What Is a Subsidiary Company?

What Is a Subsidiary Company?

Let me explain what a subsidiary company is. In the corporate world, it's a business entity owned in part or whole by another company. The company with the controlling share is the parent or holding company, and it owns or controls more than half of the subsidiary's stock. If it's 100% owned, we call it a wholly-owned subsidiary.

Key Takeaways

Subsidiaries are separate and distinct from their parent companies and operate independently. A company might buy or establish a subsidiary to get specific synergies or assets, secure tax advantages, or limit losses. You don't need shareholder approval to turn a company into a subsidiary or to sell one. The subsidiary's financials are reported on the parent company's consolidated financial statements.

How a Subsidiary Company Works

Subsidiaries are separate and distinct legal entities from their parent companies, which shows in the independence of their liabilities, taxation, and governance. However, parent companies often have considerable influence over their subsidiaries because of their controlling interest. They, along with any other subsidiary shareholders, vote to elect the subsidiary's board of directors, and there might be overlap in board members between the subsidiary and the parent. To be designated a subsidiary, at least 50% of a company's equity has to be controlled by another entity—anything less makes it an associate or affiliate company.

Subsidiary Company Financials

A subsidiary usually prepares its own independent financial statements, which it sends to the parent company. The parent then aggregates them with financials from all its operations and carries them on its consolidated financial statements. In contrast, an associate company's financials aren't combined with the parent's; instead, the parent registers the value of its stake as an asset on its balance sheet. Accounting standards generally require public companies to consolidate all majority-owned subsidiaries in their records, as this is seen as a more meaningful method than separate financials for each.

Unconsolidated Subsidiary

An unconsolidated subsidiary is one whose financials aren't included in the parent company's statements. Ownership of these is typically treated as an equity investment and shown as an asset on the parent's balance sheet. For regulatory reasons, unconsolidated subsidiaries are generally those where the parent doesn't have a significant stake. The SEC states that only in rare cases, like bankruptcy, should a majority-owned subsidiary not be consolidated.

Subsidiary Company Advantages and Disadvantages

Let's look at the advantages first. Buying an interest in a subsidiary usually requires a smaller investment than a merger, and unlike a merger, you don't need shareholder approval to purchase or sell one. A parent company buys or establishes a subsidiary to obtain specific synergies, like a more diversified product line or assets such as earnings, equipment, or property. Subsidiaries can serve as experimental grounds for different organizational structures, manufacturing techniques, and product types. They can also contain and limit problems for the parent in lawsuits, acting as a liability shield—entertainment companies often set up individual movies or TV shows as separate subsidiaries for this reason.

Now, the disadvantages. Aggregating and consolidating a subsidiary's financials can make the parent's accounting more complicated. Since subsidiaries must remain somewhat independent, transactions with the parent may have to be at arm's length, and the parent might not have all the control it wants. While a subsidiary can shield the parent from some legal problems, the parent may still be liable for criminal actions or malfeasance by the subsidiary's management. Finally, the parent may have to guarantee the subsidiary's loans, exposing it to financial losses.

Examples of Subsidiary Companies

Public companies must disclose significant subsidiaries to the SEC. Take Warren Buffett's Berkshire Hathaway, for instance—it has a long list including International Dairy Queen, Clayton Homes, Business Wire, GEICO, and Helzberg Diamonds. Berkshire's acquisitions follow Buffett's strategy of buying undervalued assets and holding them, allowing subsidiaries to operate independently while accessing broader resources. Similarly, Alphabet Inc. has many subsidiaries, with Google being the best known. These entities perform unique operations to add value through diversification, revenue, earnings, and R&D.

Is a Subsidiary Its Own Company?

Yes, a subsidiary is independent, operating as a separate and distinct entity from its parent. Often, a parent may issue exchangeable debt that converts into subsidiary shares. That said, as the majority owner, the parent influences how the subsidiary is run and may be liable for things like the subsidiary's negligence or debt.

Does a Subsidiary Have Its Own CEO?

A subsidiary usually has its own CEO and management team, but the parent company gets a significant say in who runs it and who sits on its board of directors.

What Are Sister Companies?

Sister companies are two or more subsidiaries majority-owned by the same parent company.

The Bottom Line

A subsidiary is a company completely or partially owned by another company. Acquiring and establishing them is common among publicly-traded companies, especially in tech and real estate. The advantages include tax benefits, increased efficiencies, and diversification, but drawbacks are limited control, greater bureaucracy, and potential legal costs.