Subsidiary Companies - Pulling the Strings or Bearing the Burden?
The word 'subsidiary' to most conjures up images of huge international conglomerates with subsidiaries across the globe, such as the Mars Group. While multi-nationals often use the group company model, the reality is that a group company can have useful applications closer to home.
What is a group company?
Ask an accountant and a solicitor this question, and you will often get two very different answers.
In law, the relationship is a question of control. Where one company (the 'holding' company) holds or controls the majority of the voting rights in another, or controls the board of directors, such a company is called a 'subsidiary', and the two together, a 'group'. The most obvious scenario is one company holding 51% of the shares in another. However, this is not always the case - a shareholders agreement granting a minority corporate shareholder enhanced voting rights or the right to control the majority of the board, could render the company in question a subsidiary of the other.
Therefore, provided that there is the relevant degree of control, it is possible that a holding company may be smaller than its subsidiary - or that they may compete, as Hewlett Packard does with it's subsidiary, Compaq. It is also possible for a holding company to have several generations of subsidiaries, each with their own controlling interest in several others.
Although it follows a similar 'control' principle, accounting and tax requirements for Group companies depend on the type of company and size of the group. The general view is that a group company structure is more tax-efficient than several divisions of one large company - however advice should always be sought from a qualified accountant or tax adviser.
What's in it for my business?
As a subsidiary is a separate legal entity from its holding company, there is a separation of legal liability between them. The obligations of one are distinct from the other, and a subsidiary may borrow money or even issue its own debt. Therefore, if an established company wishes to branch out into a risky new venture, it may do so without jeopardising its established business.
A company may feel that a new brand is at odds with its image, and using the subsidiary model will give it a marketing advantage.
In some cases, the Articles of Association of a holding company - it's constitutional document - may prevent it from undertaking certain activities. Indeed, many older companies are bound by restrictive objects clauses, which are difficult to amend, and forming a subsidiary, with unrestricted objects is a more straightforward procedure. Charities are a prime example - many are prohibited from trading by their constitution, so a trading 'arm' in the form of a subsidiary, allows it to trade and generate income, without falling foul with the Charities Commission.
Where a subsidiary runs into financial trouble, creditors of a subsidiary often look to the holding company for compensation. Where a subsidiary is formed purely as a façade to enable the evasion of a pre-existing liability, the courts will allow the holding company to be sued.
However, generally speaking, a holding company is protected against claims from creditors or third parties, made against its subsidiary. Two important issues arise from this principle: if you are the holding company, form your subsidiary before you undertake any risk; if you are dealing with a subsidiary, ensure you enter into an agreement with the holding company whereby they are liable for the debts or actions of their subsidiary.
How do I form a Subsidiary?
If you are forming a new subsidiary, your first step is to incorporate the company with Companies House, or via a formation agent. This can be done quickly and cheaply. It is then sensible to issue shares to the holding company, and to draw up an agreement setting out the relationship between the two companies.
For example, will the subsidiary licence any trademarks/patents from the holding company? Will it pay rent for the shared use of any premises? If investors are buying shares in the subsidiary, who will be responsible for appointing directors? Is the subsidiary permitted to compete with holding company, or is it restricted to a certain territory? Does the holding company agree to guarantee any debts? Is there a limit to the level of debt that the subsidiary may incur? Can employees of one company work for the other?
Alternatively, the holding/subsidiary company model may be used where two companies propose to merge. In this case, where one of the companies has a reputation in the market, it makes sense to preserve that reputation by allowing the parent to remain an independent legal entity. It may be more economical to acquire a controlling interest than to merge and there is likely to be less administration involved. Lastly, the regulatory burden associated with the transfer of employees can be avoided where the employees continue to be employed by the subsidiary.
When managed properly, subsidiaries are an excellent way to branch out and try something different or reach a new market, without risking it all - whether you are a multinational in Boston or a small company in Bristol.
The above is a brief overview and is no substitute for legal advice. For more information call Marti Burgess on 0117 945 3042 or email mburgess@metcalfes.co.uk to discuss matters further.
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Tony Forster Head of Company Commercial
Martino Burgess Associate
Natasha Bliss Associate
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This article summarises areas of law on issues we believe may be of use to you. It is provided for information only. It is not a comprehensive review of the subject. It does not constitute legal advice. Accordingly, it is published without responsibility for any loss arising from any action taken or not taken as a result of it.