What Is Non-Controlling Interest?
A non-controlling interest, also known as a minority interest, represents an ownership position where a shareholder owns less than 50% of outstanding shares and lacks the ability to control corporate decisions. These interests are measured at the net asset value of entities and do not factor in potential voting rights.
Most shareholders of public companies classify as holding a non-controlling interest, with even a 5% to 10% stake being considered significant in a single entity. Conversely, a majority interest in a company, where the investor has voting rights and can influence the company’s direction, contrasts with a non-controlling interest.
Key Takeaways
- A non-controlling interest, also known as a minority interest, is an ownership position where a shareholder owns less than 50% of outstanding shares.
- Minority interest shareholders individually lack control over corporate decisions and votes.
- A direct non-controlling interest receives a proportionate allocation of all recorded equity of a subsidiary, both pre- and post-acquisition.
- An indirect non-controlling interest receives a proportionate allocation of a subsidiary’s post-acquisition amounts only.
- The opposite of a non-controlling interest is a controlling interest, where a shareholder influences corporate decisions.
Understanding Non-Controlling Interest
Shareholders generally receive certain rights when acquiring common stock, including the right to receive a cash dividend if the company has sufficient earnings and declares one. Shareholders may also vote on significant corporate actions, such as mergers or sales. Corporations can issue various classes of stock with distinct rights for different shareholders.
There are primarily two types of non-controlling interests:
- Direct Non-Controlling Interest: It gets a proportionate allocation of all the equity of a subsidiary, both pre- and post-acquisition.
- Indirect Non-Controlling Interest: It receives a proportionate allocation only of a subsidiary’s post-acquisition amounts.
Investors gaining control of 5% to 10% shares often engage more directly with the company, communicating specific proposals and possibly teaming up with other investors to enhance their influence. These investors, known as Activist investors, may aim for a range of objectives from operational improvements to social policy changes.
Financial Statements and Non-Controlling Interest
Consolidation involves preparing a unified set of financial statements by combining the accounting records of multiple entities. These entities typically include a parent company (the majority owner), a subsidiary, and a non-controlling interest company. The consolidated financials enable investors, creditors, and management to view the entities as a single combined entity.
A consolidated statement also implies that a parent and a non-controlling interest company jointly own the subsidiary’s equity. Any transactions between the parent and the subsidiary, or between the parent and the non-controlling interest entity, are eliminated before generating the consolidated financial statements.
Example of Non-Controlling Interest
Consider a scenario where a parent company acquires 80% of XYZ company while a non-controlling interest entity purchases the remaining 20% of XYZ. The subsidiary’s assets and liabilities are updated to fair market value on the balance sheet and used in consolidated financial statements. If the parent and non-controlling interest entity pay more than the net assets’ fair value, the excess is recorded as goodwill.
Goodwill represents the premium paid over fair market value and is amortized into an expense account after an impairment test. This is managed under the purchase acquisition accounting method approved by financial regulatory authorities.
Related Terms: shareholder rights, minority interest, financial statements, activist investors, goodwill, corporate governance.
References
- Financial Accounting Standards Board. “Goodwill: An Investor Perspective”.
