When should a STEM business consider using a subsidiary?

As STEM businesses grow, they often expand beyond their original product, technology or area of research. New technologies, regulated activities and higher-risk projects can all raise questions about whether those activities should sit within the existing company or be carried on through a separate subsidiary.

A subsidiary is a separate company owned or controlled by a parent company. Although part of the same group, it has its own legal identity and can own assets, enter into contracts and incur liabilities in its own name.

A subsidiary can be an effective way to separate different parts of a business, but it also brings additional cost, administration and governance requirements. The decision should therefore be driven by clear commercial objectives.

Common reasons for establishing a subsidiary include:

• Separating a new or higher risk activity
• Giving a product or technology its own commercial platform
• Bringing in investment for a specific project
• Expanding overseas or entering a regulated market

Separating a new, regulated or higher-risk activity

One of the most common reasons for establishing a subsidiary is to ringfence a new or higher-risk activity from the company’s existing business.

For example, a software company may develop a new healthcare product or technology platform, or an engineering business may begin testing a safety critical product. These activities may involve different regulatory requirements (including licences or regulatory approvals), increased product liability exposure and / or additional insurance considerations.

Housing such activity within a subsidiary can help keep the associated contracts, costs and liabilities separate from the company’s existing core business.

However, establishing a subsidiary for such activity may not offer absolute protection to the parent company. The commercial separation (and associated benefits) may be undermined if, for example: (i) the parent company guarantees the subsidiary’s obligations; (ii) contracts are entered into by the wrong group company; (iii) assets or funds are mixed between the companies; or (iv) the parent company assumes direct responsibility for the subsidiary’s operations.

For that reason, it is crucial that the group is clear about which company is carrying out the activity and ensure that contracts, assets and liabilities sit within the correct company.

Giving a product or technology its own commercial platform

A subsidiary can provide a dedicated commercial platform for a particular product, technology or business line. As noted above, it can hold the relevant assets, enter into contracts, employ staff and maintain separate financial records, making performance and profitability easier to assess.

A subsidiary can also provide greater flexibility in a sale scenario. If a potential buyer is interested in acquiring one technology or business division rather than the entire group, a standalone subsidiary can often be sold more easily than a business that is fully integrated into one company.

Establishing that structure from the outset may avoid the cost and potential complexity of having to separate assets, employees and contracts immediately before a sale.

Bringing in investment for a specific project

A subsidiary can also be useful where investment is sought for a particular technology, product or project rather than the wider business.

In these circumstances, investors can acquire an interest in the subsidiary without obtaining rights across the wider business. This provides greater flexibility for both founders and investors, particularly where the project for which investment is sought has distinct funding requirements, commercial objectives or growth plans.

Expanding overseas

Businesses expanding internationally will sometimes establish a local subsidiary to employ staff, contract with customers or establish a longer-term presence within a particular jurisdiction.

It is, however, important to note that such a structure can have significant legal and tax implications. As such, before implementing such a structure, appropriate advice should be sought as to the legal, regulatory, tax and reporting requirements that may apply both in the UK and, where applicable, overseas.

Conclusion

A subsidiary can be a valuable tool for growing a STEM business. It may help separate risk, support investment into a particular project, facilitate expansion into new markets or create a more attractive structure for a future sale.

However, a subsidiary is not always the right solution. The benefits of separation and flexibility must be weighed against the additional governance, compliance and administrative requirements that come with operating multiple companies.

The most effective structures are those driven by clear commercial objectives, supported by appropriate legal and tax advice and implemented consistently in practice.

If you would like advice on whether a subsidiary structure is right for your business, please contact the BTO Corporate Team.

This article is for general information only and does not constitute legal or tax advice.