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What is a subsidiary? Everything you need to know

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What is a subsidiary?

What is a subsidiary? Everything you need to know

Updated on:
16 Jan, 2014
What is a subsidiary?
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Employ contractors and employees in 160+ countries
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Employ and pay

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starting at $199

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Employ and pay global talent starting at $199
Employ and pay
global talent

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$199

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Expanding your business into new markets is exciting. You can do so without compromising your brand name with subsidiaries. Take Facebook, for instance. It has invested in multiple companies and is a parent company for those subsidiaries. Facebook acquired Instagram and Whatsapp and bought shares of the virtual reality company, Oculus.

This article will walk you through what does subsidiary mean, how it works, its advantages and limitations, and highlight the primary steps to begin business subsidiaries. It will also help you determine whether it is a viable strategy for your business. So, read ahead!

What is a Subsidiary? 

A subsidiary or a business subsidiary is a company partially or wholly-owned by another company, known as the parent company. To own a subsidiary, the parent company must hold at least 50% of its shares. 

And, what is a wholly-owned subsidiary? When a parent company owns 100% of the subsidiary, the smaller business is called a full- or wholly-owned subsidiary.

Simply put, companies managed by a larger organization are known as business subsidiaries. From large enterprises to up-and-coming startups, they are the corporate code to conquer the market together.

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How a Subsidiary Company Works?

A subsidiary allows you to extend your reach into different industries, markets, or locations. Although the parent company maintains control and ownership over these separate entities, they often function differently to cater to specific market needs.

1. Ownership and Control

A subsidiary is a separate legal entity. However, the parent company holds a significant portion of the shares in a subsidiary. It gives the former a financial interest and stake in the performance and profitability. The parent company’s control extends to operational and managerial decisions, board representation, appointment of executives, and voting rights.

2. Legal Independence

Business subsidiaries maintain their own legal identity. It means they are distinct from their parent company. A subsidiary is subject to the laws and regulations of the country it is based in. It can enter into contracts and independently engage in business activities while following specific compliances.

3. Financial Aspects

Subsidiaries maintain their separate statements and accounting records. Each financial transaction between the parent company and subsidiary is documented. Meanwhile, both entities report their financial performance individually.  Further, the external auditors perform the audits separately for the parent company and its subsidiary.

The parent company oversees the subsidiary's audit procedure to provide accurate information and ensure proper governance. The extent of involvement can vary depending on the level of control it has.

4. Operational Autonomy

Operational autonomy refers to the degree of independence and authority subsidiaries possess in decision-making and management. Depending on customer needs and local market conditions, they can make decisions regarding their daily activities, like production, sales, and marketing. However, the parent company can influence its strategic decisions and policies.

5. Role in Global Expansion

Subsidiaries significantly contribute to the growth of the parent company. They enable the brand to establish a local presence in new markets, adapt to specific cultures and regulations, and leverage existing distribution networks. Thus business subsidiaries can help increase market share and revenue diversification.

It is essential to keep in mind that the level of ownership, autonomy, and control can vary based on the structure and objectives of the parent-subsidiary relationship.

Branch vs. Subsidiary: Which one should you choose?

The merits of setting up a subsidiary or a branch differ from business to business. Here are the primary distinctions between both alternatives: 

1. Definition and Legal Status

A branch is a secondary office operating under the same legal entity as the parent company. The parent company is liable when a branch company faces legal intricacies.

Meanwhile, a subsidiary is a separate company controlled by another company, the parent or holding company. Therefore, it functions independently, based on the ownership stakes, unlike a branch company.

2. Financial and Operational Control

A branch is a part of the business, usually termed the head office. It operates in the way the primary business suggests. In addition, it can not deal with undertakings besides the one the main company directs. Consequently, the parent company controls and dictates the operations and financial decisions.

Subsidiaries, however, have liberty in this context. They can operate independently and construct autonomous management to achieve objectives.

3. Taxation and Compliance

The overall financial statements and tax returns include the revenue of the branch company. Therefore, the holding company is responsible for fulfilling tax implications and compliance obligations on behalf of a branch.

A subsidiary files its tax returns separately from the parent company and complies with local rules and laws of the specific area. It assumes tax and compliance responsibilities, which may vary based on local regulations.

4. Risk Exposure and Liability

Profits and losses are inevitable in a business. While the liabilities are limited to subsidiaries only, a branch extends the same to its holding company. The parent company can close the branch office anytime when suffering continuous losses. However, you can sell your subsidiary company to another company to mitigate the losses.

Advantages Benefits of a Subsidiary 

Setting up a subsidiary can offer several benefits to the parent company. It presents various opportunities to capitalize on and flourish your business. The other key advantages are as such:

1. Taxation Benefits

You can enjoy various tax benefits by opening a subsidiary. However, it is essential to note the privilege may vary from one geographical location to another. For example, most countries exempt capital gains tax.

Subsidiaries may be subject to taxes within the state they operate. You can deduct interest on loans to assist the subsidiary and may be able to defer taxes on the overall profits.

2. Reduced Risk

The subsidiary is a separate legal entity, as mentioned. It does not endure or suffer the losses incurred by the parent company.

Even if the parent and subsidiary companies are legally the same, the former will bear the obligations during bankruptcy.

3. Enhanced Diversification and Efficiency

Subsidiaries divide a company into smaller parts. It allows you to achieve greater and better efficiency and encourages more effective management.

Disadvantages of a Subsidiary

Subsidiaries allow you to expand your business into other regions. However, not everything is sunshine and roses. Managing a subsidiary can be more tricky and time-consuming than assumed. Some notable downsides to it include:

1. More Legalities

Each state and country follows different laws and regulations. Owning many firms and managing their assets can cause legal concerns. You must understand and adhere to the specific compliances when working in or throughout multiple areas.

2. Increased Liability

The parent company holds the majority of shares in a subsidiary. Consequently, it is liable for all actions, debts, or legal issues. It can impact financial stability and reputation.

Process of Setting up a Subsidiary: A Step-by-Step Guide

Initiating a business requires adequate research and planning. Given below are the steps to begin your subsidiary company:

1. Choosing Identifying  the Right  Location

The location for your business is something you should not select on a whim. It is a crucial step in entering the global market. You would want a place that will provide economic benefits to your subsidiary.

Various aspects are there to decide an ideal business location. Here are some tips for identifying the best place to expand your business:

  • Accessibility to market for convenient distribution and sales.
  • Evaluate local economic conditions and growth potential.
  • Assess the cultural compatibility of the place with your business practices.

The importance of business location cannot be understated. Think about your location from the point of view of a potential customer and employee. You must consider all the details, from pricing and availability to parking and market appeal.

2. Compliance With Local Laws

Compliance with local rules is essential when opening a subsidiary. Adhering to these regulations establishes a solid foundation for responsible and successful operations.

It ensures legal legitimacy and fosters trust with stakeholders. The process involves:

  • Research and understand local laws and regulations relevant to your industry and business activities.
  • You may seek legal or expert advice for thorough guidance and proper interpretation.
  • Develop and implement internal processes and practices that align with local regulations.

Adhering to the local rules is significantly crucial to sidestep penalties and violations. Hence, prioritize compliance and navigate legal complexities to secure your prosperous future.

3. Funding and Capitalization

Funding and capitalization are the subsequent crucial aspects to contemplate. This step focuses on assessing investment requirements, identifying suitable sources, and effective financial planning.

Here is a breakdown of how you may begin the process:

  • Determine the required capital amount to initiate subsidiary operations.
  • Identify potential funding sources; it can come from the parent company, investors, loans, or both.
  • Frame a foolproof plan to outline how you will allocate the capital for smooth operations and growth.

Properly capitalizing on the subsidiary ensures its viability and growth potential. The precise consideration will lay down the groundwork for a thriving venture.

4. Business Operations

Robust business operations are the backbone of a successful establishment. Well-defined operations ensure the subsidiary can function consistently over the long term.

Smooth operations create a conducive work environment and ultimately lead to increased productivity. Its other benefits are:

  • Efficiently organized operations entail streamlined processes, lowered expenses, and optimized resource utilization.
  • Sound business operations contribute to revenue generation and profitability.

Seamless business operations allow you to connect with local customers, suppliers, and partners. It helps you tailor your products and marketing strategies to meet specific needs and preferences.

5. EOR vs. Subsidiary: How to Choose?

Employer of Record (EOR) is a solution handling HR, payroll, and legal compliance for international employees, simplifying international expansion. You must consider legal, financial, and operational implications before selecting between an EOR and opening a subsidiary.

The following factors can guide you and help you make an informed decision:

  • The level of control and autonomy you want over your business operations in the new market is a significant factor.
  • Identify and think about your risk tolerance and business's long-term sustainability.
  • The legal and regulatory aspect of the target market is crucial.

Skuad’s Employer of Record platform facilitates quicker market entry with less administrative burden. Further, it helps you navigate unfamiliar legal systems, tackle the associated challenges with compliance and global payroll management, and eliminate the overhead costs of setting up and maintaining an office.

6. Ongoing Management and Monitoring

Your work should be over now that the subsidiary is ready, yes? However, it is not so! You must assess and supervise the business to measure its performance and make necessary changes.

Constant oversight and management of the work process is essential to:

  • Ensure adherence to local laws and regulations, minimizing legal risks.
  • Manage budgets, expenses, and financial reporting to maintain fiscal health.
  • Identify areas for improvement and enhance resource utilization.

Constant and regular monitoring encourages effective knowledge transfer between the parent company and its subsidiaries. It helps align strategic goals and enhances overall efficiency.

Expand Globally With Skuad Without Establishing a Subsidiary

Opening a subsidiary can be challenging. Even proper research and planning sometimes fail to set up a company that meets your expectations. A minor complication or misinterpretation of local regulations can land you straight into a legal mess. Don’t let the fear of legal compliance stop your global expansion strategy, especially when you can bypass it with a reliable Employer of Record (EOR) platform.

With Skuad as your EOR partner, you can hire, onboard, pay, and manage remote workers from 160+ countries without setting up a subsidiary or a local legal entity. From localized contracts to compliance with country-specific laws, Skuad takes care of it all. So talk to our experts and grow globally without the headache. 

FAQs

Q1. What are two Subsidiaries Called?

Two business subsidiaries are known as sister companies or affiliate companies. Both terms describe companies under the ownership of the same parent company.

Q2. Does a Subsidiary Have a CEO?

Yes. Subsidiaries have their own Chief Executive Officer, management team, and board of directors to handle the operations. However, the parent company has a sway over who leads the position and runs the company.

Q3.  Is a Subsidiary a Corporation or LLC?

A subsidiary company can be an LLC or a corporation. The parent company decides the structure a subsidiary will take. It is typically a legal and financial decision. Further, both LLCs and corporations restrict liability and follow different taxation rules.

Q4. What is a Wholly-Owned Subsidiary Company?

When a parent company owns a subsidiary entirely, it is a wholly-owned subsidiary company. It implies the parent company holds all common stocks and has complete control over the company. Further, a wholly-owned subsidiary legally recognizes it as its own entity.

Q5. What are Tiered Subsidiary Companies?

There can be multiple tiers of subsidiary companies within a broader corporate group. For instance, a company owned majorly by a parent company is a first-tier subsidiary. A second-tier subsidiary can be the second subsidiary company of the overall parent firm.

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