A subsidiary is a company owned by another company, usually a parent company or holding company. The parent company controls the subsidiary through an ownership share of voting stock in the company (i.e. greater than 50%). The subsidiary can be acquired by the parent company or be set up by it. When the parent company holds the entire voting stock of the subsidiary (i.e. 100%), that subsidiary is considered wholly-owned by the parent. While this structure offers the parent company control, the subsidiary remains a separate legal entity. This separation pertains to any liability, tax, or other governance matter.
While both a holding company and a parent company have subsidiaries, there is a difference between the two. A holding company does not conduct operations of its own. In other words, the purpose of a holding company is in the structure and control it offers. A parent company, on the other hand, does conduct operations of its own, which are separate from those of the subsidiaries.
Reasons for Forming a Subsidiary
The most common reason to form a subsidiary is for asset protection. This is why subsidiaries are common in risk-prone industries like real estate. It is common practice for a real estate company to own several properties under the structure of a holding company in order to separate the liabilities of the subsidiary properties and protect the company assets.
Advantages of a Subsidiary
There are several reasons why companies choose a subsidiary model. Here are some of the most common advantages that subsidiaries offer:
Limited Liability for Parent Company
The limited liability offered by the parent/subsidiary structure is the most common advantage companies seek with this model. If the necessary steps have been taken to ensure proper structuring and management in this scenario, then the parent company should be shielded or limited from any potential losses of the subsidiary.
Separated Management Structure
Another attractive advantage offered by the subsidiary model is the opportunity to have multiple businesses operating with their own management structures. While each of the businesses is technically controlled by the parent company, each has the flexibility to play to their own strengths. This is helpful for both operations and the ability to take advantage of industry or location-specific opportunities.
Unique Identities or Brands
It is not uncommon for a company to seek expansion or diversification, while still wishing to retain the identity that has brought them success to-date. In such a case, the company would likely consider use of a subsidiary to solve this matter. The subsidiary is able to take on its own identity or brand, while the company still retains control and enjoys the subsidiary’s successes.
Beneficial Tax Purposes
All companies keep a watchful eye on how taxes affect their business. Some states tax only the profits made by a subsidiary instead of a tax on the total made by the parent company. In this case, a company may determine there is a benefit to conducting subsidiary operations in those states. It is common practice for multinational companies to seek out lower rates through incorporating subsidiaries in tax-friendly countries.
Beneficial Investment Purposes
In some cases, a subsidiary may provide you with beneficial investment opportunities. Depending on the structure of your subsidiary, it can be possible to reduce regulation and compliance requirements. Additionally, your subsidiary structure may make your business more appealing to investors or provide greater ease in the event of a merger through reduction of your company’s income tax payable.
Disadvantages of a Subsidiary
While the subsidiary model does offer many advantages, there are a few potential disadvantages to consider. Some of these disadvantages include:
Even though the parent company has control of the subsidiary, there is the possibility that the parent does not have full access to the subsidiary’s cash flows, depending on how management and control is structured.
In some circumstances, the parent company and subsidiary may have a linked reputation, even while operating separately or in different industries. In this case, the parent company may feel obliged to come to the aid of the subsidiary in order to uphold its reputation.
Naturally, as you expand your business, you will face more regulation and compliance rules. In the case of subsidiaries, compliance tends to grow in complication and often requires professional legal, tax, and accounting assistance. It is smart practice to seek out a professional for both forming and maintaining your subsidiary to ensure an accurate navigation of any and all regulations.