Subsidiaries: The Next Step In Your Expansion Plans?

  • By Susan Burns
  • 13 Apr, 2016

One of the ways to expand your small business that reaps huge benefits, while minimizing risks, is by adding a subsidiary.  

A parent–subsidiary structure provides liability protection, tax benefits, and facilitates future business plans. It could be the best next step for you.

What is a subsidiary?

A subsidiary is a legally separated business that is fully owned, and controlled by another company, usually referred to as the "parent" company. The parent company is the sole shareholder, or owner, of the subsidiary company.  

Why establish a subsidiary?

Legal protection and tax benefits are two good reasons to create a subsidiary. Other reasons, more fully developed below, include using a subsidiary to penetrate a market or launch a product line. Sometimes it is a smart vehicle for focused development on one specific, segregated aspect of the business, but not all of it. There may also be future plans of selling a portion of the business, or distributing different segments of the company among family members. Or, the company may have a higher risk of being sued, due to the nature of the business, and operating part of the business via a subsidiary can minimize that risk. All of these instances may justify the creation of a subsidiary.  

There are costs involved in the creation of a subsidiary, so it is typically best to do so only when those costs are minimal as compared with the resulting tax relief and other benefits.  

How does a subsidiary operate?

A subsidiary operates independently while being under the control of the parent company. As a separate entity, the subsidiary has its own board of directors and officers that manage the day-to-day operations. But, the parent company has the power to modify the board at any given time, due to the fact that it’s the only stockholder, which effectively gives it control.  

By being a separate entity from its parent, a subsidiary can be taxed, regulated, and held liable individually. That’s what makes subsidiaries such an interesting option for growing companies.    

The subsidiary is accountable to its parent company. The parent company has the legal right to have access to the subsidiary’s business plans and financial data, in order to regulate its progress, and protect the interests of the subsidiary and the parent company.

Advantages of creating a subsidiary

One of the main advantages of creating a subsidiary is the possibility to test new markets or new product lines without jeopardizing the assets and credit record of the parent company. 

In the same line of thought, if that new product line or market isn’t as profitable as expected, having a subsidiary facilitates the selling of that portion of the company. And, if it is necessary for the subsidiary to seek creditor relief under the bankruptcy laws, its creditors wouldn’t be able to go after the parent company’s assets. 

Now, let’s consider the opposite (and more positive) scenario, in which the subsidiary actually becomes profitable for the parent company. The parent then starts to receive dividends from the subsidiary, which can be used to fund the parent company and facilitate parent company growth. 

Another advantage of the parent-subsidiary structure is the possibility of having local management teams instead of a centralized management structure. This allows the parent to have better control over the subsidiary day-to-day operations such as hiring personnel, credit options, and marketing decisions, and facilitates the implementation of corporate-wide procedures and strategies.

And finally, the main reason companies consider creating a subsidiary is the tax benefits derived from its structure. When filing federal income tax returns, the parent company can file a consolidated tax return, and include profits and losses from the parent company, as well as its subsidiaries. That way, total profits of the parent can be offset by the total losses, and the company pays less in federal income taxes.  

Also, some states allow subsidiaries to file tax returns only on the profits generated within that specific state, and not those generated in other locations. The same may be applicable for the profits of international subsidiaries, which will not pay income taxes in the U.S. but might do so at a significantly lower rate in the country where they’re located. In case of international subsidiaries, however, caution is warranted because   regulations regarding taxation of parent-subsidiary foreign income can change rapidly.  

Steps to creating a subsidiary

You will, of course, want to be guided by an experienced CPA, attorney, and business advisor, but once the decision is made, creating a subsidiary is not complicated. Basically, the steps are: 

  1. Decide on where to set up your subsidiary.

  2. Create the new company. Follow the state or country’s laws to create the subsidiary. It can typically be a limited liability company or a corporation structure.

  3. Allocate assets and liabilities. As in any other business, all the necessary pieces must be put in place, before starting operations: capital contribution, inventory, machinery, accounts payable, accounts receivable, and so on. 

  4. Create the subsidiary’s bylaws. Include that any changes to the bylaws are prohibited without permission of the parent company, as the sole owner; and that only the parent company can create or make any changes to the subsidiary’s board. 

  5. Create the board of directors. The board should be very clear that the subsidiary is operated as an independent company, under the parent’s control. 

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Having a subsidiary can bring many benefits to the parent company. It’s the best way to test the waters on new lines of business, new locations, and generate revenue while preventing possible legal liabilities, and financial damage. If you’ve been incubating several new ideas but aren’t sure of their marketability, maybe it's time to consider dipping your toe in the water by launching a subsidiary.


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By Susan Burns 26 Oct, 2017
P.S. There has been a lot of discussion on social media about my post on reading fine print  when installing apps, specifically focused on the Grammarly app. Some people have responded with the interpretation that Grammarly can only use your content to correct your grammar and not for anything else.

I disagree. This is not a correct interpretation, in my opinion.

Even though that interpretation may be based on a provision in the TOS that states you keep ownership of
your content, they still have an unlimited, perpetual, royalty-free right to use it. I won’t repeat the prior
post, but do urge you to read it .

Others have suggested that Grammarly’s TOS are typical of SaaS (software as a service) agreements and,
somehow, that makes it okay. The TOS may be similar, but the products aren’t. Grammarly, in my
experience, crawls through everything you type. Everything.

The other argument proposed by someone is that because this is typical SaaS language, they don’t really
mean that they are going to use your content. Really? Then say so in a clearly-drafted, user-friendly
contract a/k/a TOS.

I have not heard of someone successfully arguing in court that even though they agreed to a license of
their product, they didn’t think the person was really going to use it … and therefore, they shouldn’t be
allowed to use it. If you know of such a case, send it my way.

Again, legal ethics prohibit me from using the service. That aside, I don’t choose to give Grammarly
access to everything I type.

As one person put it, “everything ever typed on the computer, so while it runs in the background, it
gathers password, credit card data, shopping habits, text conversations from Facebook, messenger
services, anything you do... recorded and stored.”

Finally, my posts are my opinion and my legal analysis. I am not your lawyer. And, I am not telling you
what to do.

One of my major focus points with clients is clarity. Fabulous decisions come from clarity. Make a
decision that’s right for you.

I love a great discussion! Keep the comments coming.

MSB
By Susan Burns 24 Oct, 2017

Recently I was engaged in a Facebook exchange among a group of successful business women. Someone asked for opinions on using Grammarly—an app that is marketed as “A FREE, ACCURATE GRAMMAR CHECKER BUILT FOR EVERYONE.”  

The comments started rolling in: “love it!” “best thing I have used in a long time.” “Cuts my writing time significantly.” And more like that.

I actually had installed the free app a few weeks before to give it a test run. I found it to be a nuisance because that little app was popping up and sticking its grammar-nose in every single thing I wrote. My emails. My blog posts. My word documents. That spelled danger to me, and I immediately deleted it.

My curiosity piqued, I checked the Terms of Service (which, admittedly, I should have done first). Here is what I found:

By uploading or entering any User Content, you give Grammarly (and those it works with) a nonexclusive, worldwide, royalty-free and fully-paid, transferable and sublicensable, perpetual, and irrevocable license to copy, store and use your User Content (and, if you are an Authorized User, your Enterprise Subscriber’s User Content) in connection with the provision of the Software and the Services and to improve the algorithms underlying the Software and the Services. (emphasis added)

Here's what you need to know:

  • Grammarly, Inc. is a Delaware corporation. They include in the definition of “Grammarly” not only the corporation, but also all of its subsidiaries AND other affiliates.
  • The definition of “Software” is “the software.
  • The definition of “Services” is … wait for it … “services.” 
  • And, although it is poorly drafted, it seems to be attempting to include any future Software and Services provided by Grammarly, which you recall also means any subsidiary or affiliate.

What does this mean for you?

It means that if you install Grammarly, whether it’s a free service or a paid service, you are specifically giving an unlimited perpetual license to your content to Grammarly and any company they affiliate with and any of their subsidiaries basically for any service they provide now and decide to use in the future.

That means that if you use Grammarly, instead of your own brain or a copy editor, you are no longer the exclusive owner of your content. That means they can republish, provide to third party affiliates, and use your data and materials any way they see fit.

The bottom line is that Grammarly has access to—and the unlimited, forever—right to use your content. Period.

And, once you install Grammarly, it is everywhere . It pops up in every document you create. Every. Single. One. If you don’t believe me, try it yourself.

Of course, lawyers and other professionals with a confidentiality responsibility to their clients are ethically prohibited from using Grammarly. (And, I hope they read the fine print.) But even if you don’t have an ethical responsibility to keep information confidential, do you really want to give up the right to your content?

Think about it! And next time, read the fine print. … or call me, and I’ll read it for you.


​*This post has been updated here .

By Susan Burns 28 Feb, 2017

The driverless car industry is hot and super-competitive. That’s a given. Here’s what’s not hot if you are Waymo, the self-driving car business that was spun out of Google’s parent company:

By Susan Burns 19 Feb, 2017

Recently, there was a trademark spat between Adidas and Tesla. The story piqued my interest because   the big players make mistakes that are instructive for small businesses (only on a grander scale)—and because it illustrates the importance of brand identity and underscores why it’s smart to register your mark.

In a nutshell, here’s what happened: Tesla filed with the US Patent and Trademark Office (USPTO) to register its Model 3, three-bar logo as a trademark. If the registration had been for the purpose of using the mark on a car, there would not have been a problem. BUT, Tesla registered to use its three-bar “E” on clothing. Adidas, a company known for rigorous policing of its brand identity, challenged Tesla’s right to register the mark as confusingly similar to the Adidas three-bar logo. Tesla withdrew its application. Adidas protected its three-bar brand identity.
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