How to create a subsidiary company

A subsidiary company can allow you to grow your existing company while minimizing risk. However, a parent company can only reap benefits from a subsidiary ("child") if the new business entity is set up correctly. This includes securing proper authorization to create a subsidiary from the existing company and following through with all applicable business formation requirements.

Because they are independent legal entities, subsidiaries are usually structured as corporations or limited liability companies (LLCs) and require the same formation procedures as any other new company. As the sole shareholder of the subsidiary, the parent company controls the newly formed business and holds exclusive rights to appoint its board of directors.

Here are the steps you need to take to create a subsidiary.

1. Provide authorization

The existing company must agree to form a subsidiary. Generally this occurs through a vote at a meeting of the board of directors or other management of the existing company.

The meeting minutes should include a record of the vote, and you should draw up a resolution regarding the agreement, which should be signed by the board chair. Keep a record of this authorization.

2. Decide on a business structure

Either a corporate or LLC structure is advisable, as both business types limit liability for the subsidiary. Which entity is best for the new company depends on your specific circumstances.

One of the prime considerations when choosing a business structure is potential tax consequences because the entities are taxed differently. To determine which structure makes most sense financially, consider consulting an accountant or attorney.

3. Organize and form the business

You must follow your chosen state's procedures to get the subsidiary up and running. You can find a description of the documents you must file online, usually on the secretary of state's website.

All jurisdictions require a business owner to file either articles of incorporation or organization depending on the structure selected. Before you file the documents, though, you must select and register a business name, address, and registered agent who is authorized to accept mail on the company's behalf. Once you have all the information required by your state's secretary of state, file your formation documents and filing fee.

4. Fund the subsidiary

The subsidiary needs capital before it can open for business. Transfer assets from the parent to the subsidiary, which gives the existing company ownership over the new business.

If you form the new company as a corporation, you will issue stocks following Securities and Exchange Commission (SEC) guidelines. Keep careful records of all capital transfers in the subsidiary's accounting system.

5. Organize business operations

Once the subsidiary is set up, it's time to work out all the rules that will govern operation of the business. Drafting the subsidiary's bylaws is crucial to provide a framework on how important decisions, such as the appointment or removal of board directors, will be handled.

The subsidiary also needs a board of directors to manage the company. As described above, the parent company determines who serves on the board, an arrangement that allows the parent to retain control over the subsidiary.

Creating a subsidiary can be an excellent way to expand your business, but you must ensure you're doing it the right way. An improperly formed subsidiary may not have the effects you hoped for, especially if the parent company loses control over operations of the new business. Proper formation, on the other hand, can allow it to run smoothly and better guarantee success.