Formation of subsidiaries: Overview, definition, and example
What is the formation of subsidiaries?
The formation of subsidiaries refers to the process by which a parent company creates a separate legal entity (the subsidiary) to handle specific operations, business ventures, or geographical regions. A subsidiary is typically a company that is controlled by the parent company through majority ownership of its shares or voting rights. The parent company may form a subsidiary for various reasons, such as risk management, operational efficiency, or expanding into new markets.
Why is the formation of subsidiaries important?
The formation of subsidiaries is important because it allows businesses to manage different operations separately while maintaining control over them. By creating subsidiaries, companies can reduce risk by isolating certain activities from the parent company, which protects the overall organization from potential liabilities. Subsidiaries also provide flexibility in terms of managing local regulations, taxes, and compliance requirements in different regions or industries. Moreover, subsidiaries can help companies expand into new markets, diversify their portfolios, and enhance their operational efficiency.
Understanding the formation of subsidiaries through an example
For example, a multinational corporation based in the United States might form a subsidiary in Germany to manage its operations in Europe. This subsidiary would have its own legal structure, employees, and operations, but the parent company would retain control through majority ownership of the subsidiary's shares. This allows the corporation to comply with local German laws, manage its European market operations, and isolate financial risks associated with its activities in Europe.
In another example, a technology company may form a subsidiary to handle its research and development (R&D) activities. By creating a subsidiary for R&D, the parent company can focus its main operations on manufacturing and marketing while protecting itself from any potential risks or liabilities associated with experimental or high-risk projects.
An example of a formation of subsidiaries clause
Here’s how a formation of subsidiaries clause might appear in a corporate agreement:
“The Parent Company agrees to form a subsidiary, under the laws of [Jurisdiction], to carry out the operations related to [specific business activity]. The Parent Company shall hold at least 51% of the shares in the subsidiary and retain full control over its strategic direction and financial decisions.”
Conclusion
The formation of subsidiaries is a strategic business decision that allows companies to manage risk, expand into new markets, and streamline operations. By creating separate legal entities, parent companies can maintain control while ensuring that specific activities or regions are handled in compliance with local laws and regulations. Whether for risk management, operational efficiency, or growth, forming subsidiaries is an effective way to structure and diversify a business.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.