Subsidiaries and Mergers – What Are They?

As a corporation grows and becomes more profitable, it may choose to buy up competitive businesses or a significant interest in another company’s shares and make the new acquisition a subsidiary company of the existing corporation. In this way, the buying company now controls either all or the majority of ownership in the purchased company and can therefore control the subsidiary and its future.

Subsidiary vs. Merger

Typically acquiring a firm as a subsidiary involves less of a financial investment by the corporation than if it were to buy a business and merge it with the existing operation. To merge with another company is quite distinct from creating a subsidiary, as a merger between two corporations is more like a marriage, but the union of the two must have the approval of stockholders, as they have the right to accept or disapprove the merger. Setting up a subsidiary lacks this requirement, so the head of a corporation may act with more authority in such an acquisition and go ahead without shareholders’ approval.

In addition, not all subsidiaries are in the same business sector as the acquiring corporation. Therefore, the parent company may not want the subsidiary to be so openly connected to its own operations. For example, a corporation that makes shoes might acquire a subsidiary company that manufactures socks. While the products are not entirely unrelated, they represent different areas of manufacture and retail.

Taxes

Another practical reason for large corporations (especially those that operate in the multinational arena) to create subsidiaries is the possibility of tax advantages. A subsidiary created in another country might be legible for tax breaks not available to a parent company.

Limited Liability

Subsidiaries are separate legal entities to the parent, so the parent corporation’s assets have no obligation to pay or support any debt or obligations the subsidiary may create. The focus of this advantage is that by creating a subsidiary, the parent company may undertake more financially risky ventures in its name without placing further obligations or risking the reputation of the existing corporation. Later, if and when a claim is made against a subsidiary, the parent corporation has no liability.

Another advantage inherent in acquiring or creating subsidiaries is that it is easier in the future to sell off part of the company without having to close the entire business. It also offers an opportunity to enter into new ventures and pay management of the subsidiary on a scale based upon the venture’s performance.