A subsidiary company is a company that’s owned and controlled by another (often larger) company. You may have heard of a subsidiary company referred to as a parent or holding company. The parent holding company that owns the subsidiary has control by owning at least 51% of the voting stock in that company.
There are a few ways to obtain this control, either by setting up the company and keeping majority shares or by purchasing these shares. When 100% is held by the parent company it is known as a “wholly-owned” subsidiary.
What Is a Holding Company?
A holding company is unique from typical commercial companies in that it doesn’t sell any products or services of its own, nor does it conduct any of its own business operations. Rather, a holding company is a parent entity with the sole purpose of owning, or “holding”, shares of other companies.
If you own several businesses, the holding company structure allows you to streamline management and ownership of those businesses while also limiting your liability and offering protection to your business assets. In this case, when a business is owned by a holding company, that business is considered a subsidiary of the holding company.
What Is a Subsidiary?
A subsidiary is a company owned by another company, whether a holding company or parent company. The subsidiary company can vary in entity type (LLC, C-corporation, etc.) and may be formed by the controlling company or acquired by it.
The holding company does not need to wholly own the subsidiary but rather just enough voting stock in the company to achieve a controlling interest. In other words, the holding company must own at least 50% of the subsidiary company.
The subsidiary structure is commonly used as a method for managing risk. For example, subsidiaries are a popular choice in real estate when handling ownership of several properties. These properties can be established as subsidiaries of a holding company as a way to protect each property’s assets from the potential liabilities of the others.
For example, if Holding Company Z owned Properties A, B, and C (each formed as separate subsidiary companies), then the assets of Properties A and B would not be in jeopardy if Property C experienced legal or debt trouble.
In certain cases with larger holding company structures there can be several levels of subsidiary companies known as tiered subsidiaries: first-tier subsidiary, second-tier subsidiary, third-tier subsidiary, and so on as necessary.
- First-Tier Subsidiary: This is a subsidiary of the top parent company, i.e. the very top of the ownership structure.
- Second-Tier Subsidiary: This is a subsidiary of a first-tier subsidiary, also known as a granddaughter company of the top parent company.
- Third-Tier Subsidiary: This is a subsidiary of a second-tier subsidiary, also known as a great-granddaughter company of the top parent company.
The Different Levels of a Subsidiary Company
Generally, there are three tiers of the parent-subsidiary structure. These are known as the first-tier subsidiary, second-tier subsidiary, and third-tier subsidiary, but can branch out as far as it wants.
The top of this pyramid is a company that is not owned by any other company. This is the parent company. Any subsidiary that is controlled by this company would be considered a first-tier subsidiary. When a first-tier subsidiary owns at least 51% of shares in another company, that would be referred to as a second-tier subsidiary. This can continue as long as the company chooses.
How Does a Subsidiary Company Work?
Subsidiaries are more common in some industries than others. For example, real estate companies often have subsidiaries. It begins with a company as a holding company that holds multiple properties. They may hold these properties and rent them out, and form a holding company by making each property its own LLC, as a subsidiary. This protects each home as a business and protects the parent holding company from the liabilities of each rental property.
Understanding the role of the subsidiary
As a rule, subsidiaries are viewed as a separate legal entity from their holding company. They hold their own tax liability, as well as governance, and even legal liabilities. Subsidiaries may sue other companies, but also be sued without any correlation with the parent company.
Despite this, because the holding company holds majority ownership, it will have a say in the day-to-day functions of the subsidiary. This includes the board of directors, as well as the potential to help with tax benefits, while still maintaining separate risk liability.
Is it Difficult to Start a Subsidiary Company?
Although it may sound simple, creating a subsidiary is not always an easy process. More often than not when one company works on its own, it is able to represent itself in all layers of business. When an organization owns another organization, the subsidiary loses control, and it gets a lot more to take on.
Not only are financial records held separately, but there may be transactions that occur that need to be monitored by the main company. Although the businesses operate independently, there are certain similarities that will be maintained between them. Finding the legal and managerial line can be difficult. Despite this, there are many benefits as well.
Benefits of a Subsidiary Company
There are several financial advantages of creating a subsidiary company. Here are a few of themost common benefits of subsidiary companies.
The holding company/subsidiary structure is a popular choice among business owners in a variety of industries. Some of the top benefits enjoyed by subsidiaries are their tax advantages, limited liability, and flexibility in management structure.
Tax Benefits
One reason why a holding company might purchase or obtain a subsidiary is due to taxes. Subsidiaries are only taxed on profits made in their state of formation. Rather than being taxed on all of the profits through the parent company.
This means that a huge corporation may take advantage of the lower or non-existent tax rates in one state, or country, but create or purchase a subsidiary in that country. The same can be said about nonprofit organizations. Subsidiaries often help non-profits remain tax-exempt.
Limited liability
One of the main reasons for creating a holding company subsidiary is the limited liability it affords. Legally there are lines that cannot be crossed to maintain this liability, but when it is maintained it gives a lot of protection to both entities. The holding company can use the subsidiary as a barrier against liability.
This is common in many different industries. This is why you may see a company as a subsidiary but with a slightly different variation at the end of the name. This is simply a way to separate the two entities legally in case a legal issue arises. This way the holding company will not be exposed to a lawsuit from that of the subsidiary, and they can protect their assets, while still using funding from the parent company.
This is a commonly sought after benefit of the holding company/subsidiary structure. So long as you ensure that your holding company is correctly formed and you maintain the proper formalities for structuring and managing subsidiaries, the holding company will enjoy protection from the liabilities of its subsidiaries. Additionally, the assets of each subsidiary will be protected from the liabilities of other subsidiary companies.
More independence
In cases where a smaller company sells over 50% of its shares to a parent company, it does not mean that the subsidiary loses all of its control. Subsidiaries can be individually managed which allows the managerial structure to stay the same, while liabilities are continually protected.
Tax Advantages
In certain cases, there may be tax advantages to forming a subsidiary company. For example, some states will only tax the profits of a subsidiary rather than the total profits of the holding company if it’s formed in a different state (or country). This is why it’s common to see multinationals form subsidiaries in more tax-friendly locations.
Flexibility in Management
Another attractive subsidiary benefit is the ability to have numerous businesses operating under their own management structures. Under this structure, each business is technically controlled by the holding company but each maintains the ability to form its own management style, operations, culture, and more, to adapt to a particular industry of location.
How to Create a Subsidiary
There are two methods of creating a subsidiary: formation and acquisition. If you’re looking to form a subsidiary, you can do so by registering the new company with the state in which it will operate. The actual formation process will vary some depending on which entity type you choose for the subsidiary, such as an LLC or corporation, as well as the particular regulations of the state in which you’re forming.
Another way to create a subsidiary is by acquiring an ownership stake in a company. This could be a wholly owned ownership stake (100%) or any controlling interest (greater than 50%). Note that however your subsidiary company is created, the company will require its own financial records separate from the controlling company and other subsidiaries. Additionally, the management style and autonomy of the subsidiary has flexibility and can be tailored to meet the needs of the specific company.
Is a Subsidiary Right for You?
It is common for businesses to create or purchase subsidiary companies in order to grow. There are various benefits and allow faster expansion without the risk or liability that comes without a parent-subsidiary relationship.
If you are looking to maintain the liabilities and credit claims of the holding company structure while keeping the assets of your parent company safe, this might be an option for you. Including the tax benefits, and benefits to the subsidiary in terms of funding, creating a holding company provides valuable resources.
