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
- Structure of Subsidiary Company
- Examples of Subsidiary Company
- Advantages & Disadvantages of Subsidiary Company
Types of Subsidiary Company
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.
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, the location or type of business of both companies does not matter. They may or may not be in the same location or same business line.
Structure of Subsidiary Company
The parent company has to register with the state registrar of the state in which the company operates. The ownership & stake details are to be defined during this process.
Normally, the parent company just 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 separate 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 holding company controls the subsidiary through ownership of shares, it gets voting rights to determine the board of directors.
Accounting & Financials
Subsidiaries being an independent identity and they prepare their own financial statements. They have their own bank accounts, assets, liabilities, etc. All the transactions between the parent company and subsidiary company are to be recorded. Further, these statements are sent to the parent company.
The parent company aggregates and consolidates 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 profit and loss statement or balance sheet include values for both parent & subsidiary company. For example, aggregate sales, aggregate purchase, 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 in the balance sheet.
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 financials of the subsidiary companies in its statements. However, it shows ownership of such a company as an equity asset in the companies balance sheets.
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.
Advantages & Disadvantages of Subsidiary Company
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.
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 one and the same, the parent co. may be held liable.
Increases Efficiencies & Diversification
When the size of the company increases, it often indulges itself into 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 product or service.
Subsidiaries follow the laws of a country or state it is located in. It has its separate tax ID, pays its own taxes according to its type. This is irrespective of the location of 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, subsidiaries can be shut down without affecting the image of the parent company directly.
A company can open subsidiaries to support its activities. Subsidiaries can be a tool for horizontal or vertical integration.
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.
Adhering to legal norms, accounting work, auditing accounts, etc. increase the workload of the employees.
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.
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 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 it to the parent company, following the formalities & procedures.
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 corporate veil is proven.