What is Minority Interest In Business?
Definition: Minority interest refers to a situation where a shareholder or a group of shareholders own less than 50 percent of a company’s shares with voting rights. This means that this individual or individuals do not have controlling interest over the company.
Every company that operates within the legal realm of business has investors or stakeholders that own shares in it. This allows them to be part of the decision-making process that influences the direction of the company. In other words, share ownership creates a controlling interest in a company.
Minority interest is usually held by an individual or another firm other than the company issuing the shares. The idea is that majority shareholding remains within the hands of those that are genuinely interested and actively involved in the company’s operations as to pursue its perpetual success. Otherwise, if the controlling interest lands it the hands of a competing firm, then the rival firm would likely make key decisions that would hold back the firm from its full potential.
Minority Interest Value
Minority value creates value for the shareholder whether it’s an individual or a company. Although they might not have the power to control the direction of the firm, it will still allow the shareholder to benefit in terms of dividends without having to be involved in making decisions about the company’s future. Companies that hold a minority stake in rival companies are smart for doing so because it allows them to make money in dividends if their rival performs well.
A company that has invested in the shares of another company treats that investment as non-current liabilities in its balance sheet as per the Generally Accepted Accounting Principles (GAAP). However, it is considered under the equity section of a balance sheet as per the International Financial Reporting Standards (IFRS). Minority interest may also provide some additional rights such as allowing the minority interest shareholders to access various audit rights or allowing them to participate in sales.
Minority Interest Classification
Minority interest can be classified as either active or passive. The latter refers to a situation where the shareholder owns less than 20 percent of the company’s shares. This approach is commonly used by parent companies when it comes to share ownership in their subsidiaries and it prevents the subsidiary from influencing the parent firm.
An active stake is usually above 20 percent to 49 percent of the shares. In such a case, a subsidiary would have enough power in terms of voting rights to influence the direction of its parent company. When it comes to active minority interest, companies record the dividends received from their minority shares in another company and it is usually indicated as a percentage of income. This means that the company earning dividends from minority interest would have some level of control on the decision making processes of the parent company.
In most companies, the management usually has the largest shareholding or at least has a significant shareholding. This is done so that the management will be motivated to steer the company in the right direction where it can generate value for investors. This is usually part of the 50 percent or more of the shares.
Sometimes the minority interest might be in the hands of a few shareholders but it still allows them to have controlling power. For example, two or three individuals might own 40 percent of the shares while the remaining 60 percent is distributed to a large number of investors. In this case, the two or three shareholders that own the 40 percent stake in the company can work together to achieve controlling interest in a firm. This type of situation may allow the minority stake investors to make decisions that steer the company to a different direction than what other shareholders want or they may simply go against the wishes of the upper management.