The term “subsidiary” is used often in business, however, you might not know exactly what it means. Subsidiaries are an important part of the legal structure of nearly every large company.
In this article, we discuss what subsidiary companies are, how they are used, and the best way to structure them.
What Is a Subsidiary Company and How Does It Work?
A “subsidiary company” refers to a business that is wholly or majority owned by another company. The company that owns a subsidiary is often called a “parent” or “holding” company.
A subsidiary company is typically a separate business with its own team in charge of daily operations. However, the parent company may still have voting-control over the subsidiary and can make big decisions for the company.
Businesses use subsidiaries as tools to protect valuable business assets from liabilities associated with daily business activities. Subsidiaries act like firewalls keeping the liabilities and obligations of one business separate from the assets of any other related businesses.
A large company with multiple subsidiaries is like its own business ecosystem. Each individual company can operate independently and have its own assets and liabilities. Meanwhile, the parent company maintains ownership of these businesses under one entity while overseeing how they are being run.
Is a Subsidiary Company Typically an LLC?
Most subsidiary companies are set up as limited liability companies, or “LLCs”. This is because LLCs are more flexible, cost effective and simpler to manage compared to corporations. LLCs are the most popular entity type and represent three quarters of new businesses formed. Many of these new LLCs are subsidiary companies for big and small businesses alike.
Is A Subsidiary Company A Corporation?
Subsidiary companies are rarely set up as corporations. Instead, most subsidiaries are formed as Limited Liability Companies, or “LLCs”. LLCs are chosen because they are more flexible, cheaper, and easier to manage. Big and small businesses alike prefer using LLCs for their subsidiaries because of these benefits.
So, to put it simply: No, a subsidiary company is usually not a corporation. The LLC structure is the more popular choice for subsidiaries.
What Are Some Common Examples of Subsidiary Companies?
Companies of all sizes use subsidiaries as part of their corporate structure. Some of the world’s largest corporations use subsidiaries as a necessary strategy for protecting their diverse business interests.
Here are some examples of companies that you might be familiar with who use subsidiaries:
- Google and Youtube as subsidiaries of Alphabet Inc;
- Instagram as a subsidiary of Meta Platforms, Inc., (formerly Facebook, Inc.);
- American Broadcasting Company (ABC Network) and ESPN as subsidiaries of the Walt Disney Company;
Alphabet, Inc. uses subsidiaries to successfully manage its different business lines. Alphabet, Inc. “dropped down” the Google search engine cash cow into a subsidiary to keep the business separate from the company’s other ventures.
What Are the Pros and Cons of Using Subsidiary Companies?
There are some pros and cons associated with using subsidiary companies. Here are some points to consider when deciding whether to set up a subsidiary for your business:
- Pros: Legal Protections Across Multiple Businesses
Having subsidiaries helps companies limit liability risks across a business organization. For example, one company may file for bankruptcy without dragging the other related businesses through the process. Using a subsidiary also allows you to bring outside partners into new ventures without giving them a slice of the bigger “pie” from other businesses.
- Cons: Management Costs
Operating and maintaining multiple subsidiary companies can become costly. Forming an LLC often requires paying an annual fee to keep the company in good standing, in addition to the one time filing fees. For example, Delaware requires all LLCs in the state to pay a $300 Annual Franchise Tax each year.
Additionally, subsidiary LLCs must maintain separate books, records and bank accounts in order to avoid mixing assets between businesses. This can add to the operating costs of each subsidiary company.
How Much Does It Cost to Set Up a Subsidiary Company?
The most cost effective way to set up a subsidiary company is to form an LLC. The total cost of forming and maintaining a subsidiary LLC will depend on which state it is formed in. Between state annual franchise taxes and annual registered agent fees, an LLC typically costs $400 per year to maintain.
What is a Delaware Series LLC and How Does It Work?
Delaware Series LLCs offer a simpler and more affordable way to protect multiple businesses under one company. A Delaware Series LLC is able to create an unlimited number of business cells called “protected series”. Each protected series is able to have its own business purpose, assets and liabilities.
A Delaware Series LLC provides internal asset shields. This means the business assets of each protected series are off limits to creditors of any other protected series or the parent LLC.
Delaware requires Series LLCs to pay only one filing fee and one annual franchise tax no matter how many protected series they form. The Series LLC enables you to operate an unlimited amount of businesses under the ownership of one company without multiplying the costs.
Why is Delaware the Best State for Subsidiary Companies?
Both large companies and entrepreneurs prefer Delaware as the premier location for forming LLCs. This is because Delaware’s business laws provide protections for business owners that are unmatched by any other state.
Google is likely the most recognized Delaware LLC in the world. General Motors is another well known company which has formed over 1,500 subsidiaries in Delaware. Entrepreneurs form thousands of Delaware LLC subsidiaries every month, each with discrete purposes and assets of their own.
How Are Subsidiary Companies Taxed by the IRS?
Many subsidiary companies are “single-Member LLCs”. This is the case when the parent company is the sole owner of the subsidiary. The IRS disregards single-member LLCs for tax purposes. This means subsidiary LLCs do not need to file a separate tax return. Profits and losses of subsidiaries can be accounted for on the parent company’s books.
What Is a Wholly Owned Subsidiary?
A wholly owned subsidiary is owned 100% by its parent company. Wholly owned subsidiaries are typically used to protect particularly valuable assets that the parent company wants to keep legally separated from its business activities. Examples of this would be a summer camp forming a wholly owned subsidiary to hold title to a boat or a business forming one to own its private aircraft.
What Is a Subsidiary Agreement, and How Is It Used in Business?
A subsidiary agreement is one term business owners use for the operating agreement of a subsidiary company. One unique aspect of a subsidiary’s operating agreement is that there is only one member, the parent company.