What Is a Subsidiary and How Does It Work? (With Examples)
By Indeed Editorial Team
Updated October 12, 2022 | Published February 25, 2020
Updated October 12, 2022
Published February 25, 2020
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
Some of the largest corporations in the world consist of a collection of smaller companies. A company that is part of a larger organization is called a “subsidiary.” The larger business, which must own at least 50% of the smaller business, is known as a parent or holding company.
In this article, we explain what a subsidiary is, define some of its functions, offer some compelling pros and cons of acquisition and provide examples.
A subsidiary is a smaller company that is owned and directed by a larger company.
To be considered a subsidiary, the parent company must own at least 50% of the smaller company.
If a parent company owns 100% of the subsidiary, the smaller company is considered a “wholly owned subsidiary.”
What is a subsidiary?
A subsidiary is a smaller business that belongs to a parent or holding company. The parent retains majority control over the subsidiary, owning over half of its stock. Any less than that and it is considered an "associate" or "affiliate" company. An associate company is treated differently than a subsidiary in financial reporting. A subsidiary creates its financial reports separate from its company's statements.
A parent or holding company could own one or many subsidiaries. Each subsidiary follows the rules and regulations of the state in which the parent company operates. Sometimes, a parent has full control over its subsidiary company. When this occurs, the child company is referred to as a "wholly-owned subsidiary."
Related: 7 Ways to Market a Small Business
What does a subsidiary do?
Subsidiaries exist to supplement the parent with additional bonuses such as increased tax benefits, earnings and property. Although the parent keeps majority ownership, the subsidiary remains as a separate, legal entity which shows in its liabilities and taxation.
In some cases, subsidiaries are formed for a particular purpose. For example, in the real estate industry, companies may have several properties that form the overall holding company. The individual properties are subsidiaries. Creating subsidiaries can help protect assets from each other's liabilities. So, for example, if a lawsuit threatens one of the properties, the others will not be affected.
Subsidiaries usually manage their day-to-day functions but often need to seek approval from their parent company before making bigger decisions. If a parent company were to assume the daily responsibilities of a subsidiary, then it would also need to accept liability for the subsidiary.
Why do companies create subsidiaries?
A company might decide to create one or several subsidiaries for the following reasons:
1. To raise money
By owning a subsidiary, a parent company can offer stock and drive investments for their company for just the subsidiary portion of their company. In this way, they can raise capital without incurring the risk of altering their main company’s stock value.
Related: What Is Capital in Business?
2. To save on taxes
Parent companies that own at least 80% of one or more subsidiaries can file a consolidated tax return while writing off any losses the subsidiary might incur from their total income. By separating the businesses, companies can manage and sell their subsidiaries without affecting their parent operation. They are also only accountable for subsidiary debt collection on the subsidiary accounts.
3. To report and disclose strategically
When a parent company’s assets are separated from that of its subsidiaries, it can choose which aspects of the business should be public or remain private. This can be especially helpful if the parent company is in a competitive industry and not ready to introduce a new product line.
4. To streamline brand approach
A parent company might have multiple product lines and brand identities that serve them. By having separate subsidiaries, it’s easy to differentiate brand identities and company culture into an organized structure, which, in turn, streamlines vendor relations, marketing and customer brand recognition.
Related: What Is the Brand Identity Prism?
Pros and cons of subsidiaries
Subsidiaries can offer both potential benefits and drawbacks for companies. The following list explores the pros and cons of subsidiaries:
Potential benefits of owning a subsidiary include:
Tax advantages: Subsidiaries may only be subject to taxes within their state or country instead of having to pay for all of their profits.
Loss management: Subsidiaries can be used as a liability shield against losses. For example, companies in the entertainment industry often set up individual films or shows as separate subsidiaries. Any losses that occur within those properties are contained within them.
Easy to establish: Small firms are easy to establish. As with the entertainment and real estate industry examples above, companies can set up assets to be their own subsidiary, if needed.
Synergize with other subsidiaries: Large parent companies often have a network of subsidiaries. They can work together to help each other with various processes, streamlining efficiency across all child companies.
Potential disadvantages of owning a subsidiary are:
More legalities: Owning multiple firms and their assets can cause legal concerns. Laws differ between states and countries. If the subsidiaries either work in or throughout these various areas, they will need to follow their laws and regulations.
Complex financials: Accounting becomes more difficult when organizing and consolidating a subsidiary's financials. This is especially true when a parent company owns multiple subsidiaries.
Increased liability: Since the parent company owns a majority of the subsidiary, it's liable for all of the actions of the subsidiary.
Subsidiaries can exist in small- or large-scale operations. Here are some examples of subsidiaries:
Example 1: Dream Enterprises
Dream Enterprises is an entertainment corporation. It owns several subsidiaries, with Magic Man Studios and Magic Media Networks being the largest.
Magic Man Studios: Magic Man is a subsidiary of Dream Enterprises, Inc. It owns other large media companies such as Guy With a Camera Pictures (GWACP), Magic Animation Studios, Magic Television and Magic Film.
Magic Media Networks: Magic Media Networks controls other large studios and television stations, such as Miracle Mountain News, Classic Streams, Nadar Networks and Animals Worldwide.
Example 2: Centerville Wireless
Centerville purchased a cellular company in the early 2000s. Centerville absorbed its customer base and systems as part of the acquisition.
Centerville Cable Communications, LLC: As a wholly-owned subsidiary, Centerville Cable Communications offers cable television and internet services. It has its own subsidiaries, including Centerville Developments and Center Mart.
Simulation Media, LLC: Simulation Media, LLC, is Centerville Corporation's hub for media, content and entertainment. Their most successful service is their virtual reality simulation televisions. The company owns its own subsidiaries such as various broadcast networks and theme parks.
Centerville Sports: Centerville Sports is a live sports company. They own and operate the Centerville League (which hosts multiple sporting events throughout the year), Mississippi Mayhem (one of the teams within the league), and the competitive video game team, Centerville Blasters.
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