What is a Subsidiary
BREAKING DOWN Subsidiary
Subsidiaries are separate and distinct legal entities from their parent companies, which reflects in the independence of their liabilities, taxation and governance. Given their controlling interest, however, parent companies, along with other subsidiary shareholders, vote to elect a subsidiary company's board of directors, and there may often be board member overlap between a subsidiary and its parent company. A parent company will typically aggregate financials from all its operations, including those of its subsidiaries, and carry these financials on its own consolidated financial statements. A parent company may own a foreign subsidiary, in which case the subsidiary must follow the laws of the country where it is incorporated and operates.
Subsidiary is an adjective that describes when something or someone serves to assist or supplement another thing or person. In a business setting, a subsidiary becomes part of a parent company to provide the parent with specific synergies, such as increased tax benefits, diversified risk, or assets in the form of earnings, equipment or property. The purchase of interest in a subsidiary differs from a merger in that the parent corporation can acquire a controlling interest with a smaller investment. Additionally, shareholder approval is not required in the formation of a subsidiary as it would be in the event of a merger.
Consolidated and Unconsolidated Subsidiaries
While the term subsidiary refers to companies that are at least 50% controlled by another entity, an associate or affiliate company denotes a firm held as a minority stake by another entity. Aside from being held as a majority ownership stake, subsidiaries also differ from associate companies because a subsidiary's financial statements are typically consolidated for inclusion on the parent company's consolidated financial statements.
As is common practice and per the Securities and Exchange Commission (SEC), public companies should generally consolidate all majority-owned firms, or subsidiaries. Consolidation is typically seen as a more meaningful method of accounting than providing separate financials for a parent company and each of its subsidiaries. For example, eBay reported total revenue on its consolidated income statement, for the year ended Dec. 31, 2017, of $9.6 billion. The e-commerce firm notes in the annual report that just over $1 billion of its total revenue came from its sole domestic and consolidated subsidiary, StubHub.
The SEC states that only in rare cases, such as when a subsidiary is undergoing bankruptcy, should a majority-owned subsidiary not be consolidated. An unconsolidated subsidiary is a subsidiary with financials that are not included in its parent company's financials. Ownership of such firms is typically treated as an equity investment and denoted as an asset on the parent company's balance sheet. For regulatory reasons, unconsolidated subsidiary firms are typically those in which parent firms do not have a significant stake.
Example of Subsidiaries and Their Benefits
Public companies are required by the SEC to disclose significant subsidiaries under Item 601 of Regulation S-K. Warren Buffett's Berkshire Hathaway Inc., for example, has a long and diverse list of subsidiaries, including Dairy Queen, Clayton Homes, Business Wire, GEICO Auto Insurance and Helzberg Diamonds. Berkshire Hathaway's acquisition of many diverse firms fall in accordance with Buffett's oft-discussed strategy of buying undervalued assets and holding onto them. In return, acquired subsidiaries can often continue to operate independently while gaining access to broader financial resources. An exhibit to Berkshire's annual filing, for the year ended Dec. 31, 2017, reveals that the firm owns upwards of 250 subsidiaries.
Like Berkshire Hathaway, Alphabet Inc. also has many subsidiaries. These separate business entities all perform unique operations that add value to Alphabet through diversification, revenue, earnings, and research and development (R&D). For example, Sidewalk Labs, a small startup that is a subsidiary of Alphabet, seeks to modernize public transit in the United States. The company has developed a public transportation management system that aggregates millions of data points from smartphones, cars and Wi-Fi hotspots to analyze and predict where traffic and commuters are most congregated. The system can redirect public transportation resources, such as buses, to these congested areas to keep the public transit system moving efficiently.
For Alphabet, Sidewalk Labs provides it with a business unit that develops technology that can one day help the entire company. Since one of Alphabet's largest products is Google Maps, subsidiaries such as Sidewalk Labs can strengthen the company's overall business operations.