What is Non Controlling Interest?

Key Highlights

• Non controlling interest shareholders lack independent control over corporate decisions or the ability to cast votes individually.

• In the case of a direct non-controlling interest, the shareholder is entitled to a proportional share of all recorded equity of a subsidiary, covering both pre- and post-acquisition amounts.

• An indirect non-controlling interest only receives a proportionate allocation of a subsidiary's post-acquisition amounts.

• A controlling interest grants a shareholder voting rights to influence corporate decisions.

Non Controlling Interest Example

Suppose a parent corporation acquires 80% of XYZ company, with a non-controlling interest entity acquiring the remaining 20% of the newly acquired subsidiary, XYZ. The assets and liabilities of the subsidiary reflected on the balance sheet undergo adjustments to fair market value, and these adjusted values are utilised in preparing the consolidated financial statements. In instances where both the parent and non-controlling interest pay an amount exceeding the fair value of the net assets, the surplus is recorded in a goodwill account within the consolidated financial statements.

Goodwill represents an additional cost incurred when acquiring a company at a price surpassing its fair market value. This goodwill is subject to amortisation over time, following an impairment test, and is allocated to an expense account.

Criteria for Non Controlling interest

Non-controlling interest commonly arises when a company possesses more than 50% but less than 100% ownership of another entity. The dominant voting power of the first company grants it effective control over the second company. However, it's important to note that the ownership threshold of 50% is a general guideline. In some instances, a company might consolidate the finances of another entity even with ownership below 50%. This situation may arise when the consolidating company exerts influence over the subsidiary's board of directors, enabling it to guide the subsidiary's business decisions.

Valuation of Non Controlling Interest

Assessing the worth of a company involves examining its financial statements to predict forthcoming trends related to earnings and cash flows more accurately. Nevertheless, when dealing with companies that have non-controlling interests, they typically present consolidated financial statements and often provide insufficient details for a thorough valuation of the non-controlling interest.

1. Constant Growth

The continuous expansion approach is rarely employed due to the presumption that there is minimal fluctuation in the subsidiary company's performance, either in terms of decline or growth.

2. Historical Growth

In the approach of historical growth, an examination of past financial data is conducted to identify prevailing patterns. The model anticipates the expansion of a subsidiary by projecting a growth rate derived from historical trends. This technique is not suitable for companies undergoing rapid growth or significant decline.

3. Modelling Subsidiaries Individually

Analysing each subsidiary independently is the approach taken in this modelling technique. It assesses each subsidiary individually and aggregates their respective interests to derive a consolidated value. While this method offers increased flexibility and theoretically more precise results, its execution is challenging, primarily due to insufficient disclosures from the parent company. Furthermore, the complexity of valuing numerous subsidiaries may render the process time-consuming and impractical.

Financial Statements and Non-Controlling Interest

Consolidation refers to the amalgamation of financial statements that integrate the accounting records of multiple entities into a unified set of financials. These entities typically comprise a parent company, acting as the primary shareholder, a subsidiary or an acquired firm, and a company with a non-controlling interest. Through consolidated financials, investors, creditors, and company managers can examine the three distinct entities as if they constitute a single company.

The process of consolidation also assumes that both the parent and the non-controlling interest company jointly acquired the equity of a subsidiary company. Any transactions occurring between the parent and the subsidiary, or between the parent and the non-controlling interest entity are excluded before the creation of the consolidated financial statements.

Conclusion

Ownership alone does not empower a shareholder to influence the decision-making within a company. Given the existence of various share classes in companies, an investment might involve a non-controlling interest devoid of voting rights or the capacity to impact the company. Therefore, understanding the complexities of non-controlling interests is essential, as they can significantly influence shareholders' investments. This is particularly relevant for shareholders who are not actively engaged in the company and hold less than a 5% 10% stake, as they may find themselves dealing with issues related to non-controlling interests.