The decision to start a subsidiary business can have significant financial and legal implications. It is best to consult with a business attorney to ensure that the structure meets all the necessary requirements.
A subsidiary business is a legal entity owned and controlled by another company, known as the parent or holding company. This arrangement allows companies to diversify their operations and minimize risk by containing financial liabilities.
Limited Liability
For many companies, creating a subsidiary can be a low-risk way to diversify or explore new markets. Because subsidiaries are considered legal entities separate from their parent company, they have limited shared liabilities and debts and are regulated and taxed independently from the parent company. Creditors can only seek claims against a subsidiary company when it has more than 50% of its shares owned by the parent company, and even then they must prove they were able to “pierce the corporate veil” in order to get access to the parent’s assets.
Because they are legally separate, subsidiaries can be used to test products and services without affecting the brand image of the parent company. However, they are not a foolproof method to protect the parent company from liability; if there is any criminal activity or negligence committed by the subsidiary, the parent may still be held responsible.
Subsidiaries can also be used as a tool to reduce taxes, particularly for multinational corporations. By registering their foreign operations as subsidiaries, the parent company can save on taxes by only paying for the profits earned in that country. This can help maximize profits and keep the parent company’s overall tax rate as low as possible. The financial aspect of subsidiaries is important to consider, as it can be complex to navigate regulatory and taxation issues.
Tax Benefits
A subsidiary business, which is a company owned by another corporation or LLC, is a way for a parent company to establish a presence in a new market without the financial risk that comes with setting up a standalone company. The parent company can also take advantage of tax benefits, such as the ability to deduct the losses of the subsidiary against its profits or lower corporate taxes in the country where the subsidiaries are located.
The financial and legal liability of a subsidiary is limited to the amount of capital that it has, which helps protect the parent company from potential bankruptcy or other liabilities. A subsidiary can also help to expand into international markets more easily, as it allows the company to operate as an independent entity and avoids local laws and cultures that may be difficult to navigate for a large company.
A subsidiary can allow a business to develop unique expertise in a specific field. For example, a large food company may create a subsidiary to develop a line of snack foods that are distinct from its existing brand and customer base. This is a common strategy for businesses that want to test new products and ideas, as it can be more profitable than starting an entirely new company from the ground up.
Flexibility
A subsidiary business allows a company to operate in multiple markets without incurring too much risk. The parent firm can invest in and oversee the day to day operations while keeping liabilities separate. A subsidiary may also be able to receive tax benefits and diversify risks. Having a subsidiary is especially useful for companies with limited resources or those that want to experiment with products or services.
Creating a holding company vs subsidiary company allows businesses to create unique brands that can operate independently but benefit from the resources of a larger corporation. In this way, a company can test out a product or service and determine whether it will be profitable before investing more resources. Subsidiaries can also be used to protect intellectual property by keeping the parent company’s assets away from the new entity.
However, setting up a subsidiary can be complicated and expensive. It requires a clear understanding of the laws and regulations in each country where the subsidiary will be operating. Guidance from an attorney can be useful in this regard. In addition, a subsidiary can require a large initial investment in infrastructure such as office space and equipment. This can be a challenge for smaller businesses that may not have the financial resources to start with. Additionally, cultural differences can pose a challenge for many businesses that operate subsidiaries in foreign markets.
Independence
As distinct legal entities, subsidiaries restrict shared monetary liabilities or commitments and make it easier to oversee or sell. Keeping companies separate can also help to prevent conflicts between parent and subsidiary companies.
Often, when larger companies want to expand into international markets, they purchase a smaller company that has expertise in the area and establish the latter as a subsidiary. This allows the larger company to test out new products and services without putting their entire business at risk.
Additionally, parent companies can leverage the weight of their subsidiaries when it comes to negotiating pricing and terms with suppliers and customers. This can be especially useful in developing countries that have different regulations and tax structures.
While there are several benefits of setting up a subsidiary business, it’s important to weigh the pros and cons carefully before making a decision. Having guidance from a professional can ensure that you choose the right entity type for your needs and meet all legal and tax obligations. Typically, subsidiaries are established as LLCs rather than corporations because they are more flexible, cost effective and simpler to manage compared to a corporation. The steps to forming a new subsidiary vary by state, so it’s important to research the requirements and get professional advice before taking action. Join over 1.8 million professionals using CFI to learn accounting, financial analysis, modeling and more. Start your free trial today!
