“Affiliate” and “Subsidiary” are two of the most common terms in international business. Both of these terms play key roles in global business operations. Knowing the differences between subsidiaries and affiliates is essential for any budding entrepreneur.
With that in mind, we have drafted this comprehensive blog on - affiliate vs. subsidiary. This article will help budding entrepreneurs start their international trade journey.
By the time you complete reading this article, you will have a clear idea of what subsidiaries and affiliates are.. Furthermore, you can make a strategic decision on which option will be more convenient for you.
So, let’s get started.
In digital marketing, “affiliate’ refers to a third-party marketer who promotes your product on your behalf. However, in international business, the concept of affiliate is completely different.
In international trade, an affiliate company is a commercial entity where the parent company holds less than 50% of the shares of the business. The parent company remains a minority shareholder in this structure, and they have no involvement in decision-making, board meetings, or any other daily operations.
An affiliate company can have more than one parent company as long as the percentage of shares being held by each company remains less than 50%. Under this structure, both parent and affiliate companies can operate as independent organizations.
Companies can engage in this arrangement for multiple reasons, including higher efficiency, access to resources in the international market, and financial feasibility.
A popular example of an affiliate is Bank of America. This bank has several affiliates, including the U.S. Trust, Landsafe, Merrill Lynch, and so on. If the parent company is a reputational brand like Bank of America, it can work as a social proof for the affiliates to win potential customers’ trust.
A subsidiary company is where the parent company holds a minimum of 50% of the equity. A parent company is the subsidiary's major shareholder, meaning they are the key decision-makers. For subsidiaries, the parent company is part of the Board of Directors and plays a key role in setting the goals of the business.
Note that even though the parent company largely owns the subsidiary company, it remains an independent entity. As a result, the subsidiary has its distinctive liability, tax, and governance structures.
Here is a comprehensive overview of affiliate vs. subsidiary in global business operations:
The level of ownership is the major differentiator between subsidiary and affiliate. Based on the level of ownership, an organization can be segmented into affiliates, subsidiaries, associates, and parent companies. When a parent company holds a 20% to 50% stake in a company, the later is called an affiliate company.
For a subsidiary company, the parent holds at least 50% or higher percentage of stake. Some subsidiaries are wholly owned, and the parent company has 100% equity in their companies.
Level of ownership leads to a significant aspect called the degree of control. When the parent company holds a higher percentage of stake, evidently, the degree of control will be higher.
Therefore, for a subsidiary, the parent company has majorly controls in the day-to-day operations. In addition, the parent company is an important member of the subsidiary's board of directors, and their involvement is significant in the critical decision-making process.
On the contrary, the affiliate can enjoy control and ownership of their business operations. As the parent company is holding a lesser percentage of the stake, they are not a member of the board of directors. In most cases, the affiliates are entirely responsible for making business decisions.
On some occasions, affiliate companies opt for a type of tax structure where the parent company might receive some tax deductions and lesser liabilities.
On the contrary, it is always possible for parent companies with subsidiaries to file consolidated tax returns. In this case, the parent company doesn’t require to worry about any losses the subsidiary incurred as it won’t affect their tax benefits.
In the case of affiliates, the financials are performed independently without the parent company's involvement. As a result, the affiliates' financial statements don’t appear with the parent company.
Alternatively, for subsidiaries, the financial statements are very much part of the parent company’s statements, and they appear together.
For affiliates, the operational teams are entirely separate. The parent company doesn’t have any involvement in the affiliate company's team structure, hiring, or onboarding activities.
For a subsidiary company, the management is not free to build a team without discussing it with the parent company. The parent company is involved in every step of the team-building process, from hiring, onboarding, training, and so on.
An affiliate company can seek a loan from any bank without getting approval from the parent company. The affiliate company is solely responsible for the loan, and the parent company's involvement is not mandatory.
On the contrary, subsidiaries require the parent company to be their guarantor when taking loans. Therefore, they need the parent company’s approval, and if the parent company refuses, the bank may not issue the loan to the subsidiary.
When discussing subsidiary and affiliate, entrepreneurs should also know about the similarities. To begin with, both subsidiary and affiliate terms are used to measure the level of ownership in a business operation.
Additionally, several other similarities can create confusion for new entrepreneurs. Here are a few pointers to clear your doubts:
Both affiliates are subsidiaries created for the same purpose. When a successful Multi-national Enterprise (MNE) looks to make a direct investment in an international company or when an early-stage startup plans to expand in a new country, they look for affiliates or subsidiaries.
These types of investments help the MNEs prevent controversies related to foreign ownership. Alternatively, for new businesses, a subsidiary or affiliate can be a great option to succeed in a market where they previously struggled to make a mark.
Both businesses can create their distinctive brand image while positioning their services as a subsidiary or affiliate structure. However, it takes years to develop a brand image, and changing it too frequently risks customer loyalty.
Both subsidiary and affiliate structures ensure flexibility when it comes to branding. Whether the parent company or the affiliate/subsidiary, it can grow without blurring its identity.
Whether you're planning to invest in a subsidiary or affiliate company, the scope of diversification is huge. Most MNEs invest in foreign companies to gain recognition in a new market. If you're entering an international market, you require diversification opportunities without a steep learning curve. You can diversify quickly and reach new customer segments without a huge affiliate or subsidiary structure investment.
There are many such instances where MNEs engage with affiliates or subsidiaries in the host country to remove any stigma associated with their brand image. Foreign Direct Investment (FDI) takes place when an international company acquires international assets in an international market. The purpose of making an FDI for an MNE is to acquire assets in different parts of the world to grow its market share.
The affiliate and subsidiary organizations must comply with the host country's regulations. Again, let’s take the example of Bank of America. Bank Of America generates majorities of its revenue from its home country, i.e., the U.S. market. Additionally, Merrill Lynch, a wealth management company based in London, is one of the largest subsidiaries of Bank of America, which boosted its international operations to the next level.
Whether you opt for an affiliate or subsidiary structure, one thing is common - you’ll need legal support to manage payroll, taxes, benefits, expenses, and what not! Plus, you have to stay compliant with the labor and tax regulations of the host country.
So, what’s the solution here?
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