Subsidiary company: Meaning, how it works, pros & cons

The world of business is filled with thousands of varying practices aimed at increasing a company’s revenue while adding value to its activities. Most times a company can be created with varying objectives that are outrightly distinct, when this occurs, the company is likely to establish various corporations to meet up certain aspects of its objectives; such a company created to accomplish certain aspects of a company’s objectives is called a subsidiary company.

This article offers insight into all there is to know about a subsidiary company, its meaning, advantages, and others.

What is a subsidiary company?

A subsidiary company is controlled by another separate entity. The controlling company is called the parent company or the holding company. In Nigeria, for a parent company to classify as a holding entity to the subsidiary, such a company must hold over 50% of the subsidiary.

If the parent company owns 50% and above but not 100%, the subsidiary is said to be partially owned, if the holding company owns 100% of the shares of the subsidiary, the subsidiary is wholly-owned.

Understanding how subsidiaries work

In Nigeria and most international jurisdictions, a subsidiary company is regarded as a separate legal entity from its holding company. The subsidiary company can sue and be sued in its name, can own properties, go into business and others. It is also possible to have a subsidiary company registered as a public limited liability company and the parent registered as a private limited liability company and vice versa. 

This theory of the distinct legal personality of subsidiaries was reinstated in the case of Akinkugbe v. E.H (Nig) Ltd, where the courts held that in the eyes of the law, the subsidiary has a separate distinct personality from the parent company. Nonetheless, the Companies and Allied Matters Act 2020 provides for some instances where the theory of separate legal personality would not hold sway, one such instance is in the presentation of the financial statement of the companies. 

The mere ownership stake or cordial relationship between two or more companies is not evidence to prove a subsidiary relationship. According to CAMA 2020, for a subsidiary company to pass as such to a parent company, such a subsidiary company must fulfil the following:

a. The parent company is a member of the subsidiary company and controls the selection of the board of directors of the subsidiary company;

b. The parent company holds more than half of the shares of the subsidiary company; or

c. The parent company is a subsidiary of any company. 

Subsidiary Financial statements

One of the many exceptions to the theory of legal entity under CAMA 2020 is the subsidiary and the parent company’s financial statements. Both companies would not be treated as separate legal entities to prepare the financial statement. 

The financial statement is a statement of record of all the financial records of the company, which includes the company’s balance sheet, a five-year projection, the directors’ statement and others. 

For a subsidiary company, all subsidiaries create their varying financial statements and send them over to the parent company. The parent company would in turn have the financial statements consolidated into one single document which is referred to as the consolidated financial statement of the holding companies. For example, the Stanbic IBTC Group is a parent company to the Stanbic IBTC Bank, the Stanbic IBTC Insurance and the Stanbic IBTC trustees, each subsidiary will prepare their various financial statements and have them sent to the Stanbic IBTC Group for the creation of a consolidated financial statement.

If the parent company doesn’t own 50% and above of the other company’s shares, such would be classified as an associate company and not a subsidiary company. Associate company relationships do not need to have a consolidated financial statement. 

Pros and Cons of subsidiary companies

Pros of a subsidiary company

1. Reduced losses: The losses from the parent company are reduced or contained by having a subsidiary company. With the subsidiary running the business on behalf or under the supervision of the parent company while maintaining a separate legal entity for the subsidiary; in case a loss arises, the parent company can utilize the separate entity relationship to avoid recourse of liability on it. This invariably means the subsidiary would bear the loss made.
2. Flexible: the subsidiary company makes doing business with the parent company a flexible task. It allows the parent company to make significant decisions and control varying occurrences in the subsidiary company while remaining under the veil.
   
   For instance, the parent company can easily sell the subsidiary or convert the subsidiary to a public company and quote it on the stock exchange while remaining a private limited company itself. 

Cons of a subsidiary company

1. Complex financial statements: Generally all parent companies possess very complex financial statements. The financial statements could take up over 5 subsidiaries and parent company data, which can cause some form of clerical errors or skipped data. The process and time expended in creating the consolidated financial statements for the group can be very demanding.
2. Unnecessary bureaucracy: Having a parent company that controls a subsidiary’s every action can be a step to slowing down the progress of the subsidiary. The director would require permission to undertake every minute action; this can become excessively difficult in the long run.
   
   Also, the parent company can manoeuvre sales and business dealings of its subsidiaries. For instance, a parent company might refuse a subsidiary from doing business with other rival companies except for the parent company, even companies offering such services at a reduced price are excluded. 

Conclusion

The world of business is moving fast with detailed attention placed on identifying the best business practices that can aid additional profits in the long run. Companies have continued to support structures that allow them to thrive, make profits and seamlessly do business.

Subsidiary companies provide a means for the overall growth of revenue for the parent company while maintaining a separate legal status. This article provided all there is to know about the subsidiary companies.

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