In the world of business, the term associate company is often used to describe a specific type of relationship between companies. It refers to a business in which another company holds significant influence but does not have full control. An understanding of acquisitions is crucial here, as these are often the starting point for forming associate relationships. Understanding what constitutes an associate company and how it functions is important for anyone interested in corporate structures, investments, or partnerships. In this article, we will explore the characteristics, operations, examples, advantages, and disadvantages of associate companies, and how they differ from subsidiary companies. By the end, you will have a clear understanding of what an associate company is, and how it operates within the business landscape.
What is an associate company
An associate company, also called an affiliate company, is a company in which a significant portion of shares is owned by a parent company. This portion is usually between 20% and 50%. If the parent company owns more than 50% of the shares, it legally becomes a subsidiary of that company.
An associate company is distinct from a subsidiary company, where the parent company owns more than 50% of the shares and has a controlling interest. While the parent company in an associate relationship can exert significant influence, it does not have full control over the operations and decision-making processes of the associate company. Associate companies are commonly found in various industries, including finance, manufacturing, and technology, and are often formed as a strategic investment to leverage the strengths of both companies. For more information about the relationship between companies, you can read more on parent companies.
Characteristics of an associate company
An associate company has certain distinct characteristics that define its role and relationship with the parent company. These features include:
- Influential ownership: The parent company holds a significant minority stake (usually 20% to 50%) in the associate company, enabling it to influence key business decisions. Such arrangements are also seen in limited liability partnerships, where shared responsibilities drive collaborative growth.
- No control: Unlike a subsidiary, the parent company does not have controlling interest, meaning it cannot make unilateral decisions without the consent of other shareholders.
- Autonomy: An associate company retains operational independence, meaning it operates as a separate legal entity and is not fully integrated into the parent company’s operations.
- Consolidated financial statements: Although not fully controlled, the parent company must include the financial performance of the associate company in its consolidated financial statements.
These characteristics make the associate company a flexible and strategic investment for many corporations.
How do associate companies work
Associate companies function based on the level of ownership and influence the parent company has. The parent company typically invests in the associate company to either benefit from its growth or influence its business direction, while still allowing the associate to operate independently.
- Financial integration: Parent companies must consolidate their financial statements with those of the associate company, reflecting their share in profits, losses, and assets. This is a requirement under accounting standards, as the parent is significantly involved in the associate's operations.
- Strategic influence: The parent company can influence business decisions, such as mergers, acquisitions, or product development, but it does not control the overall management or day-to-day operations. Such strategies are particularly beneficial when structuring private limited companies, ensuring operational efficiency while retaining independence.
- Partnerships and collaborations: These companies may enter joint ventures or strategic alliances with other firms, where both the parent and associate benefit from each other's resources and capabilities.
The operational independence of an associate company ensures that the parent company is not directly responsible for its financial performance, but still benefits from the association.
Associate companies example
A prime example of an associate company could be a situation where a multinational corporation like Reliance Industries owns a significant but non-controlling stake in a tech startup. This could also involve transforming the startup into a public limited company to enhance capital acquisition opportunities. For instance, Reliance may hold around 30% of the shares of the startup, which allows them to influence business decisions, but not completely control them.
This relationship might allow the startup to access capital and resources from Reliance, while maintaining its independence to innovate and run its operations. Reliance, on the other hand, benefits from the growth and success of the startup, as well as any technological advancements it brings.
Legal Provisions of an Associate Company
Section 2(6) of the Companies Act, 2013 defines associate companies, sets rules for them, and provides specific guidelines on reporting by companies and managing financial relationships between them.
- Section 2(6) defines an associate company as any company in which another company owns at least 20% of the total share capital or has significant influence, but without a majority shareholding or control over management
- Significant influence: It means the company has control over at least 20% of the shareholding or can affect business decisions through an agreement, but it does not have full control over management or policy decisions
- Equity accounting: The investing company must use the equity method, as per Indian Accounting Standards (Ind AS 28), to record profits or losses based on its share in the associate company
- Section 129 of the Companies Act requires the preparation of consolidated financial statements for any company that has an interest in an associate company. The investing company must disclose its shareholding and financial interests
These provisions ensure transparency about associate companies, promote fair practices, and protect the interests of minority shareholders.
Why Are Associate Companies Established?
Companies establish associate companies for various strategic reasons, such as:
Market entry: Partnering with local businesses helps reduce the risks when entering a new market
Access to technology and resources: Sharing new ideas, expertise, and other resources with associate companies improves the capabilities of both firms
Synergistic gains: Associate companies often work closely with core businesses to create synergies that benefit both parties
Risk diversification: The parent company shares the financial and operational risks with its associate companies, but does not have full control over them
Increased income: By sharing profits from investments in associate companies, the parent company can increase its income
Advantages of an associate company
There are several advantages to having associate companies, both for the parent company and the associate itself. Some of these benefits include:
- Access to new markets: The parent company can leverage the associate’s local knowledge and market presence to expand into new regions or industries.
- Shared resources: Both companies can share resources such as capital, technology, and expertise, leading to cost reductions and increased efficiencies.
- Risk diversification: The parent company can diversify its investments and reduce exposure to risks by investing in different sectors or markets through associate companies.
- Innovation collaboration: Associate companies can offer innovative solutions that complement the parent company’s operations, helping both parties stay competitive.
- Reduced control risks: As the parent company does not have full control, it avoids some of the operational risks associated with managing a subsidiary.
These advantages make associate companies a valuable strategic tool for corporations looking to expand and diversify their investments.
Disadvantages of an associate company
While there are several benefits to associate companies, they also come with a few disadvantages:
- Limited control: The parent company cannot make unilateral decisions, which can sometimes delay action or result in conflicts with other shareholders or management.
- Management challenges: The parent company may find it difficult to align the associate’s business strategies with its own, leading to inefficiencies or operational challenges.
- Financial performance reliance: The parent company’s financial performance can be affected by the success or failure of the associate company, even if it does not have full control.
- Potential conflicts of interest: The parent and associate companies may have differing objectives, which could lead to strategic disagreements or competition.
- Complex regulatory requirements: The parent company must comply with complex regulations around financial reporting, particularly when consolidating the associate's financials.
These challenges need to be carefully managed to ensure the success of the associate company relationship.
Difference between associate company and subsidiary company
While both associate companies and subsidiary companies involve ownership stakes by a parent company, there are key differences between the two:
| Aspect | Associate Company | Subsidiary Company |
| Ownership | Parent company owns 20% to 50% of shares | Parent company owns more than 50% of shares |
| Control | No control over day-to-day operations | Parent has control over operations and decisions |
| Financial Consolidation | Parent consolidates financial results proportionally | Parent company fully consolidates subsidiary’s financials |
| Independence | Operates independently with some influence | Fully integrated into the parent company’s operations |
| Strategic Influence | Parent has influence but not full control | Parent company has significant control and decision-making |
Conclusion
In conclusion, an associate company offers a strategic way for a corporation to invest in or partner with other businesses, without assuming full control. This structure allows the parent company to influence decisions and gain from the associate’s growth, while still maintaining a level of independence for the associate. The advantages of flexibility, shared resources, and risk diversification make associate companies an attractive option for many businesses. However, challenges related to limited control, management alignment, and potential conflicts must be carefully navigated. Understanding the nature of associate companies is crucial for businesses seeking to expand their operations and form strategic partnerships. For companies looking to expand through investments, seeking a business loan could also be an ideal option to support their growth strategies.
