Non-controlling or minority interest

Understanding minority interests, knowing how it affects operations and knowing how to calculate it is very important if you want to analyze prospective investments. Minority interest valuation is helpful in calculating the value of the enterprise and in shareholder value analysis. The enterprise value is computed by adding the minority interest to the market capitalization. Minority interest is treated as a company debts. Minority interest valuation is very crucial when reporting more than 51 percent of investments in a subsidiary, which is done in consolidation accounting.

Basically, firms acquire control of a subsidiary by buying more than 50 percent of shares but also, acquiring as low as 51 percent reduces the risk to capital compared when the parent company is making an investment of 100 percent. Again, minority interest valuation becomes important to understand the mix between minority and majority interest because it is harder for a parent company to acquire 100 percent since not all shareholders will want to part with their stock.

Minority interest is mainly used in the valuation ratios such as the Enterprise-Value-To-Sales (EV/Sales). Another ratio where minority interest is used is the Enterprise Multiple (EV/EBITDA). In order to ensure that the numerator and denominator of these ratios reflect the financial status of the company even in the case where the controlling company owns less than 100 percent of the company, the minority interest must be added. This ensures that the parent company does not own back the Enterprise Value since, as a requirement, the subsidiary’s sales or EBITDA have to be included in the controlling company’s income statement.

Equity ownership in a subsidiary is divided between controlling and non-controlling interest. The controlling interest is the portion of equity ownership that is owned by the parent firm, which owns more than 50 percent of the shares. The parent company is able to consolidate the financial results of the subsidiary with its own. If the equity ownership in a subsidiary is not attributable to the parent company, it is referred to as the minority interest. The rest of equity not consolidate with the controlling company’s financial results is recorded as NCI on Alpha’s balance sheet.

Although the items in the financial statements of the parent company reflect a fictitious 100 percent ownership of the subsidiary, the minority interest value of the subsidiary and profits that accrue to the minority owners are tracked through separate accounts on the income statement and balance sheet of the controlling company.

How to measure minority interests

In shareholder value analysis, minority interest valuation starts by finding the book value -- namely the total assets less intangible assets and liabilities -- of the subsidiary as recorded on the balance sheet. The intangible values include the patents and goodwill. The book value is multiplied by the percentage of subsidiary owned by minority shareholders.

The net income of the minority interest owners is then calculated. It is achieved by multiplying the total net income of the subsidiary by the minority percentage ownership (percent owned by the minority group).