How to Create a Subsidiary Company

In the dynamic business world, companies often seek opportunities to expand their operations and enter new markets. One effective strategy to achieve this is by establishing a subsidiary company.

To expand internationally, companies may have to set up subsidiaries in different locations. These entities, referred to as foreign subsidiaries, work as extensions of the parent company in other countries and are a vital component of multinational business strategies.

Due to several cultural, legal, and taxation differences, managing these foreign subsidiaries presents unique challenges. A basic understanding of why and how to establish a subsidiary can help put smaller pieces of knowledge into perspective.

Here, you will learn what a subsidiary company is, how to form one, reasons why companies opt for this approach, and more.

What is a Subsidiary Company?

A subsidiary company is a distinct legal entity partially or wholly owned by another company, referred to as the parent company or holding company. This means that the parent company has a controlling interest in the subsidiary, giving it the authority to make crucial decisions and exercise control over its operations. However, the subsidiary maintains its separate identity, distinct from the parent company.

Subsidiary companies are formed for various strategic reasons, including but not limited to expanding into new markets, diversifying business operations, limiting liability, and optimizing tax benefits. It's important to understand that a subsidiary operates independently to a certain extent, but the parent company can ultimately influence its actions and decisions.

Why do Companies Set up Subsidiaries?

Companies establish subsidiaries for various strategic reasons, aiming to expand their operations, diversify their portfolios, and tap into new markets. 

Diversification of Business Operations

Companies may choose to establish subsidiary companies to diversify their business operations. A parent company can diversify and reduce its dependency on a single business segment by venturing into new markets or industries. This can be a proactive strategy to adapt to changing market conditions and seize growth opportunities.

Market Expansion

One of the primary motivations for creating a subsidiary is to expand into new geographical markets. Entering foreign markets can be complex due to regulatory and cultural differences. Setting a foreign subsidiary allows the parent company to navigate these challenges more effectively while maintaining control over its international operations.

Liability Limitation

By creating subsidiary companies, the parent company can limit its liability. If the subsidiary encounters legal or financial issues, the liability is typically confined to the subsidiary's assets, protecting the parent company's assets from potential legal claims or creditors.

Tax Benefits

Tax considerations often play a significant role in creating a subsidiary. Companies can use subsidiary structures to optimize their tax liabilities, taking advantage of favorable tax rates or deductions available in specific regions. However, different jurisdictions offer various tax incentives and advantages.

The Pros and Cons of Creating a Subsidiary

Before diving into forming a subsidiary company, it's essential to weigh the advantages and disadvantages of this business strategy.

Pros

Risk Isolation: 

One of the most significant benefits of establishing a subsidiary is that it shields the parent company's assets from the subsidiary's liabilities and risks. This separation can protect the parent company's financial stability and provide opportunities for strategic growth.

Operational Autonomy: 

Subsidiaries typically have a certain level of operational independence. This can be advantageous when dealing with local market nuances, regulations, and customer preferences.

Tax Optimization: 

As mentioned earlier, subsidiaries can be used to optimize tax liabilities, potentially leading to significant cost savings for the parent company.

Market Entry: 

Subsidiaries facilitate entry into new markets, allowing the parent company to test the waters without fully committing its resources.

Cons

Complexity: 

Establishing and managing subsidiary companies can be complex and resource-intensive. It requires adherence to various legal, financial, and regulatory requirements.

Control Challenges: 

While subsidiaries have operational autonomy to a certain extent, the parent company must balance maintaining control and allowing the subsidiary to operate effectively. This can sometimes lead to conflicts.

Costs: 

The initial setup and ongoing management of subsidiaries come with costs, including legal fees, administrative expenses, and compliance costs.

Regulatory Compliance: 

Subsidiaries must comply with the regulations of the jurisdictions in which they operate. Staying abreast of changing regulations can be challenging.

Cultural and Market Differences: 

Companies expanding into foreign markets may encounter cultural differences, language barriers, and unique market dynamics, which can pose challenges.

Steps in Creating a Subsidiary Company

Now that we've explored the rationale behind forming a subsidiary and considered its pros and cons, let's go over the step-by-step process of creating a subsidiary company.

1. Market Research and Planning

Before getting on to the subsidiary creation process:

1. Conduct thorough market research.
2. Identify the target market, assess its potential, and evaluate competition.
3. Develop a comprehensive business plan that outlines your goals, strategies, and financial projections.

2. Legal Structure and Registration

Choose the legal structure for your subsidiary. This decision depends on factors such as the nature of your business, jurisdiction, and regulatory requirements. Common legal structures for subsidiaries include limited liability companies (LLCs), corporations, and partnerships.

Register your subsidiary in compliance with the laws and regulations of the jurisdiction where it will operate. This process often involves filing documents with the relevant government authorities, obtaining licenses, and adhering to local business requirements.

3. Funding and Capitalization

Determine how you will finance your subsidiary. Will the parent company provide capital, or will you seek external funding? Ensure the subsidiary is adequately capitalized to cover startup costs and initial operating expenses.

4. Business Contracts and Agreements

Draft essential legal documents, including articles of incorporation or organization, bylaws, and operating agreements, depending on the chosen legal structure. Additionally, consider shareholder agreements, if applicable. These documents outline ownership, governance, and operational details.

5. Board of Directors and Governance

Appoint a board of directors or managers to oversee the subsidiary's operations. Ensure the governance structure aligns with the jurisdiction's legal requirements and the parent company's corporate governance principles.

6. Financial Management and Reporting

Establish robust financial management systems for the subsidiary. Implement accounting and reporting practices that comply with local regulations and the parent company's financial standards. Consider integrating financial reporting systems with the parent company for transparency and oversight.

7. Human Resources and Staffing

Recruit and hire the necessary staff to operate the subsidiary successfully. Ensure that the hiring process complies with local labor laws and regulations. Provide employee training as needed and consider HR policies and benefits packages.

8. Operational Setup

Set up the physical infrastructure and operational processes required for the subsidiary to function efficiently. This includes securing office space, IT infrastructure, and equipment or machinery.

9. Compliance and Regulatory Requirements

Stay informed about local and international regulations for your subsidiary's operations. Comply with taxation, licensing, environmental, and industry-specific regulations.

10. Risk Management and Insurance

Assess the potential risks associated with the subsidiary's operations and implement risk management strategies. Adequate insurance coverage is essential to protect against unforeseen events and liabilities.

12. Monitoring and Reporting

Implement reporting mechanisms to monitor the subsidiary's performance, financial health, and compliance with legal and regulatory requirements. Regularly review financial statements and operational metrics to assess the subsidiary's progress.

13. Integration with the Parent Company

Maintain open lines of communication between the subsidiary and the parent company. Set up reporting, decision-making, and collaboration protocols to ensure alignment with the parent company's goals and strategies.

14. Review and Adapt

Periodically review the subsidiary's performance and strategic alignment. Be prepared to adapt and change your subsidiary's operations and strategies as market conditions evolve.

Manage Your Global Team with Skuad

Creating a subsidiary company is a strategic move that can offer various advantages to businesses seeking to expand their operations, diversify their portfolio, and enter new markets in different countries. However, the process is challenging, time-consuming, and expensive. It involves careful planning, compliance with legal and regulatory requirements, and ongoing management and oversight.

With Skuad, you don’t need to establish a subsidiary in the country you want to expand to. Skuad is an EOR (Employer of Record) platform that allows you to hire, onboard, and pay employees without setting up a local legal entity. Our unified platform allows you to expand your business and workforce while staying 100% compliant with local laws and regulations. Talk to our experts to learn more.

FAQs

What are the requirements for a subsidiary?

The specific requirements for a subsidiary vary depending on factors such as the jurisdiction in which it operates and its industry. Generally, you'll need to register the subsidiary, choose a legal structure, secure necessary licenses and permits, and comply with local tax and regulatory requirements.

Does a subsidiary need to be 100% owned?

No, a subsidiary must not be 100% owned by the parent company. Depending on the parent company's strategic objectives, they can be partially or wholly owned subsidiaries. In the case of a wholly-owned subsidiary, the parent company owns all of its shares. In contrast, in a partially owned subsidiary, the parent company holds a controlling interest but may have minority shareholders.