Key Takeaways

  • An affiliate company is generally a business in which another company owns a minority interest (less than 50%), or both are under common control.
  • Contracts often include affiliate clauses that extend rights and obligations to current or future affiliates, which may create risks if affiliates later become competitors.
  • Loss of affiliate status can affect ongoing obligations (e.g., license rights), so agreements should clearly outline what happens if affiliation ends.
  • Affiliate determination is made by factors like ownership percentage, control rights, contractual ties, and SBA affiliation rules for small businesses.
  • Affiliate vs. subsidiary: subsidiaries are more than 50% owned and tightly controlled, while affiliates maintain operational independence with limited ownership.
  • Strategic benefits of affiliates include market expansion, risk sharing, and leveraging brand or distribution networks without full consolidation.
  • Accounting treatment differs: affiliates may require equity method reporting, while subsidiaries are consolidated into financial statements.

An affiliated companies clause is applicable to any subsidiary or parent company of an organization. An affiliated company may be an entity that already exists, or one that is started or acquired in the future. In a nutshell, an affiliated company is any company that controls a separate entity (directly or indirectly) or is controlled by another company.

The term "affiliation" refers to a relationship between two companies in which one falls under the other. Or, in a different scenario, Company A is an affiliate of Company B if they both fall under Company C. Affiliation between two companies can also exist if at least half of the voting shares of each company are owned by the same person, legal entity, or corporation.

Under the affiliated companies clause, an affiliate can be:

  • One member of a controlled group of companies
  • An unincorporated business under an employer's common control
  • An entity not classified as an employer, but which is required to be associated with an employer

Affiliate clauses in contracts

In some contracts, a party's affiliate can be given the same obligations and rights as the party themselves. A great example of this is license agreements. In other contracts, companies can be required to provide warranties and representations about their affiliates as well as themselves. This is commonly applicable in merger agreements.

If Company A and Company B enter into a contract, it is possible that a current or future affiliate of Company A could one day become a competitor of Company B. This affiliate (let's call it Company C) could also be an entity that Company B did not want to do business with for some reason. It is important for Company B to consider whether the rights and obligations that Company C could acquire as an affiliate could be detrimental.

In order to establish control, a contracting party may ask for a percentage lower than 50 percent. It is possible that they may have a subsidiary in which they feel they have de facto voting powers without owning a majority of the stock. In these circumstances, one should consider specifying that these non-controlled subsidiaries are also to be affiliates.

Risks and Protections in Affiliate Clauses

When drafting affiliate clauses, parties should consider safeguards against unintended consequences. For instance, if an affiliate later becomes a competitor, granting it contractual rights could harm the original party. To manage this risk, contracts may:

  • Restrict competitor affiliates by expressly excluding them from rights.
  • Require disclosure of affiliates to ensure transparency about current and future relationships.
  • Limit rights to named affiliates instead of broadly applying to all present and future affiliates.

Companies also negotiate representations and warranties about affiliates, particularly in mergers and acquisitions, to ensure affiliates meet compliance standards and do not create hidden liabilities.

The loss of affiliate status

The agreement should specify provisions that come into play if affiliate status is lost. These would cover an orderly process of phasing out specific obligations and rights. Let's suppose that one company had a license to use a particular software, and the affiliate also had the right to use this software. If the termination of the affiliation could cost an affiliate the rights to use this software with immediate effect, it could be extremely problematic.

Affiliate vs. Subsidiary Relationships

A key distinction in corporate structures is the difference between affiliates and subsidiaries.

  • A subsidiary is more than 50% owned and controlled by the parent company, which usually consolidates its financial results into the parent’s accounts.
  • An affiliate company typically involves less than 50% ownership. Affiliates operate more independently, and the parent may influence—but not fully control—decision-making.

This distinction matters for governance, tax reporting, and liability exposure. For example, subsidiaries are legally distinct but financially tied to the parent, while affiliates carry greater independence and may pursue different strategies.

How affiliates are determined

In most cases, it's enough to specify that certain companies will be considered affiliates even if the relevant legal relationships do not qualify as controlling. The Small Business Administration (SBA) determines affiliation in a variety of ways:

  • A company is considered to be an affiliate of another company when one has control of another, or if both are controlled by a third party. Whether or not this control is being exercised is irrelevant, as long as the ability to control can be proven.
  • The SBA will take various factors into consideration, including ownership, a previous connection with another entity, management, and contractual relationships. All of these play a part in deciding whether two companies are affiliated.
  • The control that is in place may be either affirmative or negative. Negative control refers to cases in which a minority shareholder can prevent the shareholders or board of directors from taking action.
  • Even if a concern, entity, or individual has control indirectly, by means of a third party, affiliation may be found in some circumstances.

The SBA will decide whether an affiliation exists by taking all the circumstances into account. An affiliation may be found even in a case in which there is not a single factor which, on its own, could constitute affiliation.

It is important to note that businesses largely owned by investment companies that fall under the Small Business Investment Act (1958) as amended are not considered affiliates. This also applies to development companies that qualify under the Act.

Strategic Role of Affiliate Companies

Affiliate companies often serve strategic purposes in business planning. A corporation may form or invest in affiliates to:

  • Enter new markets without taking on full risk.
  • Partner with local businesses in industries or jurisdictions with foreign ownership restrictions.
  • Share resources like distribution channels, intellectual property, or technology.
  • Limit liability by separating certain operations into partially owned entities.

From a financial perspective, affiliates may be reported using the equity method of accounting rather than full consolidation, ensuring their activities are tracked without overstating the parent company’s assets or revenues.

Frequently Asked Questions

  1. What is the main difference between an affiliate and a subsidiary?
    An affiliate company usually involves less than 50% ownership, while a subsidiary is more than 50% owned and controlled by the parent.
  2. Can affiliate companies be considered part of the same corporate group?
    Yes, affiliates are often part of a broader corporate network, but they maintain operational independence compared to subsidiaries.
  3. Why do contracts include affiliate clauses?
    Affiliate clauses ensure obligations and rights extend to affiliated entities, protecting both parties in complex business relationships.
  4. How does the SBA determine if companies are affiliates?
    The SBA considers ownership, control, management ties, contractual agreements, and even indirect influence through third parties.
  5. How are affiliate companies reported in financial statements?
    Typically, affiliates are accounted for using the equity method, while subsidiaries are consolidated into the parent’s financials.

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