Risky Expansion?

When a company embarks on a venture that's high risk, it may make sense to protect the established company from liabilities that will or could arise in the new venture. A commonly used and quite effective (and relatively inexpensive) means is to set up a subsidiary corporation and operate the new venture within it.

A subsidiary corporation is one in which another corporation, the parent corporation, owns at least a majority of the subsidiary's stock and therefore has control over it. Such a structure can be effective at protecting the parent company from liabilities that arise in or as a result of the activities of the subsidiary, but only if the subsidiary is managed in a certain manner:

• Both corporations are adequately capitalized.
• Corporate formalities (e.g., election of officers, annual board meetings, filing of separate tax returns, etc.) are observed for each entity.
• Both corporations are held out to the public as separate enterprises.
• The two corporations keep separate financial records and do not commingle funds.
• The parent corporation does not completely dominate operations of the subsidiary to advance only the parent's interests.
• The parent corporation avoids contractually guaranteeing debt of the subsidiary.

Failure to adhere to these could result in creditors being able to "pierce the corporate shield" and hold the parent corporation accountable for the debts of the subsidiary.

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