An associate company, also known as an affiliate company, is a company in which a notable portion of shares is owned by a parent company. The portion usually lies between 20% and 50%. Ownership of higher than 50% of the stock legally turns it into a subsidiary of the parent company.
Because the minority interest (less than 50%) does not include the right to control the affiliate company’s board decisions, the parent company does not have full authority over the policies and business decision-making aspects of the associate company.
When are Associate Companies Formed?
Associate companies are typically created during the course of a joint venture, where one firm buys a significant amount of stake in another firm to create a larger organization with synergies. They can also be formed when a large organization seeks to diversify and/or expand and invests in a smaller company without making it a subsidiary (i.e., purchasing between 20% and 50% of the stock).
In contrast with a subsidiary, the associate company’s financial statements need not be consolidated with that of its parent or parent companies.
Investing in associate companies allows larger companies to expand their operations or enter into new markets.
The association may serve as a prudent investment option, especially for companies that are looking to purchase a majority stake in another business, particularly in a competitor.
Both the parent and associate companies can take advantage of stable financial support, research and technological advancement, and improved production capabilities.
An associate company helps boost the parent company’s profitability and overall value.
Berkshire Hathaway, a conglomerate holding company, holds significant minority holdings in multiple organizations. It owns 17.6% of American Express and 26.7% of the Kraft Heinz Company, among many others. Legally, this means that the companies are associate companies of Berkshire Hathaway.
The overly complex structure of associate companies tends to draw criticisms from investors and regulators, particularly in relation to the actual financial standing of the businesses. In some instances, the multi-layered corporate structure allows the parent company to divert funds or launder money through investments or loans to the associate company.
In addition, parent companies may purchase a stake in foreign associates to secure tax benefits and avoid large tax bills. In other cases, the parent fails to provide a fair and accurate view of the associate’s financial standing, thus misrepresenting the entire group’s overall financials.
CFI is the official provider of the global Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep learning and advancing your career, the additional CFI resources below will be useful: