Subsidiary CompanyA company owned or controlled by another company

Many companies want to expand their areas of operations once they are established and have a good amount of growth.

The most common course of action here is to establish a branch in a different city or state.

Doing so increases the reach of the company.

It may now be able to cater to new customers outside of the company’s previous area of operations.

Other popular companies such as McDonald’s, Burger King, and the like expand their area of operations through franchising.

In such a set-up, the franchisee, usually a relatively smaller business owner, purchases the right to use another business’s existing brand, trademarks, and other proprietary knowledge.

But more importantly, a franchise grants the franchisee to operate using the same brand as the franchiser.

So let’s say you’ve purchased a McDonald’s franchise.

You can basically say that you own a McDonald’s store.

But what if I tell you that a company that wants to expand still has more options?

And one option among them has everything to do with subsidiary companies (or just simply, subsidiaries).

A subsidiary company is a company that is owned or controlled by another company referred to as the parent or holding company.

Do note that while the parent/holding company owns or controls the subsidiary company, the latter (subsidiary) is still its own legal entity separate from the former (parent/holding company).

In this article, we will be delving deeper into what a subsidiary company is.

We will learn what its definition is and how it works.

Is it something that the parent or holding company creates from scratch?

Is it always preferable to set up a subsidiary company over the other options of expansion?

Let’s find out.

What is a Subsidiary Company?

A subsidiary company is a company that is owned or controlled by another company.

We refer to the owner as the parent or holding company.

A parent or holding company may partially or wholly own the subsidiary company.

Generally, a company only needs to own a majority of the stocks of another company for it to become a parent or holding company.

The other company then becomes a subsidiary company. In most cases, a majority means more than 50%.

To illustrate, let’s say that the MD company purchases shares of AG company equal to 60% of the latter’s outstanding shares.

This makes MD company a parent or holding company of AG company which is now the former’s subsidiary company.

Now while the parent or holding company essentially owns or controls the subsidiary company, they are still legally separate entities.

This means that both companies still prepare their own set of financial statements.

Aside from that, they separately pay for taxes and other liabilities which limits the sharing of liabilities between the parent and the subsidiary.

The subsidiary company can still operate independently from the parent company.

It will still have its own brand, such as in the case of individual brands.

However, no one can deny the influence of the parent company in the business operations of the subsidiary company.

Since the parent company is a major shareholder, whoever it elects as a director is more than likely to get a seat on the board of directors.

While this can be seen as a hostile move, it can also serve as a way for the parent company to drive its overall business strategy.

Having a board of directors that is in tune with the goals of the company makes it easier to execute certain strategic decisions.

Why a Subsidiary Company?

Setting up a branch doesn’t result in the creation of a separate legal entity.

Granting franchises does expand a business’s operations, but someone else becomes the owner of the new store.

The franchiser doesn’t own the new business.

What makes a subsidiary company different from these two is that it allows a business to own or control a separate legal entity.

This means that the two entities can still operate independently of each other.

This also allows them to limit the sharing of liabilities.  

A company can choose to establish a new company to act as its subsidiary.

But the more common approach is to purchase or take control of an already existing company.

A company gains control of another company if it owns a majority of the shares of the other company.

In most cases, a majority means more than 50%.  

A subsidiary company is considered a wholly-owned subsidiary if the parent company owns 100% of it.

In the case of multinational companies, only the subsidiary companies need to align with local regulations and laws.

Since the subsidiary company is still its own legal entity, it can take advantage of a more favorable tax schedule.

For example, the tax rate for corporations in Ireland is only 12.5% which is significantly lower than the US’s 21%.

Setting up a subsidiary company is a common course of action for companies that want to expand into the international market.

A company can even opt to purchase another existing company and make it a subsidiary.

This eliminates the hassle of having to conduct research and development into forming a new successful company.

This also applies if the company wants to expand to other areas of expertise.

With subsidiary companies, a parent company can diversify its business while minimizing the risks of doing so.

The Pros and Cons of a Subsidiary Company

Pros

The main draw of a subsidiary company is that it still maintains its own legal entity status.

This means that while the parent company owns it, it is still a separate legal entity capable of operating independently.

This is more beneficial if the subsidiary company already holds a popular brand.

Instead of creating a new brand, the parent company can choose to adopt the popular brand for the subsidiary company.

Also, since the two are separate legal entities, the parent company can limit the sharing of taxes and financial obligations.

Setting up subsidiary companies also makes it easier to simplify the division of the company.

For example, if a company has a presence in multiple countries, splitting it into subsidiaries allows for simpler navigation of different legal and financial systems.

Each subsidiary company is then free to maintain its own financial and managerial structure that best fits the culture of the country where it resides.

Additionally, a subsidiary company may take advantage of a better tax rate compared to its parent company.

On the part of the subsidiary company, when another company acquires it, it can benefit from an injection of cash to fund its operations.

Not only that but it can also come with expertise and knowledge from the parent company.

More importantly, the subsidiary company can still maintain a degree of independence from the parent company.

Cons

The flipside to all of these is that a subsidiary company also comes with its own set of drawbacks.

In some cases, managing a branch is easier than managing a subsidiary company.

There can also be control issues if the parent company only partially owns the subsidiary company.

Even if it is the major shareholder, the other shareholders still hold the power to negate its influence.

Also, a subsidiary company is a separate legal entity.

As such, it has its own set of documents that it needs to maintain, including legal paperwork.

Maintaining all of these can become very costly for the parent company.

Not to mention the potential complexity of consolidating all financial reports.

Lastly, the bureaucracy that comes with owning several subsidiary companies can become a drawback.

While I said that a subsidiary company can still maintain a degree of impendence, a very bureaucratic structure can curtail such independence.

Setting Up a Subsidiary Company

In setting up a subsidiary company, a parent company has two courses of action: create a new company to act as its subsidiary, or purchase a majority share of an already existing company.

In the first route which is creating a new company, the parent company will need to undergo the usual procedures of incorporation.

The subsidiary will have to be registered within the state or country where it is to be founded.

The parent company will be registered as the owner of the new company during the incorporation process.

In the second route which is purchasing a majority share of an already existing company, the parent company gains major ownership and control of the subsidiary company.

The parent company can then elect directors to take seats on the subsidiary’s board of directors.

In most cases, the parent and subsidiary companies may share the same directors.

Since the subsidiary company is a separate legal entity, it can function independently from the parent company.

However, this also means that they have to maintain their own set of records, including financial statements.

Transactions between the parent company and the subsidiary will also have to be recorded.

Additionally, the parent company has to consolidate all of the financial statements of its subsidiaries along with its own.

This is why you commonly see “Consolidated Income Statement” or “Consolidated Balance Sheet” on a popular company’s set of financial statements.