How to Best Use LLCs in a Subsidiary Structure

The Basics of a Subsidiary Structure

A “subsidiary” is a company that is owned or controlled by another company. The subsidiary is often referred to as the “daughter” company. The controlling or owning company is generally called the “parent” company. While many parent companies will completely own the “child” companies, they can also be just one of the owners or members as well. In most cases, however, the parent company will be the majority shareholder.

Although the parent and daughter companies are connected, they really are two distinct legal entities. That means that they can be different legal structures, such as a corporation and an LLC. You must also take steps to ensure that you are complying with state law to maintain these structures. That includes having separate:

• owners or directors (although these individuals often overlap);
• meetings and records of meetings;
• books and records; and
• operating agreements, bylaws, and other internal regulations.

The managers in a subsidiary do not work for the parent company. Instead, they report to the parent company just as they would a majority shareholder or member. The parent company maintains control by drafting the corporate bylaws, LLC membership admission agreement, or other formation documents in a certain way.

Benefits of a Subsidiary Structure

There are all kinds of reasons to have a subsidiary structure. Many of these reasons deal with mitigating or addressing risk. For example, imagine you own a business that makes natural soaps. Your business is doing well, so you consider adding an additional venture that produces natural toothpaste. While the two products are similar, they are different enough that you have some concerns about risk. One of the ways that you can deal with that is to create a separate company that only produces your new toothpaste. That way, if your venture falls through, the assets in your soap business will be protected.

In other situations, you may have a buyer that only wants to purchase a portion of your company. You can use subsidiaries to facilitate a sale of just part of your larger business as well.

Other benefits of a subsidiary structure may include the following:

• Sharing resources – Using a subsidiary instead of two separate businesses allows you to keep using a lot of the resources of the larger company, including your marketing efforts and goodwill.
• Tax benefits – In some situations, you may be able to offset losses in one part of your business with revenues in another part of the company. This type of tax maneuvering allows you to save money by keeping the company’s overall taxable income lower.
• Structuring that addresses employment laws – Sometimes smaller businesses can avoid some of the more in-depth requirements for necessary employee benefits such as retirement plans, health care, and wage laws. Developing a subsidiary can help you save money on these various expenses as well.
• Ease of setup – Creating several connected businesses is relatively easy to do, especially compared to the benefits available in the long run. LLCs are a great business structure to use in subsidiary arrangements because they offer asset protection without all of the paperwork or other requirements that many state laws require of corporations. Creating an LLC operating agreement (and you may need several of them) is relatively straightforward.

Every business is different, and the benefits that matter the most for your structure may not be the same as the next business owner. Nonetheless, LLCs are often one of the best options for a subsidiary structure.

What Is an LLC?

A limited liability company, or LLC, is one of the least complicated and most advantageous business structures available today. It offers the benefits of pass-through taxation without all of the filing requirements of a corporation. That means that taxes are often lower, with far less hassle and paperwork. It also offers great asset protection between your personal assets and your business assets, or, in the case of subsidiary structures, among business entities.

LLCs and Asset Protection

One of the most valuable aspects of creating an LLC is that it offers business owners a way to protect their personal assets if the business is sued or has a significant outstanding debt to a creditor. Sole proprietorships and partnerships leave personal assets open to this type of risk, but an LLC keeps everything separate.

LLCs also keep business assets separate among several businesses as well. Holding several partnerships, for example, would leave each partnership vulnerable to the obligations of each other. In that type of situation, you might as well have everything in one large company because that is what is being done from an asset protection standpoint anyway. Instead, creating several LLCs connected by one large LLC or corporation would keep the business liabilities from overlapping. In that way, if one LLC is debilitated by debt or a lawsuit for another reason, the other “arms” of the subsidiary remain intact.

Creating a Parent/Subsidiary with LLCs

In many situations, companies start out as just one business venture. As they expand, they may want to include additional brands or categories of products. That means that you may start out with one or two companies already. Combining them to create a subsidiary relationship is actually a pretty straightforward process.

Exceptions to Subsidiary Risk Protection

Even when you use an LLC, there are some exceptions to the general rule that a parent company is protected from the actions of its “children.” Some of the most common limitations include the following situations:

• No real independence – A subsidiary has to operate like a separate business, which includes all of the formalities that an LLC or corporation requires. If the parent company and the subsidiary share all of the same members, have the same bank account, use the same resources, and do not even operate under different names (although they may formally have different names), the parent company is far more likely to end up being legally responsible for the subsidiary company’s debts or other legal obligations. It is vital that the subsidiary acts as an independent company, even if it does share some of the same resources from the parent company or other subsidiaries.
• Insolvent subsidiaries – Some business owners will create subsidiaries and then decline to fund them just to insulate the parent company. However, when you do this, you are essentially operating as a company that is already in bankruptcy before anyone ever deals with it. State and federal regulators do not like this business strategy as it is unfair to creditors and customers. Generally, the law will permit those who are seeking repayment for credit arrangements or legal liability to look to the parent company to compensate them for their losses.
• Shifting assets – You also cannot move assets to another subsidiary or parent company just to avoid having to pay a lawsuit. This is very similar to running an insolvent company, but some business owners will deliberately do this to shake off creditors. This can be considered fraud, and it is never a good idea.

Exceptions to risk protection are very fact specific. However, you can avoid most of these issues if you treat each subsidiary company as if it is a stand-alone entity.

Drawbacks to Subsidiary Structures

Creating subsidiary structures may not be a good idea for every type of business. Because you have to develop and maintain several LLCs (or corporations), it does take additional time, effort, and money to use this type of business structure. If you overlook any requirement, that can put your entire operation at risk as well.

It costs money to create each LLC, and most states have annual filing fees that must be paid too. Each LLC must also have its own operating agreement and articles of organization as well. However, these documents can be very similar in many circumstances.

In many situations, the advantages of this type of structure will outweigh the costs. Decreasing risk can be very valuable to small and mid-sized businesses, so you just have to determine whether that type of benefit is a good idea for your company.

How We Can Help

We offer easy-to-use forms and walkthroughs to create necessary LLC documents in your state, including operating agreements, membership agreements, and articles of organization. Check out what we have to offer by viewing our legal documents.