What Are Affiliated Companies?

Companies are affiliated when one company is a minority shareholder of another. In most cases, the parent company will own less than a 50% interest in its affiliated company. Two companies may also be affiliated if they are controlled by a separate third party. In the business world, affiliated companies are often simply called affiliates.

The term is sometimes used to refer to companies that are related to each other in some way. For example, Bank of America has many different affiliated companies including Bank of America, U.S. Trust, Landsafe, Balboa, and Merrill Lynch.

Companies may be affiliated with one another to get into a new market, to maintain separate brand identities, to raise capital without affecting the parent or other companies, and to save on taxes. In most cases, affiliates are associates or associated companies, which describes an organization whose parent has a minority stake in it.

Understanding Affiliated Companies

There are several ways companies can become affiliated. A company may decide to buy out or take over another one, or it may decide to spin off a portion of its operations into a new affiliate altogether. In either case, the parent company generally keeps its operations separate from its affiliates. Since the parent company has a minority ownership, its liability is limited, and the two companies keep separate management teams.

Affiliates are a common way for parent businesses to enter foreign markets while keeping a minority interest in a business. This is especially important if the parent wants to shake off its majority stake in the affiliate.

There is no single bright-line test to determine if one company is affiliated with another. In fact, the criteria for affiliation changes from country to country, state to state, and even between regulatory bodies. For instance, companies considered affiliates by the Internal Revenue Service (IRS) may not be considered affiliated by the Securities and Exchange Commission (SEC).

Affiliates Versus Subsidiaries

An affiliate is different from a subsidiary, of which the parent owns more than 50%. In a subsidiary, the parent is a majority shareholder, which gives the parent company’s management and shareholders voting rights. Subsidiary financials may also appear on the parent company’s financial sheets.

But subsidiaries remain separate legal entities from their parents, meaning they are liable for their own taxes, liabilities, and governance. They are also responsible for following the laws and regulations where they are headquartered, especially if they operate in a different jurisdiction from the parent company.

An example of a subsidiary is the relationship between the Walt Disney Corporation and sports network ESPN. Disney owns an 80% interest in ESPN, making it a majority shareholder. ESPN is its subsidiary.

SEC Rules Surrounding Affiliates

Securities markets around the world have rules that concern affiliates of the businesses they regulate. Here again, these are complex rules that need to be analyzed by local experts on a case-by-case basis. Examples of rules enforced by the SEC include:

• Rule 102 of Regulation M prohibits issuers, selling security holders, and their affiliated purchasers from bidding for, purchasing, or attempting to induce any person to bid for or purchase, any security which is the subject of a distribution until after an applicable restricted period has passed.
• Before disclosing nonpublic personal information about a consumer to a nonaffiliated third party, a broker-dealer must first give a consumer an opt-out notice and a reasonable opportunity to opt out of the disclosure.
• Broker-dealers must maintain and preserve certain information regarding those affiliates, subsidiaries, and holding companies whose business activities are reasonably likely to have a material impact on their own finances and operations.

Tax Consequences of Affiliates

In nearly all jurisdictions, there are important tax consequences for affiliated companies. In general, tax credits and deductions are limited to one affiliate in a group, or a ceiling is imposed on the tax benefits that affiliates may reap under certain programs.

Determining whether companies in a group are affiliates, subsidiaries, or associates is done through a case-by-case analysis by local tax experts.

What Is a AAA Credit Rating?

AAA is the highest possible rating that may be assigned to an issuer’s bonds by any of the major credit-rating agencies. AAA-rated bonds have a high degree of creditworthiness because their issuers are easily able to meet financial commitments and have the lowest risk of default.

Rating agencies Standard & Poor’s (S&P) and Fitch Ratings use the letters “AAA” to identify bonds with the highest credit quality, while Moody’s uses a slightly different “Aaa” to signify a bond’s top-tier credit rating.

Understanding AAA

Since AAA-rated bonds are perceived to have the lowest risk of default, these instruments tend to offer investors the lowest yields among bonds with similar maturity dates (lower risk = lower return). The term “default” refers to a bond issuer failing to fulfill its obligations, namely failing to make semiannual interest payments or repay the principal amount when due.

AAA ratings are given to government debt and companies’ corporate bonds. The global credit crisis of 2008 resulted in a number of companies losing their AAA rating, most notably General Electric (GE). As of September 2022, only two companies held the AAA rating outright: Microsoft (MSFT) and Johnson & Johnson (JNJ). Apple (AAPL) is split, with a Aaa rating by Moody’s and a AA+ (one notch below AAA) from S&P.

Even the United States suffered a ratings cut by S&P, to AA+ in 2012—losing its vaunted AAA status due to political infighting over raising the debt ceiling. Moody’s and Fitch maintained the U.S. at Aaa and AAA ratings, respectively.

Types of AAA Bonds

Municipal

Municipal bonds can be issued as either revenue bonds or general obligation bonds—with each type relying on different sources of income.

Revenue bonds, for example, are paid using fees and other specific income-generating sources, like city pools and sporting venues. On the other hand, general obligation bonds are backed by the issuer’s ability to raise capital through levying taxes. Pointedly: State bonds rely on state income taxes, while local school districts depend on property taxes.

Secured and Unsecured

Issuers can sell both secured and unsecured bonds. Each type of bond carries with it a different risk profile.

A secured bond means that a specific asset is pledged as collateral for the bond, and the creditor has a claim on the asset if the issuer defaults. Secured bonds may be collateralized with tangible items such as equipment, machinery, or real estate. Secured collateralized offerings may have a higher credit rating than unsecured bonds sold by the same issuer.

Conversely, unsecured bonds are simply backed by the issuer’s promise to pay. Therefore, the credit rating of such instruments relies heavily on the issuer’s income sources and business outlook.

Benefits of a AAA Rating

A high credit rating lowers the cost of borrowing for the issuer (or borrower). Therefore, it stands to reason that companies with high ratings are better positioned to borrow large sums of money than fixed-income instruments with lesser credit ratings. And a low cost of borrowing affords firms a substantial competitive advantage by letting them easily access credit to grow their businesses.

For example, a business may use the incoming funds from a new bond issue to launch a new product line, set up shop in a new location, or acquire a competitor. All of these initiatives can help a company increase its market share and thrive over the long haul.

The Bottom Line

Credit ratings are assigned to debt issues and bonds by the three major debt-rating agencies: S&P, Moody’s, and Fitch. Their credit ratings have a strong influence on the cost of borrowing for the issuer. The better the credit rating, the lower the cost to borrow.

AAA/Aaa ratings are the highest ratings issued by the credit-rating agencies and likely result in the lowest borrowing costs or yields. Investors seeking a better return should look down the credit-ratings scale for bond issuers with lower ratings and higher yields.