Related party transactions occur between parties with a relationship, creating potential conflicts of interest. Publicly traded companies must disclose them. Decisions on such transactions consider benefits, value, and legality. Non-reporting companies may transact with related parties, but it can be criticized.
A related party transaction is a business transaction conducted between two parties who have a relationship with each other. This relationship gives one party control or influence of the transaction over the other. Such transactions are legal, but they may create conflicts of interest and there are certain circumstances where they will not be permitted. Publicly traded companies are required to disclose related party transactions in their financial statements.
For companies that have a legal obligation to disclose, a related party transaction may occur between a company and a significant shareholder, officer, director, or family member of one of the foregoing. Special relationships are maintained between companies and people in all of these classes. Companies usually assemble panels to make decisions on proposed related party transactions to determine whether a transaction is legal or justifiable.
Things considered when making a decision regarding a transaction with a related party include the benefit to the company, as well as to the other party, along with the value of the transaction and the nature of the transaction. If the company suspects that a conflict of interest may be created, such as when it is willing to bargain with a vendor in a related party transaction without considering prices from other suppliers, the transaction will fail. Likewise, if the transactions appear to be illegal business practices, the company will not move forward. Companies also want to avoid scandal and, therefore, may choose to vote on a proposed settlement even if it is legal, if they believe people might suspect impropriety.
If the panel determines that a related party transaction is legal and in the best interests of the company, it can provide approval for the transaction to be conducted. There are certainly instances where a related party transaction offers the best deal for the business and is also beneficial to the shareholders. Transaction information is recorded in the accounting records on the company’s books so that people who review the financial statements can clearly understand the nature of the transaction.
Non-reporting companies are free to transact with related parties. Small businesses often take advantage of offers from people they have relationships with and gain favor by hiring and promoting these people. These practices are sometimes criticised, especially in small communities where it can be difficult to break into certain areas of the business community due to ingrained habits and practices.
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