Definition of subsidiary: a company which is primarily owned by another company, rather than external shareholders.
What is a subsidiary?
A subsidiary is a descriptive term for a company in a corporate group, which isn’t the parent company at the very top of the organisational structure.
A typical group structure sees shareholders buy shares in a listed parent company which trades on a stock exchange.
Let’s look at Domino’s Pizza Group PLC.
However, this is a parent company doesn’t necessarily perform all the activities and business of the group.
- Domino’s Pizza Group PLC owns a company called DPG Holdings Ltd, a private limited company which acts as an intermediate holding company.
- DPG Holdings Ltd, in turn, owns Domino’s Pizza UK & Ireland Ltd, a company which reported a turnover of £436m in 2019.
- Domino’s Pizza UK & Ireland Ltd is clearly one of the main trading arms of the Domino’s UK group, and due to its position in the group structure under the parent company, it is classed as a subsidiary.
Quick note: 51% or more of a companys shares must be owned by another company for it to be classed as a subsidiary. Subsidiaries which are 100% owned by another company are known as ‘wholly-owned subsidiaries’.
Why do groups use subsidiaries?
Companies operate in groups with a parent and subsidiaries for several reasons:
Bolt-on acquisitions. When a company acquires another business, this is usually done by buying the shares of the company. This has the effect of bringing the acquired business into the group as a new subsidiary. Therefore highly acquisitive groups may have tens or hundreds of subsidiaries resulting from a history of purchases.
Limiting liability. By trading through various subsidiaries, a group can insulate itself against a serious financial loss (such as an environmental disaster, a class-action lawsuit from the workforce, or a collapsed pension scheme). This is because creditors can usually only pursue the subsidiary itself for assets during the bankruptcy process, and not the wider group.
Ease of sale. Keeping discrete parts of a conglomerate packaged up inside separate legal entities makes it much simpler to sell those businesses. This can be done by transferring the shares in the subsidiary to the new owner.
In practice, groups become very integrated in other ways, such as the use of a shared IT and accounting system and centralisation of functions such as human resource and property management.
However, in principle, it’s still much neater to structure a transaction where all the acquirer needs to do is purchase a single subsidiary.
If a group operated several businesses from a single company, the sale & purchase agreement would have to go into intricate detail as to which parts the acquirer is and isn’t actually buying.
How is the word subsidiary used in a sentence?
“The results of the parent company and its subsidiaries are included in these group financial statements.”
“The subsidiary of xyz plc has ceased trading and bankruptcy proceedings have already begun.”
“The two joint venture partners formed a subsidiary to carry out the activities of the partnership.”
How can you find out whether a company is a subsidiary?
The quickest way to find out if a company is a subsidiary is to read its financial statements.
Under relevant GAAP and company rules, a company must disclose both its immediate parent (i.e. the entity which holds its shares) and its ultimate parent (i.e. the entity which sits at the very top of the group structure).
This can be found usually at the very back of the statutory financial statements, which you can download from the Companies House website.
Here’s an example of the note in the accounts of Domino’s Pizza UK & Ireland Ltd:
How does the definition of subsidiary relate to investing?
Investors should be aware that when shares in a listed company are purchased, the investor is effectively gaining partial control of an entire group of companies, and not just the parent company.
Investment books will explain that in evaluating the value of a company, investors should perform research on the activities, governance, management and financial position of a business.
This may involve looking at the balance sheet of subsidiaries to measure the assets and liabilities. Do some of the subsidiaries have borrowings which exceed their fixed assets and current assets, for example.
These can be warning signs that a subsidiary is too thinly capitalised to be resilient in poor trading conditions.
A group of companies are managed as one, and therefore you will see that subsidiaries often lend funds to others to ensure that all companies remain solvent. Therefore it’s the consolidated position of the entire group which is most relevant when calculating financial ratios.
Investing courses can provide further information on this interesting topic.