What is a parent company

subsidiary company

A subsidiary describes a company that is economically dependent on the parent company, but is legally independent. The dependency is shown by the fact that the parent company exercises a certain amount of control over the subsidiary. In this respect, the cooperation is dominated by domination and profit transfer agreements.

In this lesson you will learn about the subsidiary as well as its requirements and characteristics. The practice questions at the end of the lesson will help you check your level of knowledge and, if necessary, close knowledge gaps.

  • Synonyms:subsidiary | Subsidiary
  • English:subsidiary | affiliate | subsidiary company | affiliated company

When does a subsidiary matter?

The majority of a subsidiary belongs to the superordinate parent company, which can exert significant influence on the decisions of the subsidiary.

The subsidiary is closely linked to the parent company. If this goes into bankruptcy, this also regularly means the end of the subsidiary. Conversely, the parent company can usually cope with the bankruptcy of the subsidiary. Because of this constellation, subsidiaries have an impact on different areas of the company.

The subsidiary plays an important role in:

  • Corporate governance
  • Concentration on core competencies
  • Stabilize and expand the market position
  • Personnel policy
  • Use of tax advantages
  • Expansion efforts at home and abroad
  • Expansion of resources
  • Strengthening competitiveness
  • Intensification of research and development
Examples of subsidiaries
It is mainly large corporations that prefer to outsource departments, especially IT departments.

A well-known example is the German semiconductor manufacturer Infineon, which is a subsidiary of the Siemens group. The reason for the outsourcing of this technology division was the strongly fluctuating profits and sales in the semiconductor market, which should be separated from the business results of the parent company.

Another example is Opel. The German automobile manufacturer now belongs to an American automobile group, namely General Motors. Opel is firmly anchored in the European market and has its own brand, so that this market position is used profitably by the American parent company.

The same applies to the frozen pizza manufacturer Wagner, which is a subsidiary of the Swiss food company Nestlé.

Motives for founding a subsidiary

Parent companies have different motives when it comes to setting up subsidiaries.

Motives for founding subsidiaries:

  • With the Separation of different lines of business Transparency is created in the parent company and subsidiary. This also means that the corporate management has a better overview of the business administration.
  • For example, a German company would like to expand towards China in order to produce and sell there. Then establish it local subsidiary or takes over a company on site in order to integrate it as a subsidiary in the parent company.
  • Some parent companies have several subsidiaries, each of which produces different goods. In this way, for example, the Broadly diversified corporate risk and increase the presence in different markets.
  • Sometimes a subsidiary is formed in order to Save taxes.
  • Subsidiaries are also established around to separate individual areas of activity from one another and thus to achieve greater transparency, for example in the case of conglomerates with a vertical and horizontal group structure.
  • If a division does not belong to the actual core business of a company or is no longer part of it, outsourcing can be considered. That can be done with the aim that To sell subsidiaries in whole or in part at a later date.
  • A subsidiary is easier to sell because it has its own legal form and its own economic situation due to the separation from the parent company assessed more transparently and well-founded because subsidiaries also draw up their own balance sheets.

When is a company a subsidiary?

A company is a subsidiary if certain requirements are met:

  • Another company holds a stake equal to the majority of the voting rights, which must be at least half of the voting rights.
  • Another company is a partner in the company with any share and has the right to appoint or remove a majority of the company's organs.
  • Another company can exercise a controlling influence over the company, for example on the basis of a company's articles of association, a profit transfer agreement or a domination agreement.
  • There is a uniform service in accordance with Section 290 (1) HGB (Commercial Code) or a participation in accordance with Section 271 (1) HGB.

Under the domination agreement, the subsidiary is obliged to operate in the interests of the parent company. Conversely, the parent company must consolidate the subsidiary in consolidated financial statements. It doesn't matter where in the world the subsidiary is located.

Characteristics of a subsidiary

Subsidiaries are also distinguished by certain characteristics in relation to the parent company.

Features of a subsidiary:

  • In terms of finances, the subsidiary is almost always majority owned by the parent company.
  • If the subsidiary is a stock corporation (AG), the parent company regularly takes over the majority of the shares.
  • If the subsidiary is a limited liability company (GmbH), the parent company regularly has the majority of the share capital.
  • In legal terms, a subsidiary is independent from the parent company.
  • If 100% of the capital of a subsidiary is owned by the parent company, it is a "Wholly owned subsidiary".
  • The subsidiary is always controlled by the parent company.
  • It is not a subsidiary if a partnership or a natural person owns the subsidiary.

The demarcation of the subsidiary from other forms of corporate cooperation

There are other forms of corporate cooperation that are confused with subsidiaries and need to be delimited. These include joint ventures, branches, sister companies and the nesting company, which are different from subsidiaries.

Differentiation from the joint venture

Joint ventures differ from subsidiaries in terms of the consolidated financial statements. Parent companies are obliged to include subsidiaries in the consolidated financial statements. In contrast, joint ventures do not have the controlling influence of the parent company or uniform management, so that they are listed in the consolidated financial statements using the equity method or proportionate consolidation.

What does the equity method mean in connection with the subsidiary?

In the Equity method This is a special form of accounting in which the parent company takes into account the participation in the subsidiary in its consolidated financial statements. In this respect, the subsidiary's profits and losses have a direct impact on the parent company's balance sheet. The equity method is used if the subsidiary is not fully consolidated in the consolidated financial statements.

Differentiation from the branch

Unlike the subsidiary, the branch is not legally independent as it remains part of the main branch.

Differentiation from sister companies

By sister companies we mean two subsidiaries that linked by capital and therefore interdependent are.

Differentiation from the nesting company

A nesting company is when a corporation has a significant stake in another corporation, at least 10%. The special feature is that the subsidiary's income and capital are not subject to double taxation. Because the share value of the parent company in the nesting company is no longer subject to trade tax and corporation tax.

Advantages and disadvantages of a subsidiary

Subsidiaries have some advantages, but also disadvantages, in relation to the parent company.

Advantages of a subsidiary:

  • By outsourcing a company division in the form of a subsidiary, innovations are promoted more strongly.
  • Legal independence from the parent company
  • Concentration of the parent company on core competencies, which among other things can strengthen competitiveness and optimize costs.
  • Improved flexibility for both the parent company and the subsidiary
  • Even distribution of economic and financial risks
  • Better distribution of the tax burden
  • If it is a subsidiary abroad, the subsidiary offers a better opportunity to integrate into the international corporate strategy compared to other forms of company.
  • Another advantage of a subsidiary is that the outflow of know-how from the parent company is limited or prevented.

Disadvantages of a subsidiary:

  • Economic dependence on the parent company
  • Possible conflicts of interest between the subsidiary and the parent company
  • Long start-up time of 10 to 12 years
  • High financial and organizational effort until the first successes can be seen

Practice questions