What Is Non-Controlling Interest?
A non-controlling interest, also known as a minority interest, is an ownership position wherein a shareholder owns less than 50% of outstanding shares and has no control over decisions. Non-controlling interests are measured at the net asset value of entities and do not account for potential voting rights.
Most shareholders of public companies today would be classified as holding a non-controlling interest, with even a 5% to 10% equity stake considered to be a large holding in a single company. A non-controlling interest may be contrasted with a controlling, or majority interest in a company, where the investor does have voting rights and can often affect the course of the company.
- A non-controlling interest, also known as a minority interest, is an ownership position whereby a shareholder owns less than 50% of outstanding shares.
- As a result, minority interest shareholders have no individual control over corporate decisions or votes by themselves.
- A direct non-controlling interest receives a proportionate allocation of all (pre- and post-acquisition amounts) recorded equity of a subsidiary.
- 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 investors with more than 50% ownership seek to impact change in a company.
Understanding Non-Controlling Interest
Most shareholders are granted a set of rights when they purchase common stock, including the right to a cash dividend if the company has sufficient earnings and declares a dividend. Shareholders may also have the right to vote on major corporate decisions, such as a merger or company sale. A corporation can issue different classes of stock, each with different shareholder rights.
Generally, there are two types of non-controlling interests: a direct non-controlling interest and an indirect non-controlling interest. A direct non-controlling interest receives a proportionate allocation of all (pre and post-acquisition amounts) recorded equity of a subsidiary. An indirect non-controlling interest receives a proportionate allocation of a subsidiary's post-acquisition amounts only.
For the majority of publicly traded companies, the number of outstanding shares is so large that an individual investor cannot influence the decisions of senior management. It is generally not until an investor controls 5% to 10% of the shares that they vie for a seat on the board or enact changes at the shareholder meetings through lobbying efforts.
Activist investors are investors that purposefully buy large shares of a company to gain a controlling interest and to enact change within that company. Many hedge funds, private equity funds, and prominent individuals target companies that they believe are mismanaged and can be run more efficiently. Bill Ackman, the CEO of Pershing Square Capital Management, is one of the most widely known activist investors.
Financial Statements and Non-Controlling Interest
Consolidation is a set of financial statements that combine the accounting records of several entities into one set of financials. These typically include a parent company, as the majority owner, a subsidiary, or a purchased firm, and a non-controlling interest company. The consolidated financials allows investors, creditors, and company managers to view the three separate entities as if all three firms are one company.
A consolidation also assumes that a parent and a non-controlling interest company jointly purchased the equity of a subsidiary company. Any transactions between the parent and the subsidiary company, or between the parent and the non-controlling interest firm, are eliminated before the consolidated financial statements are created.
Example of Non-Controlling Interest
Assume that a parent company buys 80% of XYZ firm and that a non-controlling interest company buys the remaining 20% of the new subsidiary, XYZ. The subsidiary’s assets and liabilities on the balance sheet are adjusted to fair market value, and those values are used on the consolidated financial statements. If the parent and a non-controlling interest pay more than the fair value of the net assets, the excess is posted to a goodwill account in the consolidated financial statements.
Goodwill is an additional expense incurred to buy a company for more than the fair market value, and goodwill is amortized into an expense account over time after an impairment test. This is done under the purchase acquisition accounting method approved by the Financial Accounting Standards Board (FASB).