legal entity owned by a larger company. A franchise may be a small business that contracts with a larger company to sell the corporation’s services or products and use its intellectual property (e.g., trademarks, copyrights).
Q2. Can a business expand overseas without forming a subsidiary?
Yes, the rise of free trade and open economies have paved the way for businesses to expand globally. There are several corporate mechanisms through which a foreign company can control stakes in any local business. Some popular strategies include forming Affiliates, Branches, Mergers & Acquisitions, Representative Offices, or Subsidiaries.
Among new-age global employment solutions are SaaS-based Professional Employer Organization (PEO) or Employer of Record (EOR). These platforms facilitate easy on-boarding and managing of employee payroll, benefits, expenses, taxes, social contributions & local insurance policies without businesses needing to set up a local legal entity.
Q3. Should subsidiaries need to be registered?
Since a subsidiary is considered a separate legal entity, it needs to be registered in the state or country where it is located. However, if the parent company purchases stock in an existing company, the newly formed subsidiary may have been already registered.
Q4. What Documents Do I Need to Set Up a Subsidiary Company?
Forming a subsidiary involves legal and financial aspects. Qualified legal advice will determine the exact document types needed to set up a subsidiary company. Few essential documents include company bylaws and indemnification agreement, an employer identification number (EIN), bank accounts, a business plan, and financial statements.