When Does It Make Sense to Open a Local Subsidiary?

What is a subsidiary company?

The definition of a subsidiary is a company whose ownership is retained and controlled by a parent company. A subsidiary may also be referred to as a subsidiary company or a daughter company, while the parent company is otherwise known as a holding company. In more technical terms, for the parent to hold a controlling interest in the subsidiary company, it has to have at least 50 percent control of its stock. 

A subsidiary is a separate legal entity to its parent for tax, regulation, and liability purposes. However, the parent benefits from the subsidiary by enabling it to perform functions related to the business they are operating (e.g., manufacturing components needed to produce the goods sold). 

Things to consider when opening a local subsidiary

Locations of employees are specified

First, you must specify the locations of your employees. If your company has employees scattered and severely varied all over the world, then opening a foreign subsidiary may not be the best choice for you. The rule of thumb states that there should be five employees in the same location to consider opening a local subsidiary office there. (READ: How to pay out your remote employees?)

Investors and lenders are in full support of the decision

Second, it must also be made sure that your company’s investors and lenders are in full support of this hefty move. It makes no sense to hide such a huge decision from the people who will provide your company the finances you will need to buy a lot, construct an office, and generally set up a subsidiary company. Being transparent and open to your investors and lenders will also lessen the chance of cultivating conflict among the parties involved in your company.

‍Tangible and intangible aspects to be transferred to the subsidiary are considered

Third, you will also need to consider the tangible and intangible aspects that will be transferred from your company to the subsidiary corporation. A significant portion of aspects like responsibilities, assets, and liabilities will obviously be fetched to the new business entity. Estimate how much of these aspects will be needed to let the subsidiary functionally operate, and determine whether you have enough of these to still manage both entities well. For instance, to let the subsidiary get started with your business operations, a chunk of your working capital will be necessitated. Whether you have enough capital should be well thought about. This is also one of the many reasons why opening a local subsidiary is such a significant move—most subsidiary companies are set up only by the most valuable corporations. A corporation only decides to expand if it has the means to do so. 

‍Benefits and Drawbacks of Opening a Local Subsidiary

Every business venture will have corresponding benefits and drawbacks. How these drawbacks will be mitigated may determine the future of the company. But before that, listing the pros and cons of opening a subsidiary will totally get the mitigation process going. Below is a table that details the pros and cons of opening a local subsidiary.‍

Pros

• Company may only be subject to taxes in corresponding state or country
• Losses can be contained and limited
• Diffusing your company’s business geographically may make it easier to sell and establish your services
• Interaction and engagement among corporate divisions and subsidiaries may lead the company to success

Cons

• More burden is given to the accounting and legal teams
• Bureaucracy and control are greater
• Parent company is liable for the subsidiary’s contingencies, including its debts
• Financial statements are an added burden

A good number of companies has proven just how effective opening a local subsidiary is. For example, Berkshire Hathaway’s acquisition of many diverse firms is a strategy related to buying undervalued assets and holding onto them until they succeed. While Berkshire Hathaway acquires these subsidiaries, they can still operate independently while gaining access to a much broader financial resource. Now, Berkshire owns more than 270 subsidiaries.

Alphabet Inc. also owns many subsidiaries that perform unique operations and add value to the parent company through diversification, revenue, earnings, and research and development. One subsidiary of Alphabet is the Sidewalk Labs, a startup that aims to modernize public transit in the United States. It provides Alphabet with a business unit that develops technology that will eventually help the entire company.

Moving Forward

A sense of teamwork, collaboration, and partnership toward goals can be evident in just investing in a local subsidiary. As a parent company, it is your job to nurture and develop your daughter's company in hopes that it will one day help you get back on your feet when things go upside down. 

A company could have a plethora of reasons when they decide to open a local subsidiary. It could expand their market, limit and contain the losses, or increase engagement among company employees. Whatever these reasons are, it is always important to assess the risks, the costs and potential, and determine the best possible move for your company.

Frequently Asked Questions

What are subsidiary accounts?

Subsidiary accounts are accounts that are kept within the subsidiary’s ledger. The ledger then summarizes the subsidiary accounts into a control account in the general ledger. Subsidiary accounts are used to track data at a particular level for certain types of transactions like accounts receivable and accounts payable. 

What is a subsidiary ledger?

A subsidiary ledger or a subledger is a group of similar accounts that have their combined balances equal to the balance indicated in a specific general ledger account. The general ledger account that summarizes a subsidiary ledger's account balances is called a control account or a master account. A subsidiary ledger should provide details behind entries in the general ledger used in accounting. 

What is subsidiary cooperative?

A subsidiary cooperative is any organization that has the majority of its membership or shareholders come from a cooperative. It receives technical, managerial, and financial assistance from a cooperative. 

Why do companies create subsidiaries?

As previously pointed out, creating subsidiaries is a significant decision by any company. Some decline the idea but some push through anyway. The reasons why some companies make subsidiaries include the following: 

• Recognition. Companies create subsidiaries to establish goodwill and healthy relationships with their customers. A subsidiary company can help its parent company be positioned to attract more customers by expanding its market. Of course, all of these just depend on how the parent company utilizes the subsidiary. 
• Raise Capital. A subsidiary makes it more efficient for the parent company to offer stock in a portion of the company and does not affect the parent company in whatever ways. Startups, which is the current state of the subsidiary, find it easier to raise funds for the company by holding an initial public offering. This is also done to cash out some of the primary investors’ personal investments. The parent company may find it more difficult to raise capital for a new venture so it is utilized to achieve exactly the same goal. 
• Increased Engagement. Creating a subsidiary requires hiring new employees and expanding the talent pool in the workforce. Engagement and interaction among corporate divisions and subsidiaries will also be a byproduct, and will increase the corporation’s chances of success. 

What are the advantages of a subsidiary company? 

• Tax Deduction. The tax liability of the parent company will be substantially reduced through deductions allowed by the state. 
• Risk Reduction. The framework and dynamics at which a parent company and its subsidiary operate mitigate the risk and reduce vulnerability because this creates a separation of legal entities. If the subsidiary is bankrupt, the obligations will be assigned to the holding company once it is proven that both companies are legally the same. 
• Increased Efficiency. Opening a subsidiary company will also result in higher efficiency for the parent company. This is because the once enormous company is split into smaller and more manageable subsidiaries. 

How to create a subsidiary company in South Africa? 

According to Corporate Finance Institute, foreign nationals who look into setting up a subsidiary in South Africa will need to prepare 2.5 million South African Rands (165,868.75 United States Dollars) as an investment to the company. These funds must first be in your existing bank accounts and eventually transferred to a South Africa bank. You will also need to submit proof that your company has South African employees working for your company for more than six months already. The following steps are then followed: 

1. To register your company, Articles of Incorporation should be filed. 
2. A Memorandum of Incorporation should be completed. 
3. A Notice of Incorporation should be accomplished. 
4. A bank in South Africa should be opened. 
5. The company should have itself registered for VAT and other taxes. 
6. Unemployment insurance should be filed with the Department of Labor. 
7. The company should be registered for Occupational Injuries and Diseases Compensation. 
8. The company should apply with the District Council. 
9. (OPTIONAL) The company reserves a company name. This is not necessary as the Companies Act of 2008 states that a company can register with or without a name, so the registration number becomes the company name. 
   

What are the features of a subsidiary company? 

A subsidiary company operates as a unique, separate, and distinct corporation to the parent or holding company. Therefore, they have the authority to perform, but not limited to, the following:

• Enter into contracts. 
• Sue and be sued. 
• Own assets. 
• Remit federal and state taxes. 
• Borrow money from financial institutions and their parent company. 

What are the Best Buy subsidiaries? 

Best Buy is am American multinational consumer electronics retailer headquartered in Richfield, Minnesota.The subsidiaries it owns includes Best Buy Mobile, Geek Squad, Magnolia Home Theater, and Pacific Sales.

Do you need to register a subsidiary company? 

Not necessarily. The registration of the subsidiary company is a decision that rests in the business owner or the parent company. This is because subsidiaries are not legally required to be incorporated. In other words, the incorporation of the subsidiary as a legally separate entity is dependent on how the parent company is utilizing it.