A:

Minority interests are usually the result of joint ventures or acquisitions where the selling party maintains some interest or control in the business. According to U.S. accounting rules, when a company acquires more than 50% of another firm, the buying party needs to account for all profits, assets and liabilities in its financial statements. It cannot take credit for the percentage of those items that remain with the minority interest, though.

To illustrate, suppose that Company Red acquires Company Blue, but Company Blue retains 15% of the shares. Company Red can't claim the assets of Company Blue as its own, but it still has to reflect the impact of minority interests on its income statement. This changes the formula for calculating enterprise value for Company Red.

Minority Interest

In financial accounting, minority interests are considered non-current liabilities on a balance sheet. They also impact the balance of assets and liabilities on the income statement. If a parent company takes part in any further consolidations, especially if the parent company is being bought out by another party, the minority interest becomes an important variable in the enterprise value.

Enterprise Value

The enterprise value is a hypothetical money value assigned to a firm, designed to take into consideration all claims on assets from all possible claimants. It is often considered a more detailed and realistic version of market capitalization when pricing a possible acquisition, but it has its detractors as well.

In a simple, standard enterprise value calculation, the company's market capitalization is combined with the outstanding debt remaining on company books. Any acquiring firm must pay off the debt of its new business. Any cash on hand or liquid cash equivalents are subtracted as well. The acquiring company assumes any liquid assets, which offsets some of the purchase costs.

When pre-existing minority interests are involved in a consolidation, the enterprise value must take into consideration the impact of those interests. The market capitalization formula does not include minority interests. Any acquiring firm still has to pay for minority interest, so the total value of the minority interests are added to market cap and debt before excess cash is taken out.

The formula for calculating enterprise value in cases that involve minority interest can be written as:

Enterprise Value = Market Capitalization + Outstanding Debt + Value of Minority Interest - Excess Cash on Hand - Cash Equivalents

In most cases, the minority interest does not significantly impact financial results. When investors want to calculate the enterprise multiple or similar fundamental ratios, minority interests need to be added to enterprise value there as well.

Hypothetically, it could be possible to subtract the portion of earnings or earnings before interest, taxes, depreciation and amortization (EBITDA) owed to the minority interest from the parent company before performing some of the calculations. Often, however, the minority interest is not a public company and does not have to face public reporting standards. It would be too difficult to find the specific financial separation, so this method of forming enterprise value is the most efficient proxy.

RELATED FAQS
  1. What is the relationship between minority interest discount and fair market value?

    Learn how to determine the fair market value and minority interest discount for the sale of a share of a closely held corporation. Read Answer >>
  2. Why do investors with minority interest receive a minority interest discount and ...

    Discover why investors with minority interest usually receive a discount to the fair value of their ownership share, and ... Read Answer >>
  3. Enterprise value versus market capitalization

    Learn the difference between market capitalization and enterprise value, and understand how these two common valuation tools ... Read Answer >>
  4. What are the pros and cons of holding a non-controlling interest in a company?

    Read about the advantages and disadvantages of a non-controlling interest in a company, including large corporations and ... Read Answer >>
Related Articles
  1. Investing

    Understanding Verizon's Capital Structure (VZ)

    Verizon has a highly leveraged capital structure, and this debt capitalization and the company's equity have affected its enterprise value.
  2. Investing

    Yahoo Stock: Capital Structure Analysis (YHOO)

    Learn about Yahoo's capital structure, including whether or not a decline in year-over-year earnings is leading the company to use more debt.
  3. Investing

    Using Enterprise Value To Compare Companies

    Learn how enterprise value can help investors compare companies with different capital structures.
  4. Financial Advisor

    Growing Minorities and Advisors: An Opportunity

    The growing wealth and size of minority groups present an opportunity for advisors, but first they should consider their unique needs and characteristics.
  5. Investing

    Verizon Stock: Capital Structure Analysis (VZ)

    Investigate Verizon's capital structure, and understand how debt and equity capitalization and enterprise value interact with each other.
  6. Investing

    HP Enterprise Shares Hit Hard After Poor Quarter

    After HP Enterprise (NYSE: HPE) reported a 10% drop in sales in fiscal 2017's first quarter, and a year-over-year decline in revenue of more than $1.3 billion to just $11.4 billion, it appears ...
  7. Personal Finance

    What to know for an investment banking interview

    Find out what you need to know and how to prepare for an investment banking interview.
  8. Investing

    Nike Stock: Capital Structure Analysis (NKE)

    Analyze Nike's capital structure to understand how the business is being financed. Discover how much equity capital is used and what trends have developed.
RELATED TERMS
  1. Minority Interest

    1. A significant but non-controlling ownership of less than 5 ...
  2. Custodial Account

    1. An account created at a bank, brokerage firm or mutual fund ...
  3. Enterprise Value (EV)

    Enterprise Value (EV) is a measure of a company's total value, ...
  4. Uniform Transfers To Minors Act - UTMA

    An act that allows a minor to receive gifts such as money, patents, ...
  5. Freeze Out

    An action taken by a firm's majority shareholders that pressures ...
  6. Exempt Transaction

    A type of securities transaction where a business does not need ...
Hot Definitions
  1. Donchian Channels

    A moving average indicator developed by Richard Donchian. It plots the highest high and lowest low over the last period time ...
  2. Consumer Price Index - CPI

    A measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, ...
  3. Moving Average - MA

    A moving average (MA) is a widely used indicator in technical analysis that helps smooth out price action by filtering out ...
  4. Stop Order

    A stop order is an order to buy or sell a security when its price increases past a particular point in order to limit losses ...
  5. Inflation

    The rate at which the general level of prices for goods and services is rising and, consequently, the purchasing power of ...
  6. Candlestick

    A chart that displays the high, low, opening and closing prices for a security for a single day. The wide part of the candlestick ...
Trading Center