What Is a Subsidiary and How Does It Work?February 25, 2020
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". 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.
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 own 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 their 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 own 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.
Pros and cons of subsidiaries
Subsidiaries help companies in some areas but they also have drawbacks. The following list explores the pros and cons of subsidiaries:
- 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.
- 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.
Differences between a subsidiary and a division
The main difference between a subsidiary and a division is that a division is part of the internal structure of a company. Although it may operate under a different name, a division is still within the entity itself. A subsidiary, however, is a different entity entirely.
Another difference is that the subsidiary can involve itself in a different operation than the parent. A division's work must relate to the parent. For example, if the company produces video games, a division may manufacture its base discs. The subsidiary, in this case, could be a comic book studio producing for its own gain. Subsidiaries also can conduct business in the same realm as the parent. Their business can be in anything, whether it relates to the parent or not.
A parent is also responsible for all actions taken by a division, while a subsidiary governs itself since it's legally a separate company. A division's performance impacts the parent. They are part of the same entity and will feel the effect of each other's actions. Since subsidiaries are separate companies, if they experience hardship or decline, it won't affect their parents.
Subsidiaries can exist in small- or large-scale operations. Here are some examples of subsidiaries:
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.
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 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.