What Is Controlled Company?
The controlled company refers to a company controlled by another entity or another person by owning more than 50% of the total voting shares. Therefore they have the decisive voice for managing the affairs of the company.
After the company is classified as the controlled company, it is not required to follow the rules which apply to the public companies that require the company to have the majority of the independent directors or have independent compensation and the nomination committees.
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Controlled Company Explained
The controlled company refers to the company which is being controlled by another entity or another person who is having the decisive voice for managing the affairs of the company.
However, to avail such controlled company exemptions that apply to them, it has to comply with various disclosure requirements. According to these, the foreign controlled company has to disclose the fact that it is relying on the exemption available to the controlled company, and the various corporate governance standards which are not complied by the company.
It is used for the shareholding structureShareholding StructureTo assist management in evaluating ownership, the shareholder structure contains records of classes of shares issued, the number of shares and percentage of shareholding owned by each shareholder, and the voting rights available to shareholders with the shares held by them. in the company where a person or the group of persons has the majority of the shares of the company and thus have the decisive voice for managing the affairs of the company.
There is the risk that minority holders might not receive the proportionate shares, and there could be a transfer of the resources of the company by controlling shareholders for private purposes. So, it is an important matter of concern that the methods should be developed by the company to protect the shareholder’s interest. With this approach, the performance of the whole company will be good.
After getting classified as the controlled company, it doesn’t require to abide by or follow the rules as are applicable in the case of the public companies. It is such as having had the majority of the independent directors, etc.
Let us try to understand the concept with the help of a suitable example.
We can take the example of a company named Fashion web ltd who deals with fashion clothes having a total share capitalShare CapitalShare capital refers to the funds raised by an organization by issuing the company's initial public offerings, common shares or preference stocks to the public. It appears as the owner's or shareholders' equity on the corporate balance sheet's liability side. of $500 million. On May 31st, 2019, a company named Textile hub ltd purchases the shares of the Fashion web, amounting to $200 million. Then again, on September 15th, 2019, Textile hub LTD. purchases the shares amounting to $100 million. of Fashion hub ltd. Whether the Fashion web ltd is the controlled company or not?
In the present case, the Textile hub ltd. holds total shares worth $300 million of Fashion web ltd out of the total shares of $500 million. From this, the holding of the Textile hub ltd. in the Fashion web ltd comes to be 60% ($300 / $500 * 100). The controlled company refers to the company where another company owns the majority of its share i.e., more than 50% of its total value of the shares.
Considering this, since Textile hub Ltd owns 60% of the total shares of the Fashion web ltd, i.e., Fashion web’s more than 50% shares. So from September 15th, 2019 onwards ( as before that holding was less than 50%), the Fashion web ltd becomes the controlled company, controlled by the Textile hub ltd.
Rules And Exemptions
The type of foreign controlled company, as defined by NYSE or Nasdaq, is controlled if more than 50% of its voting rights or director election can be done by a single person or a group of people or entity. Such companies that are listed under NYSE may depend on certain exemptions, which will help them to avoid some standards of listing procedures to be followed related to corporate governance. These standards also include rules like the board should consist of independent directors in majority.
However, if they want to follow the exceptions, then they are required to make certain disclosures, as follows:
- They will strictly depend on and follow the exceptions.
- The reasons of following or the basis of following them.
- If the company does not comply with any standards related to corporate governance, then they should disclose them.
Thus, the above are some rules and exceptions that these type of companies should adhere to during operations.
Some important advantages of the concept of foreign of employee controlled company are as follows:
- After getting the status of the controlled company, the rules that apply to the public companies that require the company to have the majority of the independent directorsIndependent DirectorsThe term "independent director" refers to a member of the board who is not associated with the organization and who provides a neutral opinion because he or she is not tied to the current management., or have independent compensation and the nomination committees are not binding.
- There are various other exemptions available, the advantage of which can be taken by such a company.
- They benefit from a good and stable leadership and ownership. The company that takes control is the one with good governance and management practices that helps the controlled enterprize.
- The above also leads to efficiency in operational process and decision making.
- Hostile takeover, which is common for entities that are not very strong and matured, can be avoided because now they are under the control of an established company which provides protection against such takeovers.
- Strategies for value creation and investment are better designed to help focus on long term goals.
- The foreign or employee controlled company, being under the influence and protection of established companies, can withstand economic downturns and crisis better.
- The controlling company will have a opinion over how to allocate assets and fund on an efficient basis, resulting in higher and better returns. This ensures a clear vision about the future, steady return for shareholders and better capital allocation.
It is equally important to identify the disadvantages of the concept in the financial world, particularly related to corporate governance, conflict of interest or accountability to its stakeholders. Some important disadvantages to be noted as given below:
- In case the company avails for the controlled company exemptions that apply to them, it has to comply with various disclosure requirements as given in instruction 1 to the item 407 (a) of the regulation S-K. Accordingly company has to disclose the fact that it is relying on the exemption, the basis on which such exemption is availed, and the various corporate governance standardsCorporate Governance StandardsCorporate governance is a set of rules or practices through which an entity is directed and controlled to increase shareholders wealth by increasing the economic value and is concerned about its relations with various entity stakeholders. which are not complied by the company.
- Since the majority of the holding is with a person or group, there is a risk for the interest of minority shareholders of the companyMinority Shareholders Of The CompanyMinority interest is the investors' stakeholding that is less than 50% of the existing shares or the voting rights in the company. The minority shareholders do not have control over the company through their voting rights, thereby having a meagre role in the corporate decision-making.. There is the risk that minority holders might not receive the proportionate shares, and there could be a transfer of the resources of the company by controlling shareholders for private purposes.
- The majority of the votes in the company belongs to the controller in practice. Hence, the decision made by them is the decisions of their own, which might not be good for the company as a whole. I.e., in case the controller decides by giving priority to their motive; then it may prove riskier for the company, which is being controlled by others.
However, it is to be noted that the benefits and drawbacks of the system can differ, depending on the nature and size of operations, the type of sector, competency, skill, experience and knowledge of management of both the organizations. Overall it is necessary that the interest of the controlled company is protected.
This article has been a guide to what is Controlled Company. We explain its rules and exceptions along with examples, advantages and disadvantages. You can learn more from the following articles –