What is a Subsidiary?

A subsidiary company is a smaller company that is owned by a larger company, known as the parent or holding company. The parent company must own a majority share of the subsidiary's total capital in order for it to be considered a subsidiary. Companies that are 100% owned by the parent company are called "wholly owned subsidiaries."

Example of a Subsidiary

A subsidiary can be created when a company purchases or becomes the majority shareholder of another company. In this relationship, the parent company owns a controlling share of the subsidiary's stock or capital, giving it the power to control the subsidiary's activities and decisions. One well-known example of a holding company with subsidiaries is Berkshire Hathaway, chaired by Warren Buffett.

How a Subsidiary Works

Owning a subsidiary is different from a merger, as the acquired company remains a separate entity. A parent company can acquire a controlling share of another company with less capital than a merger would require, making it a subsidiary. Subsidiaries may operate in different industries from the parent company, as seen with Dairy Queen and GEICO, both owned by Berkshire Hathaway.

Accounting and Taxes With Subsidiaries

Corporations can file consolidated federal tax returns for a group of affiliated companies, consisting of a parent and subsidiaries. This may be done to offset the losses of one company with the profits of another. Some parent companies create subsidiaries to limit their liability, especially when operating overseas with lower tax rates.

Pros and Cons of a Subsidiary

There are benefits to owning a subsidiary, such as limiting risks to the parent company, potential tax advantages, and synergy with other group companies. However, there can also be drawbacks, including possible liabilities for the parent company, complex accounting and tax reporting, and less independence for subsidiary companies.

What It Means for Investors

Investors should research subsidiary companies before investing in a parent company to understand how they may impact financial performance. Subsidiaries can either contribute positively to a parent company's growth and revenue or have a negative effect on performance.