What is a Parent Company and How to Establish One?
11 November 2022
Companies frequently have a diverse range of assets, which may include other enterprises. The parent company is the most popular moniker for these enterprises, and they play an essential role in the corporate landscape. If you want to run your own business, reading up about what parent companies are, their examples, how they relate to their subsidiaries, etc. is important.
This article gives you a detailed insight into what a parent company is, how it works, its examples, importance, features types, what are subsidiaries and how it is different from a holding company. Read on!
What is a Parent Company?
A parent company owns a majority number of stakes in another company, which gives it control of the subsidiary’s operations and activities. Parent firms can choose to be actively involved or have a hands-off attitude as the owner of their subsidiaries. But they always maintain some level of control depending on how much managing power is assigned.
The majority of large corporations have at least one subsidiary. Parent firms are generally formed through mergers and acquisitions or spin-offs. To help improve the parent company’s structure, subsidiaries are integrated either vertically or horizontally.
How Do Parent Companies Work?
A parent company could be an aggregation of various unrelated companies. It can either create its subsidiary or buy existing companies. A parent company is not the same as a holding company. Parent corporations are capable of running their own business, unlike holding or shell companies which are formed to own several subsidiaries passively often for tax considerations.
Parent companies have a controlling or majority stake in the subsidiary company, which gives them the authority over the other company’s conduction and operations. Parent companies also have the option to be actively involved or practice a hand-off attitude in the management of their subsidiary.
Parent corporations and their subsidiaries may be horizontally integrated i.e. which indicates that the parent firm holds over multiple subsidiaries throughout its product or supply chain. They may also be vertically integrated i.e. all corporate entities have the same value level.
When a company holds enough stock or more than half of another company’s stock giving it the authority to oversee the other company’s activities it becomes a parent company and the latter company becomes a subsidiary company. As the majority stakeholder, it can control the operations and decisions of the subsidiary company. It holds the power to remove or appoint board members as well as determine how the company will conduct its operations.
Despite being the parent company the subsidiary is still a separate legal entity and retains few rights.
Management of the subsidiary by its own board of directors
The directors of the subsidiary company should make decisions that are in the best interests of their own company, not the parent firm
Subsidiary directors are subject to the same rules and regulations as any other corporation
Directors are not obligated to report to the parent company’s board of directors. While subsidiary company directors have the right to run the business as they see appropriate, the parent company has the authority to remove any of the directors if they are not satisfied with the performance
Parent firms have numerous options for controlling subsidiaries while giving them some independence. For example, a parent company can increase its control over a subsidiary firm by including various conditions in the Articles of Incorporation and limiting the power of the subsidiary in the company’s by-laws.
Why are Parent Companies Important?
A parent company structure can provide numerous advantages to both the parent company and the subsidiaries. a few of them are mentioned below:
The parent-subsidiary relationship can offer various marketing benefits for both the parent company and the subsidiary company. The subsidiaries benefit from a well-known existing company image and marketing.
2. Revenue Growth
Parent firms are entitled to receive a share of the profit earned by their subsidiary companies. These payments can enable a firm to boost its revenue through the operations of its subsidiaries.
3. Guidance by the Parent Company
By collaborating with a larger and more established company, subsidiaries can gain experience in different fields that could help them to run their company smoothly.
4. Liability is Reduced
A subsidiary business with its own board of directors is in charge of its own activities, which can safeguard the parent company from legal action. The parent company has no liability for the actions and operations of the company.
Features of a Parent Company
Features of the parent company are mentioned below:
The parent business establishes or acquires its subsidiary company to grow its business or diversify its liabilities. The subsidiary operates and expands its existing services and operations but it can also venture into new markets under the control of the parent company. So the products or services offered by the subsidiary company may be completely distinct and unconnected to those of its parent firm.
2. Structure of Management
The parent, as the majority shareholder in the subsidiary company, has the power to elect or fire the members of the board of directors and control its management structure. It also has the authority to change the by-laws and corporate governance regulations of the subsidiary company.
The parent firm normally retains financial control, but the subsidiary benefits from expanded access to capital sources and lowered expenses. The level of independence of a subsidiary is determined by the degree of control exercised by the parent firm.
In the parent-subsidiary relationship, the subsidiary company is a legally independent entity. As a result, parent firms and their stockholders are usually not accountable for the actions of the subsidiaries. A parent business will explicitly identify its financial and operational extent of authority when it takes control of the company to ensure transparency.
Types of Parent Companies
Parent corporations are classified into two types: holding businesses and investment firms.
1. Holding Company
A parent holding company is a firm that owns the outstanding stock of other companies. A holding company’s goal is to own shares in other companies in order to form a corporate group. It does not generate its own goods or services. A holding company is a parent company that has no other operation other than controlling the shares of its subsidiaries.
2. Investment Company
An investment company is a parent business that owns stock in other corporations for the purpose of investing rather than controlling them.
How to Become a Parent Company?
A corporation can become a parent company in a variety of ways. Mergers and acquisitions (M&A) or spin-offs are the most common.
•Merger and Acquisition
In acquisition a larger and more established firm owns a majority stake in a smaller company, gaining control. The companies can choose to become parent companies by acquisition with a desire to expand into new markets. A company can also buy the other company to thin out the competition or to acquire resources.
A firm can also become a parent firm by spinning off a portion of its own operations and forming a subsidiary. The spinned-off part may have a different management system and strategies from the parent company hence they become separate entities.
Examples of Parent Companies
Here are a few examples of parent companies to better understand the concept:
Alphabet was founded in 2015 by Google co-founders Larry Page and Sergey Brin. Page and Brin created Alphabet by condensing Google and incorporating firms focusing on certain industry areas, such as Life Sciences and Calico, under Alphabet.
Metais also an example of a parent company. After multiple high-level acquisitions over the years, like taking over Instagram and WhatsApp.
A holding company and a parent company are nearly identical. However, they do have some differences:
A parent company means a company that owns a controlling or majority stake in another company, giving it authority over the subsidiary’s operations.
Holding companies are relatively idle with their subsidiaries, serving merely as a shell to keep their subsidiary’s outstanding stock.
Because parent corporations have active influence over their subsidiaries, even if they are not hands-on and enable the subsidiary to handle its own operations, they cannot avoid liability in this manner.
A holding business does not manufacture or provide its own goods or services.
A parent company is a commercial entity that owns a majority stake in a smaller company. Becoming a parent company allows organisations to obtain access to new assets and tax advantages. They have the authority to control the management structure and the operations of the subsidiary company. However, the subsidiaries are independent entities with their own legal obligations and are liable for their own actions.
Q1. What are the subsidiaries of a parent corporation called?
Ans: A subsidiary is a company that is owned by another company, which is commonly referred to as the parent company or the holding company. The parent firm has a controlling interest in the subsidiary company, which means it owns or controls more than half of its stock.
Q2. How does a parent company function?
Ans: A parent company means that it operates by owning more than half of another company’s stock, giving them complete control over the subsidiary’s operations. The parent firm can opt to change a subsidiary’s present direction and mode of operation, or it can simply function as a hands-off manager.
Q3. What are the advantages of having a parent corporation?
Ans: Having a parent company provides advice for business management, resulting in a more stable business. The entrepreneur essentially has a success blueprint as well as access to skilled people who have a vested interest in her success.
Q4. Do parent firms have to pay taxes?
Ans: Most of the time, the parent business maintains control by being the sole shareholder or by establishing subsidiary bylaws. Because the two businesses are different, each pays its own taxes on its own earnings.
Q5. Is a parent business in charge of its subsidiary?
Ans: A subsidiary is a corporation whose shares are held fully or substantially by another company. While the subsidiary is a separate corporation that functions autonomously, the parent firm ultimately controls the subsidiary’s actions by appointing its leadership.
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This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information, and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
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