What is a subsidiary company?
A subsidiary company is the one that is controlled by another company, better known as a parent or holding company. The control is exerted through ownership of more than 50% of the voting stock of the subsidiary. Subsidiaries are either set up or acquired by the controlling company. In cases, where the parent company holds 100% of the voting stock, the subsidiary company structure is referred to as a wholly owned subsidiary.
Subsidiaries have a separate legal entity from that of their parent company. They are independent in terms of their liabilities, taxation, and governance. Thus, a subsidiary company structure can sue and be sued separately from its parent. Nevertheless, due to the majority ownership, the parent has a major say in the election of subsidiary’s board of directors and its functioning. The separate legal entity of the subsidiary may help the parent company to gain tax benefits, track the results of a unit separately, segregate subsidiary risk from the parent company, prepare assets for sale etc.
Levels of Subsidiary Company
Larger parent-subsidiary structures may involve several layers of subsidiaries, termed as a first-tier subsidiary, second-tier subsidiary, third-tier subsidiary and so on.
As shown in subsidiary company example Figure 1, where the uppermost company in the tiered structure is not owned by any other company, the subsidiaries controlled by this company is a first-tier subsidiary. Where a first-tier subsidiary owns more than 50% of shares in another entity, this entity is referred to as second-tier subsidiary and so on.
Subsidiary Company Examples
Subsidiary Company Example #1 – Walt Disney
The Walt Disney company has more than 50 subsidiaries. Partial list of subidiary companies is provided below
You may check out the full list here
Subsidiary Company Example #2 – Nike Inc
Nike Inc has more than 100 subsidiary companies. The partial list of the subsidiaries is provided below.
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You may have a look at the full list of the subsidiaries here
The difference with minority passive holding and associate company
- Subsidiaries are entities where the parent or holding company owns more than 50% of its voting stock.
- In contrast, if the parent holds 20%-50% of the voting stock of another company, that company is referred to as an associate company.
- Further, where the parent holds less than 20% of another company’s stock, that investment is a minority passive investment.
In the case of a subsidiary company structure, financial statements of the subsidiary are merged with the parent’s statements and the consolidated financial statements are furnished along with standalone results in the audited financials of the parent.
For minority investments, the investment is categorized as a financial investment in the asset side of the parent’s balance sheet while dividends received are shown in the income statement under financial income.
Accounting Treatment of Subsidiary Company
The consolidated financial statements need to incorporate all subsidiaries of the parent. All intragroup balances, transactions, income, and expenses are eliminated during consolidation. There has to be uniformity in accounting policies for like transactions while combining the accounts.
- For the consolidated income statement, 100% of the subsidiary’s income and expenses are included. Any net income attributable to non-controlling interest of subsidiary company structure is subtracted from the consolidated net income to get the net income attributable to the parent.
- On the same lines, 100% of subsidiary’s assets and liabilities are included in the Consolidated Balance Sheet and the non-controlling interest of the subsidiary is recorded as a separate line item under equity section, labeling it as non-controlling interest in subsidiaries or minority Interest.
- The purchase price of an acquired subsidiary above its fair value is reported as Goodwill in the Parent’s balance sheet and classified as an unidentifiable asset.
- For greater than 80% ownership, the parent is required to submit consolidated tax returns.
Consolidated and Unconsolidated Subsidiary Companies
- As per regulations, parent companies are required to consolidate all subsidiary financials. However, subsidiaries may remain unconsolidated in rare cases like when a subsidiary company structure is undergoing bankruptcy wherein the parent is unable to control the subsidiary’s operations.
- Such firms are treated as equity investments and recorded in the same way as an associate investment is recorded in the parent company’s balance sheet.
Subsidiary Company Structure and Other Business Combinations
Business combinations can be categorized as mergers or acquisitions, consolidations and special purpose entities.
While a subsidiary company structure has its own true identity and the existing organizational structure even after the acquisition by a parent or holding company, mergers result in absorption of the smaller company into the larger company which purchases it, resulting in the merging company ceasing to exist. Consolidation is the formation of a completely new company through a combination of two firms while special purpose entities are created by sponsoring firm for a special purpose or a project.
Valuation Issues in Cross Holdings- EV/EBITDA
Firms with cross holdings are faced with valuation issues like in the case of EV/EBITDA estimation. When a holding is categorized as a minority holding, operating income of holding company does not reflect the income of the minority holding. However, the numerator of the multiple includes the market value of equity which includes the value of minority holding thus leading to an overvaluation of the parent’s stock. Hence, the value of minority holding has to be subtracted to arrive at the correct EV.
In case of majority holding like for subsidiaries, the EBITDA includes 100% of subsidiary operating income while the EV reflects only the portion of the holding belonging to the firm. This could give a misleading interpretation of low multiple which could categorize the holding company stock as undervalued. For consolidated holdings, adjustments would thus be required to exclude the value and operating income of the holding from the numerator and denominator respectively.
Growing businesses usually establish subsidiaries or purchase controlling stake in existing companies since this gives them the benefit of expanding their business at minimal risk. The parent-subsidiary relationship helps in locking the liabilities and credit claims of the subsidiary company structure, keeping the parent’s assets safe. There could also be other specific synergies benefitting parents, for example, increased tax benefits, diversified risk or assets like earnings, equipment or property. The subsidiary, in turn, benefits from the brand reputation of the parent company and/or valuable resources.
Although the two companies are considered separate legal entities for liability purpose, they are considered as a single entity for reporting financials. In case the holding is >80%, the parent can gain valuable tax benefits and offset profits in one business with losses in another.
Legal costs involved in acquiring subsidiaries is usually less than that of mergers. Further, the acquisition of subsidiaries in foreign land results in tax benefits apart from easing business conditions with otherwise less co-operative countries. This helps to increase market share and gain competitive advantage through economies of scale.
This has been a guide to what is a subsidiary company. Here we discuss levels of the subsidiary company, its accounting treatment, subsidiary company structure and business combinations and valuation issues around such cross-holdings. You may also learn more about Corporate Finance for the following articles –