Parent Company: Definition, Features and Importance

By Indeed Editorial Team

Published 29 September 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Forming a parent company is an effective business strategy to grow an organisation, take control of the market and increase revenue streams. These companies form by acquiring smaller companies to operate under one large umbrella company. Learning about parent companies can help you understand how to build and improve an organisation. In this article, we define parent companies, outline their features and the way they form, explain how they differ from holding companies and discuss their benefits.

What is a parent company?

A parent company is a company that holds a controlling interest in another company, giving it control of its operations. The parent organisation requires a minimum of 51% ownership to have control. It can have an active or passive approach, depending on the authority given to subsidiary managers, but it maintains active control. In the active approach, the new owners directly influence operations. In the passive approach, the new owners appoint subsidiary managers to take control of operations.

Becoming a parent organisation can offer businesses access to new assets and tax benefits. The two organisations are separate entities, protecting them from tax, regulation, debt and legal action against the subsidiaries.

Related: Sister Company: Examples and How It Compares to a Subsidiary

Features of a parent company

The following are the characteristic features of parent companies to help you understand how they work:

Management structure

Parent companies elect the board of directors for subsidiaries and organise their management structure. Having majority shares allows a parent organisation to dictate the governance rules and make essential business decisions. It can also take a passive approach by hiring a senior manager or management team to control the subsidiary's daily operations.

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Liability

Parent and subsidiary companies are separate entities, making them legally independent of each other. Parent companies aren't liable for the legal actions taken against the subsidiaries. They can use this to create a corporate structure that spreads out their assets, reducing the risk of creditors attempting to access their assets in the event of legal action.

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Independence

Parent companies determine the level of independence of subsidiary companies. They can delegate power and authority to the subsidiary's management team, allowing them to hire employees and report their financials separately while maintaining the organisation's financial control. Providing this autonomy to the subsidiaries is a protective measure to diffuse potential liability issues to the parent company.

Related: A Guide to Non-Controlling Interest (With Examples)

Operations

Subsidiaries provide more resources and fresh ideas and diversify the organisation's liabilities. Parent companies can use them to expand existing services or add a new line of business. This can allow parent companies to broaden their operations.

How do parent companies form?

Parent companies can form in the following two ways:

Acquisition

Parent companies often use the acquisition method to buy out smaller companies to use their resources and ideas, broaden the parent's operations or reduce overhead or market competition. Larger companies may acquire smaller companies through takeovers by buying majority shares to gain control. This involves buying 51% or more of its stock to obtain majority voting rights.

Spin-off

Parent companies can also form through spin-offs. This occurs by creating an independent company through the sale or distribution of new shares of an existing company. The primary aim of spinning off is to streamline the company's operations. Companies can do so by separating from underperforming parts of the company to focus on more productive subsidiaries. A spin-off can also occur when the business operations of a subsidiary move in a different direction than the parent firm. This can allow it to develop an additional revenue stream that provides value.

Examples of parent companies

The most common examples of parent companies are conglomerates and limited liability companies. A business conglomerate is a multi-industry company with multiple businesses that sometimes specialise in unrelated industries under one umbrella company. This large company owns controlling stakes in the smaller companies. Conglomerates diversify their business risks by participating in multiple markets.

A limited liability company is a business entity that combines the elements of a corporation with those of a sole proprietorship. This can remove the liability of the company's debt from the shareholders.

Comparison between parent and holding companies

Parent and holding companies may appear similar as they own and control other companies. The following identifies their differences:

Purpose

A holding company controls stock and membership interests in operating companies. Its main aim is to benefit solely from the tax advantages and revenue from subsidiaries. Parent companies aim to broaden their business operations and diversify their products while enjoying tax benefits and income from the subsidiaries.

Goods production

Holding companies earn all their revenue through their investment in subsidiaries. They typically serve as shell companies, which are inactive companies that an organisation can use for various financial activities or keep dormant for future use. They don't participate in the production of goods or services.

In contrast, parent companies take control of the business operations of the subsidiary companies. This involves designing, creating, marketing and selling goods and services. They may directly handle the business operations or hire a senior manager to take control of operations.

Related: What Are Public Goods? (With Definition and Examples)

Business control

A holding company owns a majority of a subsidiary company's shares but doesn't control the subsidiary's operations. It leaves subsidiary managers or management boards to take control of business activities. Parent companies can implement an active or passive approach, where they can leave a subsidiary management team to control the business activities. They can still directly influence business operations without subsidiary managers in the active approach.

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Benefits of parent companies

The structure of parent companies can offer benefits to both parent companies and subsidiaries. Some of these benefits can include:

Broad consumer base

Subsidiary companies can benefit from the already established brand image of the parent organisation. They can also benefit from its high marketing budget, allowing them to create new marketing campaigns. The established brand name may come with a broad consumer base for the goods and services, making it easier for the subsidiaries to market their products.

Business guidance

Working with larger and more established parent companies offers subsidiary companies the benefit of receiving guidance on the most appropriate business operation strategies. They have access to business blueprints and business professionals from the parent organisation to facilitate this. This can help them avoid losses by making informed decisions and minimising the risk potential of investments.

Increased revenue streams

Parent companies can receive a percentage of the subsidiaries' earnings in exchange for their professional resources. They can discuss and agree on the rate or remuneration. Some parent companies agree to higher revenue percentages if they pay employee wages for the smaller companies.

Reduced competition

Forming a parent organisation with the acquisition method reduces competition, as it buys out smaller companies in the same field. This is an effective way to monopolise the market, providing higher revenue opportunities. A reduction or lack of competition allows a company to control the market in its favour.

Related: Revenue vs. Turnover: Definitions, Differences and Examples

Diverse operations

The acquisition method of forming a parent organisation can allow it to broaden its operations. Acquiring a smaller company includes taking control of its resources, such as assets, employees and ideas. This offers the company an opportunity to diversify its operations.

Direct business control

Parent companies can directly control their business operations through vertical and horizontal integration. Vertical integration is a strategy that allows a company to take control of various aspects of the production process. For example, an event organising company can set up a ticket selling company to facilitate ticket sales of the event. This allows the company to eliminate the need for an outsourced ticket sales company, enabling it to take direct control of the production process.

Horizontal integration is a strategy where a business joins with another at the same level of the supply chain, allowing it to take control of the market. Joining two top competing companies in an industry can reduce market competition, allowing them to take over the market.

Expense reduction

Both the parent company and subsidiaries can enjoy the benefits of reduced expenses. The availability of more resources can allow a parent organisation to implement vertical integration. This means it can directly take control of parts of the subsidiary's production process, eliminating any outsourcing needs. Subsidiary companies can also enjoy these benefits if the parent organisation takes up some responsibilities based on their remuneration agreements, such as payment of employee wages. They can also reduce their marketing costs.

Related: SME vs. MNC: Definitions, Benefits and Key Differences

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