Subsidiary Company: Definition, Examples, Pros, and Cons
What Is a Subsidiary Company?
In the corporate landscape, a subsidiary refers to a business entity that is partially or wholly owned by another company. The entity that holds the controlling share is known as the parent company or the holding company, which owns or controls more than half of the subsidiary's stock. When a subsidiary is entirely owned by its parent company, it is termed a wholly-owned subsidiary.
How a Subsidiary Company Works
Subsidiaries operate as separate legal entities distinct from their parent companies, which is evident in their independent liabilities, taxation, and governance. However, due to their controlling interest, parent companies often exert significant influence over their subsidiaries. They, along with any other shareholders of the subsidiary, participate in voting to elect the subsidiary's board of directors, and there is frequently overlap in board membership between the subsidiary and its parent company.
Subsidiary Company Financials
Typically, a subsidiary prepares its own independent financial statements. These statements are submitted to the parent company, which consolidates them along with financials from all its operations for inclusion in its consolidated financial statements. Conversely, the financials of an associate company are not combined with those of the parent company. Instead, the parent company records the value of its investment in the associate company as an asset on its balance sheet. Accounting standards generally mandate that public companies consolidate all majority-owned subsidiaries in their records. Consolidation is considered a more meaningful accounting approach compared to separate financial statements for the parent company and each of its subsidiaries.
Unconsolidated Subsidiary
An unconsolidated subsidiary is one whose financials are not included in the parent company's statements. Ownership of unconsolidated subsidiaries is usually treated as an equity investment, recognized as an asset on the parent company's balance sheet. For regulatory compliance, unconsolidated subsidiaries typically represent those in which a parent company holds a minimal stake.
Advantages
Acquiring a stake in a subsidiary generally requires a smaller investment compared to a merger. Additionally, unlike mergers, shareholder approval is not necessary for the purchase or sale of a subsidiary.
A parent company may establish or acquire a subsidiary to achieve specific synergies, such as diversifying its product line or acquiring assets like earnings, equipment, or property.
Subsidiaries can serve as testing grounds for various organizational structures, manufacturing techniques, and product types.
Furthermore, subsidiaries can help contain potential issues for the parent company in the event of lawsuits, acting as a sort of liability shield. Entertainment companies frequently create individual movies or TV shows as separate subsidiaries for this purpose.
Disadvantages
Consolidating a subsidiary's financials can complicate the accounting process for the parent company.
Since subsidiaries must maintain a degree of independence, transactions with the parent company may need to be conducted "at arm's length," which might limit the parent company's control.
While a subsidiary can provide some protection against certain legal issues, the parent company may still be held liable for criminal actions or corporate misconduct by the subsidiary's management or staff.
Lastly, the parent company may be required to guarantee the subsidiary's loans, exposing it to potential financial losses.
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