A holding or parent company may choose to expand their business operations or more evenly distribute risk by setting up subsidiary companies. Importantly, a parent company and its subsidiaries are separate entities. Below, we set out four features of parent companies including operations and management structure, to better understand how these two structures differ from one another.
The parent company creates and either wholly or owns by majority its subsidiaries. As mentioned, a parent typically forms or purchases a subsidiary to expand its business operations or diversify its liabilities. Although the subsidiary may operate to broaden existing services, it may also engage in new lines of business. As such, the subsidiary’s products or services may be entirely different and unrelated to its parent company.
2. Management Structure
As a sole or majority shareholder, the parent elects the subsidiary’s board of directors and organises its management structure. It is also responsible for deciding the subsidiary’s bylaws and establishing the rules for its corporate governance. The parent company may choose to withdraw from managing day-to-day operations, and by selecting a strong management team. This would allow the subsidiary to operate with some level of independence.
The parent company typically maintains financial control, although the subsidiary benefits in turn with increased access to funding sources and a reduction in expense costs. The degree of control the parent company chooses to exert will determine a subsidiary’s level of independence.
The parent corporation can delegate more power to the subsidiary’s management team to provide for increased autonomy, allowing the subsidiary to hire employees, report its financials separately, and conduct its business operations as an independent entity. Providing independence to a subsidiary is a protective measure the parent company implements and is not intended to remove its ability to exercise control.
Independent operations aim to prevent stakeholders from treating the entities as one company, diffusing potential liability issues for the parent. For transparency purposes, a parent company will clearly define the financial and operational delegations of authority at the outset.
Though there is an ownership-based relationship, both the parent and subsidiary company are separate entities and legally independent of one another. As a result, parent companies and their shareholders are not usually liable for the debts or actions of their subsidiaries. Conglomerates may use this liability shield to create a corporate structure which spreads assets amongst affiliates, reducing the risk of a creditor reaching all of the parent corporation’s assets.
Under common law, however, a court may ‘pierce the corporate veil’, casting aside the separate legal personality of the entities to hold the parent accountable in instances where it has attempted to frustrate or evade its legal obligations. Exceptions to the separate legal entity doctrine occur where there is an appearance of impropriety on the part of the parent company or if it has engaged in unfair or fraudulent conduct. The parent company’s actions determine its liability (e.g. whether it has engaged the subsidiary to escape corporate liability).
If you are considering expanding your business’ activities and setting up a subsidiary company, get in touch with our business structuring specialists on 1300 544 755.