Understanding subsidiary companies
A subsidiary company is a business entity or corporation either fully owned or partially controlled by another company, known as the parent company. The parent company usually holds a controlling interest in the subsidiary company, from 51 to 99 percent. In cases where the subsidiary is fully owned—100 percent—by another company, the subsidiary is referred to as a wholly owned subsidiary.
There are two ways a company can become a parent:
Through mergers and acquisitions (M&A), or
Creating a smaller company (subsidiary) to take care of specific parts of your operations so the parent can focus on other strategies and operations.
The amount of power a parent company has over a subsidiary depends on their relationship. There are some that focus on particular verticals, and there are others that are considered “horizontally-integrated”—which means all companies operate at the same level. “Vertically-integrated” parent companies are those owning several companies involved in a supply or product chain.
The advantages of a subsidiary
There are a few advantages for subsidiary companies have over parent companies such as:
Brand recognition. As subsidiaries grow in size, they can establish their brand recognition and increase the overall share of the market.
Risk reduction. The parent/subsidiary framework mitigates risk as it creates the legal separation of entities. When a subsidiary experiences loss, those losses don’t readily transfer back to the parent company but in the case of a bankruptcy, the subsidiary’s obligations may be assigned to the parent if it can be proven that the parent and subsidiary companies are legally the same.
Increased efficiencies and diversification. By creating subsidiary silos, they’re able to achieve greater operational efficiency through building a management style and corporate culture that works for them.
Tax benefits. Subsidiaries can receive tax advantages, especially if a subsidiary is organized in a different state or country.
Easier mergers and acquisitions. Subsidiaries can merge or sell company subdivisions easier and cheaper than if it was a parent company.
Nonprofit benefits. Nonprofit organizations can engage in for-profit activities while maintaining the parent’s nonprofit status.
LLC vs. corporations
Before choosing to create your subsidiary, you’ll need to understand how you plan to structure your business success for today and the future. One variation of the parent and subsidiary structure is to have either or both restructure as an LLC. Companies have a choice of being organized as a corporation or LLC but must first think of how those decisions affect several mitigating factors like taxes, location, legal requirements, cost of formation, and shareholders. Setting up a subsidiary corporation can offer significant liability protection, as well as other financial benefits.
You can also create an A corporation, in which you would need to own at least 50 percent of the shares of the subsidiary. There is also an option to create a C corporation subsidiary as the ownership would be by guarantee.
Why form a subsidiary company
After forming a single-member subsidiary limited liability company (LLC) whose single member is the parent company, you have the option to create a subsidiary. By compartmentalizing the risks of a subsidiary LLC, you’ll separate all toxic assets that could cause harm to the parent company. The objective is to avoid punishing the other subsidiaries with financial or reputational harm.
As you develop more subsidiaries, keeping track of all your products and services at each will be a critical step in your expansion. Even if your small business doesn’t currently have inventory control, you’ll need to implement a solution that tracks all purchased products, as well as the fixed asset accounting to ensure you’ll have a balanced ledger at the end of each fiscal year.
Subsidiary company examples
You can choose to create a new brand identity for your subsidiary when you’re ready to branch out from your parent’s identity and culture. Here, you’ll be able to build upon your parent’s cache without compromising their name. You’re also able to have the advantage of having multiple identities under the same roof, each with its own culture, management structure, and legal structure.
One example is Meta, Inc. As Instagram LLC, Oculus VR LLC, and WhatsApp Inc became subsidiaries of Facebook after they were acquired by Facebook.
How to set up a subsidiary company
Before adding a subsidiary to your small or mid-sized business, you need to consider the advantages and disadvantages first. Once you’ve decided you’re willing to weigh the risks, as well as ensuring you meet the requirements, you can start to create your subsidiary.
Choose the subsidiary type. You have to decide between a subsidiary LLC or subsidiary corporation.
Hold a meeting with your board of directors or management. In your meeting, you must state the type of business entity chosen and the resolution needs to be signed by the chairman and archived.
Choose your state. You need to know where you’ll form your subsidiary and complete all of the necessary paperwork by that state.
Organize your paperwork. Prepare the articles of incorporation (for a corporation) or articles of organization (for an LLC).
Name your subsidiary. Make sure to create one that isn’t in use in that state.
Choose a registered agent.
If you form the subsidiary as an LLC, list the parent company as the owner and if it is a corporation, issue all of its stock to the parent company. After filing your formation documents with the Secretary of State, you’ll be able to start your subsidiary.
Adding in a cloud ERP solution
After setting up your subsidiary, now you need to organize all of your operational information—from the parent company to all subsidiaries. To ensure you’re keeping track of all the necessary financials, you’ll need to implement an all-in-one solution. A cloud enterprise resource planning (ERP) solution allows you to manage all aspects of your business on a single platform. Adding this will help give you the flexibility to build your processes for your organization.