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.

FAQs about forming a subsidiary company

What is a subsidiary company and how is it different from a regular business?

A subsidiary company is a separate business that is owned and controlled by another company (called the parent company). The main difference from a regular business is that a subsidiary has a parent company that owns it, while a regular independent business is owned by individual people or investors who aren't part of another company.

What are the main steps to create a subsidiary company?

Creating a subsidiary involves five main steps that must be completed in order: 

1. Receive official permission from your parent company's board of directors through a formal vote and written approval. 
2. Choose what type of business structure your subsidiary will be (like an LLC or corporation). 
3. File the paperwork with your state to officially register the new business and choose a unique name. 
4. Provide money or assets to get the subsidiary started and running. 
5. Set up how the business will operate day-to-day, including hiring managers and creating rules for how decisions get made. 

Each step has specific legal requirements and paperwork that must be done correctly to make sure your subsidiary is properly established and protected.

Should I make my subsidiary an LLC or a corporation?

The choice between LLC and corporation depends mainly on your tax situation and future plans for the business. An LLC is usually simpler and offers "pass-through" taxation, while corporations have more formal structure and face "double taxation." Most experts recommend talking to a tax professional before deciding, since the wrong choice could cost you thousands of dollars in extra taxes each year.

How much money do I need to start a subsidiary?

The money needed varies widely depending on your business type and state requirements. At minimum, you'll pay filing fees to register the business, which typically range from $50 to $500 depending on your state and business structure. Beyond filing fees, you'll need enough money to actually run the business. The parent company usually provides this funding by transferring cash, equipment, or other assets to the subsidiary. It's important to put in enough money so the subsidiary can operate independently and pay its bills. If you don't provide adequate funding, courts might ignore the separation between parent and subsidiary, which could put the parent company at risk for the subsidiary's debts.

What are the biggest benefits of creating a subsidiary?

Subsidiaries can make it easier to expand into new markets or attract investors who are only interested in the subsidiary business. They also provide liability protection, because if the subsidiary gets sued or goes bankrupt, the parent company's assets are usually protected. Depending on how you structure things, you might be able to reduce your overall tax bill or defer taxes on profits. 

What are the main challenges or risks of having a subsidiary?

The biggest challenge is the upfront cost and ongoing complexity of running separate businesses. You'll need to maintain separate bank accounts, file separate tax returns, and follow different rules for each subsidiary, which can be expensive and time-consuming, but necessary. If you don’t follow these procedures, courts could ignore the separation between parent and subsidiary. This is called "piercing the corporate veil," and it can happen if you mix funds between companies or don't maintain proper records.

Do I need a lawyer to create a subsidiary company?

While you're not legally required to hire a lawyer, it's usually a smart investment for most businesses because creating a subsidiary involves complex legal and tax decisions. A lawyer can help you choose the right business structure, draft proper operating agreements, and make sure you follow all the legal requirements to maintain separation between parent and subsidiary. However, if you have a very simple situation and are comfortable with legal paperwork, you might be able to use online legal services or do some of the work yourself.