A subsidiary company is a business entity that is fully or partly owned by another entity. If an X company buys Y company, Y becomes the subsidiary company of X. The company that buys another company becomes a holding company. Hence, it holds significant ownership & control over the subsidiary company.
The holding company is also called the parent company & the subsidiary company is also called the daughter company. It shows the relationship that the subsidiaries belong to the holding company.
Types of Subsidiary Company
Partly Owned
The parent company owns 50% or more but less than 100% shares in the holding company. Such a subsidiary is partly owned. Here parent company does not get full control over the subsidiary company.
Wholly Owned
The parent company holds 100% shares & controls in the subsidiary company. Though, A wholly-owned subsidiary company is not a merger.
Points to Remember
- When the parent company holds less than 50% shares in any company, it is called an affiliate company.
- A holding company can have more than one subsidiary company. But a subsidiary company can have one and only one holding company. However, a subsidiary can have a subsidiary or more of its own.
- The parent company can be larger or smaller than the subsidiary. It need not be more powerful than the subsidiary. The size of the firm or employees does not decide the relationship. The only control over ownership is the key factor.
- Also, both companies’ location or type of business does not matter. They may or may not be in the same location or same business line.
Structure of Subsidiary Company
Formation
The parent company has to register with the state registrar of the state in which the company operates. We should define the ownership & stake details during this process.
Operation
Normally, the parent company oversees the operations of the subsidiary company. However, in certain cases, the parent company may supervise day to day operations of a subsidiary company.
Subsidiaries are separate legal entities. They have their own concerns regarding the handling of taxation, regulations & liabilities. Subsidiary companies can sue & be sued separately from the parent company. The obligations of a subsidiary may or may not be obligations of the parent company. One of these companies can be undergoing legal proceedings, bankruptcy, tax delinquency, or be under investigation without affecting other companies directly. Though affecting public image is altogether an intangible thing.
Hence, forming a subsidiary protects the assets from each other’s liabilities.
The copyrights, patents, trademarks, etc., of a subsidiary company, stay with them until the parent shuts it down.
Since the holding company controls the subsidiary through ownership of shares, it gets voting rights to determine the board of directors.
Accounting & Financials
Subsidiaries are independent identities, and they prepare their own financial statements. They have their own bank accounts, assets, liabilities, etc. All the transactions between the parent company and the subsidiary company will be recorded. Further, these statements are sent to the parent company.
Consolidated Accounting
The parent company aggregates and consolidates the subsidiary’s transactions into its own books of accounts. According to the Securities & Exchange Commission (SEC), public companies should consolidate all majorly owned firms or subsidiaries to show true & fair value. The figures in the profit and loss statement or balance sheet include values for both parent & subsidiary companies. For example, aggregate sales, aggregate purchases, aggregated assets & liabilities.
In contrast, a parent company does not consolidate accounts of the affiliated company. It registers the value of the stake in such an affiliate company as an asset on the balance sheet.
Unconsolidated Accounting
In rare cases, the SEC allows this option. That is to say, when a parent company does not hold a significant stake, a subsidiary company is undergoing bankruptcy, major liquidation crises, etc.
The parent company does not include the financials of the subsidiary companies in its statements. However, it shows ownership of such a company as an equity asset in the company’s balance sheets.
Also, read the Holding Company Structure
Examples of Subsidiary Company
- Facebook is a popular company in the digital industry. It has various subsidiaries acquired from time to time. Instagram is a photo-sharing application acquired by Facebook in April 2012. It also acquired Whatsapp – a popular messaging application, in 2014. Lastly, in march 2014, It bought shares of a virtual reality company, Oculus.
- Google & Nest are subsidiaries of Alphabet.
- TCS – Tata consultancy services are of TATA Group.
- Jio belongs to the Reliance Group.
- Lenovo acquired Motorola.
Image Source: Geekologie
Advantages & Disadvantages of Subsidiary Company
Advantages
Contain & Limit Losses
The probable losses of a parent company can set off against the subsidiary companies’ profits. The assets of subsidiaries can be used as a liability shield against financial losses.
Risk Reduction
The risk and uncertainty of losses, issues & obligations are distributed between two companies. In the case of bankruptcy, however, if an advocate proves that the parent company and subsidiary company are the same, the parent co. maybe held liable.
Increases Efficiencies & Diversification
When the company’s size increases, it often indulges itself in related & unrelated diversification. Subsidiaries help to split the activities according to common groups into smaller companies. They become easily manageable. The employees there can give their complete focus on their respective products or service.
Tax Benefits
Subsidiaries follow the laws of the country or state it is located. It has its separate tax ID, pays its own taxes according to its type. This is irrespective of the location of the parent company & related laws. Parent companies can intentionally open subsidiaries in areas where they receive tax benefits—for example, special economic zones or rural areas where the government gives certain deductions for operating business.
Easy Establishment & Selling
Innovations & experiments can be done through subsidiary companies. Different organizational structures, manufacturing techniques & types of products can be developed & put in the market. In case of failure, we can subsidiaries shut down the subsidiaries without affecting the image of the parent company directly.
Synergies
A company can open subsidiaries to support its activities. Subsidiaries can be a tool for horizontal or vertical integration.
Disadvantages
Limited Control
Though the parent company has significant stake and voting rights in a subsidiary, it cannot control all the activities of the company directly. However, the wrong decision taken by such a company affects the image of a parent company.
Workload
Adhering to legal norms, accounting work, auditing accounts, etc., increase the workload of the employees.
Bureaucracy
Decision-making becomes a tedious task as it has to go through the various levels of the organization. Also, it gives an open window to malpractices & bureaucracy.
Complexity
Aggregation & consolidation of accounts makes it complex for any person to analyze the financial statements. For example, the value of sales, purchase, loss, profit, etc., show aggregate values; it is difficult to trace each value to its origin.
Moreover, there are different rules and regulations as per accounting standards & taxation, which determine the norms for the stake of the parent company & liability. They differ from country to country. To understand all of them is a task in itself.
Time & Cost Consuming
Employees have to spend time in the preparation of accounts, sending them to the parent company, following the formalities & procedures.
Burdensome
Since subsidiaries are independent to a certain extent, they may have their own issues. The parent company cannot control everything that happens there. The parent company may become liable for criminal actions on a subsidiary in case the corporate veil is proven.
Quiz on Subsidiary Company
This quiz will help you to take a quick test of what you have read here.
Hi Sanjay,
Thank you so much for the insightful and simplistic explanation of the what a holding or parent company is and entails. I have been fascinated with this concept as my ambition is to own multiple companies with a major stake in them.
Much appreciated.
Eva
Hi Sanjay
Thank you for the great article. I work in policy and governance and this article helped me understand a great deal about parent and subsidiary company relationships etc.
Thanks
Very insightful