Associate CompanyWhat makes a company an associate company?
Companies will often invest in other companies.
Take one of the biggest companies for example – Berkshire Hathaway Inc.
One of America’s largest companies, Berkshire Hathaway Inc. has investments in several other companies such as GEICO, Duracell, American Express, The Coca-Cola Company, and even Apple Inc. among others.
And by investments, I mean that they hold shares of these other companies.
This means that Berkshire Hathaway Inc. is essentially an owner of these other companies (some partial, some full).
A company investing in another company is usually a relationship of mutual benefit.
By investing in other companies, the investor can potentially increase its profits.
Additionally, the investor can diversify its business operations.
For example, when a food company invests in a clothing company, such action diversifies its business portfolio.
On the part of the investee, it enjoys the benefit of having an injection of funds.
The investee can then use such funds to finance its operations.
It may even use said funds for a planned expansion (e.g. opening a branch, introducing a new brand, etc.).
In addition to the financial support, the investee may also make use of the expertise and guidance of the investor who is usually a bigger company.
Depending on how much is invested in the company, it may be considered a subsidiary or associate company of the investor (referred to as the parent company in this case).
An investee becomes a subsidiary when the investor (parent company) owns a majority of its share.
In most cases, a majority means more than 50%.
So what about when the parent company owns less?
Does it automatically make the investee an associate company?
In this article, we’ll try to answer these questions by learning what an associate company is and how it works.
What is an Associate Company?
An associate company (a.k.a. affiliate company) refers to a company in which another company (parent company) has an ownership stake.
The percentage of ownership by the parent company is not enough to make it a major shareholder.
However, it is just enough for the company to have significant influence.
In most cases, this means that the percentage of ownership is at least 20% but not more than 50% of the investee’s total outstanding share.
Any more than that makes the investee a subsidiary of the parent company instead.
Being a minority interest (less than 50%), the parent company understandably does not have the right to control the associate company’s board decisions.
This also means that it does not have full authority over any policies and/or business decisions of the associate company.
But it does have a significant influence on the affairs of the associate company, meaning that its vote still matters.
Generally, unlike with a subsidiary, the parent company does not have to consolidate its associate company’s financial statements.
Instead, it treats its investment in the associate company as an asset. This makes it less of a hassle to account for than a subsidiary company.
However, there are still some tax rules that a parent company has to consider when it comes to associate companies.
When is an Associate Company Usually Created?
Associate companies are usually created along with a joint venture.
In such a case, several companies pool resources to pursue the joint venture, essentially making them partial owners.
Typically, the percentage of ownership of each owner isn’t enough for it to have a majority share.
As such, the joint venture becomes an associate company of each owner.
A parent company may also make another company an associate company when it wants to diversify its business portfolio.
Or simply, it just wants to invest in other companies to potentially increase its profits.
It just makes enough investment in such a business for it to have a significant influence, but not so much that it makes the other company a subsidiary.
When an investor only wants to diversify its business portfolio without minding whether it has full or major control of the investee, then it will more than likely just settle with making the investee an associate company.
A parent company may also go with this route if it doesn’t want to deal with the hassle of accounting for a subsidiary company.
For one, a parent company does not need to consolidate the financial statements of its associate companies.
The parent company can simply treat the investment as an asset.
Why Set Up an Associate Company
The main benefit of investing in an associate company is the potential for more profits.
They do say that two heads are better than one.
But aside from that, here are other benefits that a parent company may enjoy when it has an associate company:
- Investing in a company that belongs to another industry diversifies the business portfolio of the parent company. This has also the added benefit of doing away with research and development costs that come with launching a new venture. An example of this is when a fast-food company invests in a tech company.
- Making another company an associate is also an option when a parent company wants to expand its area of operations. For example, a company may want to conduct business in another country. Instead of establishing a branch there, the company may opt to invest in a similar business, making it an associate.
- A company may want to test the waters first before making a major investment in another company. So it makes the other company an associate first. If the results are satisfactory, the parent company may increase its investment in the associate company just enough to make it into a subsidiary company.
- Both the parent and associate company can benefit from each other. The associate company benefits from an injection of funds. Additionally, it may receive other forms of support. On the other hand, by having an associate company, the parent may potentially increase its profits.
- Accounting for an associate company is easier than that of a subsidiary company. The parent company does not have to consolidate the financial statements of its associate companies.
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Cornell Law School "associate company" Page 1 . June 1, 2022
Cornell Law School "18 CFR § 367.1460 - Account 146, Accounts receivable from associate companies." Page 1 . June 1, 2022