Hardly a day passes where we don’t receive a claim against a company with a very confusing network of subsidiaries, sister companies, or affiliates. Although the claim might be against a sister company, sometimes trying to figure which entity will ultimately be responsible for paying depends on many factors of ownership.
Credit professionals may think that the company to which they are selling is a subsidiary of a major corporation, but when it declares bankruptcy, trying to assert that the parent company is responsible can get messy, since it all depends on how much who owns what. To minimize some confusion regarding corporate relationships and ownership, let me take a moment to explain the following entities in laymen’s terms.
1) Parent Company – A business becomes a parent company when it owns another legally separate entity. The parent company establishes ownership by either creating the entity or purchasing the majority of voting shares of stock. It further influences the operation and management of the other entity, which is known as having a “controlling interest”. A parent company can change its ownership status by purchasing more shares, or by selling some or ultimately all of its shares. The entities that a parent company has controlling interests in are called “subsidiaries”.
2) Subsidiary – As stated above, a “subsidiary” is a legal entity that is majority owned by a parent company, i.e., 51% or more of the voting stock. A subsidiary is also sometimes referred to as a “child company”. Wholly owned subsidiaries are 100% owned by the parent company. A subsidiary can also have controlling interests in its own set of subsidiaries. When the credit professional is told that their customer or client is a subsidiary of a well-known parent company, the three questions to confirm are:
a) Does the parent own 51% or more of the subsidiary’s voting stock?
b) Should the subsidiary default on its payment obligation, will the parent company step in and assume the obligation?
c) Does the subsidiary have autonomy to bind agreements in the first place or does a representative from the parent company also have to sign off?
In addition, many corporate credit reports will often indicate to what extent a subsidiary is owned by a parent company. In particular, it will be noted that the D&B number of the subsidiary will roll up to the D&B number of the parent, providing another level of confirmation that indicates ownership.
3) Sister Company – Sister companies are subsidiary companies owned by the same parent company. Each of the sister companies can operate separately and may have no connection other than sharing the same parent company. Sister companies can be quite different from each other, producing different products and selling to completely different markets. For example, as Berkshire Hathaway is the parent of many subsidiary companies, these subsidiaries are then sister companies to one another.
Because both subsidiary and sister companies are separate legal entities, it is not always obvious that the companies are subsidiaries of a parent company, let alone the same parent. Furthermore, interaction between the sister companies or subsidiaries is not required and may not take place at all. In fact, in some cases, sister companies may compete against one another in the same market.
4) Affiliate – “Affiliates” and “subsidiaries” are both measurements of ownership that a parent company has in other companies. An affiliate has only a minority share of its stock controlled by the parent company. Multinational corporations often set up affiliates under other names to break into the markets of other countries. This is done to protect the parent company’s name in the event that the affiliate does not succeed, or where the name of the parent corporation may not be perceived in a favorable light.
5) Division – A division is a part of a business entity. This means that a division, although it can often operate under a different name and have its own financial statements, is still a part of the business entity itself and not separately incorporated. A division is like a hand on the body, whereas a subsidiary is like an offspring. Although parents, subsidiaries, and affiliates can all have several divisions with their own profit centers, they are still under the legal entity to which they belong.
So why is understanding the difference between these terms so important? At the end of the day, every creditor needs to know the legal obligations of the entity with which it is doing business. For example, although a division may be operating under another name, its debts and all other obligations are technically still the responsibility of the parent company, in which the financial condition of the division will affect the parent company and vice versa.
On the other hand, the financial condition of a subsidiary company, especially in view of taxation and various regulations, does not always impact the parent company. Even if the subsidiary company is experiencing a financial crisis, this does not necessarily mean the parent company will be affected. At the same time however, there are many situations where although the parent is not doing well, its wholly owned subsidiary is still quite viable, and cash gets drained from the subsidiary to support the parent. Unfortunately, sometimes the result has been where the parent has dragged the subsidiary down with it and both eventually failed.
In corporations with many subsidiaries, affiliates, and divisions, trying to sort out the chain of ownership and confirming which entity has the ultimate legal obligation to pay can be a complex process. Although understanding a corporate family tree can be very confusing, it’s a credit professional’s responsibility to always make sure who owns what, and who has the ultimate obligation to pay the bill.
Your questions and comments are most welcome (nseiverd@cmiweb.com).
Nancy Seiverd, President, CMI Credit Mediators, Inc.
