What is Subsidiary?

A subsidiary refers to a smaller company that is partially or wholly owned and controlled by a larger parent company. The parent company, also known as the parent or holding company, exercises control over the subsidiary through ownership of its voting stock. In essence, it means that the parent company has the power to make critical decisions and influence the subsidiaries’ operations and strategic direction.

Why Do Companies Establish Subsidiaries?

Companies establish subsidiaries for various reasons, including:

  • Expansion into new markets: Subsidiaries provide an opportunity for companies to expand their operations into different regions or countries, allowing them to tap into new customer segments and markets.
  • Risk management: By dividing different aspects of the business into separate subsidiaries, companies can mitigate risks and protect their assets. In case one subsidiary faces financial difficulties, it will not affect the entire organization.
  • Tax benefits: Creating subsidiaries in jurisdictions with favorable tax laws can offer significant tax benefits for companies.
  • Separate legal entities: Subsidiaries are distinct legal entities from their parent companies, which means they can enter into contracts, own assets, and be held responsible for their own liabilities.

Types of Subsidiaries

Subsidiaries can be classified into several types based on their relationship with the parent company. These include:

Wholly-owned subsidiaries:

In this case, the parent company owns 100% of the subsidiary’s shares, allowing maximum control over its operations and decision-making. This type of subsidiary is often used when the parent company wants complete dominance over a particular market or industry.

AdvantagesDisadvantages
Full control over operations and decision-making.Burden of complete responsibility for the subsidiary’s financial performance.
Ability to maintain consistent business strategies and branding.No sharing of risks or resources with other partners.

Majority-owned subsidiaries:

In this scenario, the parent company owns more than 50% but not 100% of the subsidiary’s shares. The parent company still retains significant control but may have to consider the perspectives and interests of other shareholders.

AdvantagesDisadvantages
Control over the subsidiary’s strategic direction.Potential conflicts of interest with minority shareholders.
Sharing of risks and resources with other shareholders.Complexity in decision-making due to various stakeholders.

Joint ventures:

A joint venture is a subsidiary formed through a partnership between two or more companies, aiming to achieve a common business objective. In this case, both parent companies contribute capital, resources, and expertise to the venture while sharing risks, profits, and decision-making.

AdvantagesDisadvantages
Combine expertise and resources of multiple companies.Potential conflicts arising from different management styles and strategies.
Shared risks and costs.Less control over important decisions due to shared ownership.

Limited liability subsidiaries:

This refers to subsidiaries where the parent company’s liability is limited to the amount invested in the subsidiary. Limited liability subsidiaries protect the parent company’s assets from being liable for the subsidiary’s debts or legal obligations.

Foreign subsidiaries:

These subsidiaries are established in foreign countries, allowing the parent company to expand operations globally. Foreign subsidiaries are subject to the laws and regulations of the host country while benefiting from potential tax advantages and access to international markets.

Subsidiaries play a crucial role in business expansion and diversification strategies. Whether it is to break into new markets, mitigate risks, or enjoy tax benefits, companies carefully establish and manage subsidiaries as separate legal entities. Understanding the different types of subsidiaries and their respective advantages and disadvantages is essential for businesses planning to leverage this corporate structure effectively.