What Is a Subsidiary?
In the corporate world, a subsidiary is a company that belongs to another company, which is usually referred to as theparent company or holding company. The parent holds a controlling interest in the subsidiary company, meaning it owns or controls more than half of its stock. In cases where a subsidiary is 100% owned by another company, the subsidiary is referred to as a wholly owned subsidiary.
Key Takeaways
- A subsidiary is a company that is more than 50% owned by a parent company or holding company.
- Subsidiariesare separate and distinct legal entities from their parent companies.
- Companies buy or establish a subsidiary to obtain specific synergies or assets, secure tax advantages, and contain or limit losses.
- Shareholderapproval is not required to turn a company into a subsidiary or to sell a subsidiary.
- A subsidiary's financials are reported on the parent's consolidated financial statements.
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How Subsidiaries Work
Subsidiariesare separate and distinct legal entities from their parent companies, which is reflectedin the independence oftheir liabilities, taxation, and governance. If a parent company owns a subsidiary in a foreign land, the subsidiary must follow the laws of the country where it is incorporated and operates.
However, given their controlling interest, parent companies often have considerable influence over their subsidiaries. They—along with other subsidiary shareholders, if any—voteto elect a subsidiary company'sboard of directors, and there may often be a board-member overlap between a subsidiary and its parent company.
To be designated a subsidiary, at least 50% of a company's equity has to be controlled by another entity. Anything less, and the company is considered anassociate or affiliate company.
Subsidiary Financials
A subsidiary usually prepares independent financial statements. Typically, these are sent to the parent, which will aggregate them—as it does financials from all of its operations—andcarry them on its consolidated financial statements. In contrast, an associate company's financials are not combined with the parent's. Instead, the parent registers the value of its stake in the associate as an asset on its balance sheet.
Accounting standards generally require that public companies consolidate all majority-owned subsidiaries. Consolidation is viewed as a more meaningful method of accounting than providing separate financials for a parent company and each of its subsidiaries.
Anunconsolidated subsidiaryis a subsidiary with financials that are not included in its parent company's statements. Ownership of unconsolidated subsidiaries is typically treated as an equity investment and denoted as an asset on the parent company's balance sheet. For regulatory reasons, unconsolidated subsidiaries are generally those in which a parent company does not have a significant stake.
The Securities and Exchange Commission (SEC) states that only in rare cases, such as when a subsidiary is undergoing bankruptcy, should a majority-owned subsidiary not be consolidated.
Subsidiary Pros and Cons
Buying an interest in a subsidiary usually requires a smaller investment on the part of the parent company than a merger would. Also unlike a merger, shareholderapproval is not required to purchase or sell a subsidiary.
A parent company buys or establishes a subsidiary to obtain specific synergies, such as a more diversified product line or assets in the form of earnings, equipment, or property. Subsidiaries can be the experimental ground for different organizational structures, manufacturing techniques, and types of products.
In addition, subsidiaries can contain and limit problems for a parent company to some extent, with the subsidiary serving as a kind of liability shield in the event of lawsuits. Entertainment companies often set up individual movies or TV shows as separate subsidiaries for this reason.
However, subsidiaries also have a few drawbacks. Aggregating and consolidating a subsidiary's financials can make the parent company's accounting more complicated.
Since subsidiaries must remain independent to some degree, transactions with the parent may have to be "at arm's length," and the parent might not have all of the control it wishes. And while a subsidiary can help shield the parent company from certain legal problems, the parent may still be liable for criminal actions or corporate malfeasance by the subsidiary. Finally, it may have to guarantee the subsidiary's loans, leaving it exposed to financial losses.
Pros
Contained/limited losses
Potential tax advantages
Easier to establish and sell
Synergy with other corporate divisions, subsidiaries
Cons
Extra legal and accounting work
Greater bureaucracy
Complex financial statements
Liability for subsidiary's actions, debts
Real World Examplesof Subsidiaries
Public companies are required by the SEC to disclose significant subsidiaries. Warren Buffett's Berkshire Hathaway Inc., for example, has a long and diverse list of subsidiary companies, including International Dairy Queen, Clayton Homes, Business Wire, GEICO, and Helzberg Diamonds.
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Berkshire Hathaway's acquisition of many diverse businessesfollows Buffett's oft-discussed strategy of buying undervalued assets and holding onto them. In return, acquired subsidiaries can often continue to operate independently while gaining access to broader financial resources.
Like Berkshire Hathaway, Alphabet Inc. has many subsidiaries, the best known of which is Google. These separate business entities all perform unique operations intended to add value to Alphabet through diversification, revenue, earnings, and .
For example, Sidewalk Labs seeks to modernize public transit in the United States. The company has developed a public transportation management system that aggregates millions of data points from smartphones, cars, and Wi-Fi hotspots to analyze and predict where traffic and commuters are most congregated. The system can redirect public transportation resources, such as buses, to these congested areas to keep the public transit system moving efficiently.
Is a Subsidiary Its Own Company?
Yes. A subsidiary is independent, operating as a separate and distinct entity from its parent company. Often, a parent company may issue exchangable debt that converts into shares of the subsidiary. That said, the parent company, as a majority owner, can influence how its subsidiary is run and may be liable, for example, for the subsidiary's negligence and debt.
Does a Subsidiary Have Its Own CEO?
As a subsidiary functions as a separate entity, it usually has its own management team and CEO. However, the parent company will get a significant say in who runs the company and who sits on its board of directors.
What Are Sister Companies?
Two or more subsidiaries majority owned by the same parent company are called sister companies.
The Bottom Line
A subsidiary is a company that is completely or partially owned by another company. Acquiring and establishing subsidiaries is fairly common among publicly traded companies, especially in industries like tech and real estate. The advantages of these business structures include tax benefits, reduced risk, increased efficiencies, and diversification. Drawbacks include limited control and greater bureaucracy and legal costs.
