Creating a second company is an
exciting venture and will entail taking many of the same steps as when you
created your first company. However, there may also be some new questions you
have to consider when getting started, a primary one being: what kind of legal
organizational relationship, if any, do you want your new company to have to
your existing one? You can choose to keep your companies as completely separate
entities that have no legal relationship to each other, or you can choose to
link them in a parent-subsidiary relationship. There are multiple factors to
consider when choosing whether or not to form a parent-subsidiary relationship,
some of which will be addressed in this post.
What is a Parent-Subsidiary Relationship?
A parent-subsidiary relationship is
created when one company (the “parent”) controls another company (the “subsidiary”).
This is typically created when the parent owns a controlling amount of stock or
shares in the subsidiary company, meaning that they have majority voting power
over the subsidiary. A parent can be either sole shareholder or majority
shareholder of its subsidiary. So, if you are hoping to include other members
or shareholders in your new company venture, you are not necessarily prevented
from doing so just because your new company is a subsidiary. As sole or
majority shareholder, the parent can exert control over the subsidiary by
voting to approve or remove the subsidiary’s board members and vote on certain
major decisions on how the subsidiary operates. But, as the subsidiary is still
its own legal entity, it has its own aspects of control that keep it separated
from the parent. Despite the parent’s voting power over the subsidiary’s board,
the subsidiary’s directors and officers are still responsible for managing the
company and acting in the subsidiary’s best interests.
Some Factors to Consider When Deciding on a
Parent-Subsidiary Relationship
One question you need to ask
yourself is whether you want one of the companies to have influence over the
other. As mentioned above, a parent company gets that title by owning a
majority of shares in the subsidiary to give it some control over the
subsidiary. Do you want your existing company to have a controlling interest
and make decisions for your new company, or do you prefer that the activities
and decisions are conducted separately? If you want or don’t mind a controlling
relationship, then parent-subsidiary may be preferable, but if you do not want
that, then keeping the companies completely separate is likely the option for
you.
Another major factor is choice of
entity for both companies. The current entity structure of your existing
company (we’ll call that “Company A”) and the entity structure you hope to use
for your new company (let’s call that “Company B”) can affect whether a
parent-subsidiary relationship is even possible. Only certain entity types can
own or be owned by other companies. For example, a subsidiary cannot be an S
Corporation. This is because S Corporations cannot have businesses as
shareholders; only real people can be shareholders in an S Corporation. So if
Company A is already an S Corporation, then you cannot structure Company B to
be the parent of A. Similarly, if you want Company B to be the subsidiary, you
cannot structure it as an S Corporation. Other entities, like C Corporations
and LLCs are not restricted like this and can be owned by a parent company.
Both C Corporations and LLCs can also be parent companies themselves, although
it is far more common to see parent companies structured as C Corporations.
Now, hearing about this relationship
between two companies may raise questions for you about whether the two
companies’ liabilities are becoming entangled. Typically, parent companies will
not be held liable for the actions of its subsidiary, assuming that their
business activities are also kept separate. However, this liability protection
does not exactly go both ways. While a parent can usually be protected from
liability if the subsidiary is sued, if the parent company is sued, then its
ownership interests in the subsidiary are considered the parent’s property and could
be at risk. So if your parent company is at high risk of being sued (or at
least at a higher risk than the subsidiary), you might not want to risk your
other company by making it a subsidiary.
As mentioned above, parent companies
can be protected from their subsidiary’s liabilities if they keep their
business activities distinct from that of the subsidiary. An easy way to keep
liabilities as separate as possible is to keep all assets, like properties and
finances, separate between the companies. You will need to be careful to not
have the companies share a common bank account, shared marketing materials, or
doing business under each other’s names. (Of course, this is also true even if
there is no parent-sub relationship.) If you do, you may risk losing the
liability protections between the companies. This can be especially tricky when
you are still in the process of creating your second company, especially if you
have been getting a boost from your first company, whether it’s financial,
reputational, etc. So, as soon as you know that you want to create a new
company, you need to do your best to separate out the assets, finances, and
activities of your separate companies and make relevant parties aware of the
separation. For example, when speaking with potential investors or applying for
grants, you need to make clear which business you are representing in that
moment. All assets should be clearly delineated between the companies and
should only be used by the company that officially owns it. The two companies
should have separate bank accounts, and you need to be careful how you market
the companies in relation to one another. Regardless of whether the companies
are parent-subsidiary or completely independent of each other, you need to
conduct the businesses clearly and separately from each other to not muddy the
waters and risk losing liability protections.
The relationship – if any – between
the companies is one of many considerations you will need to consider when
creating a second business. Be sure to consult with an attorney for tailored
legal advice to ensure that you protect your existing company and structure
your new company properly.
By Olivia Filed