What is Non Controlling Interest?
Definition: Non controlling interest is an ownership stake whereby an individual or an institution owns less than 50% stake in a company or business. The lack of controlling interest means an investor cannot control management decisions, but he or she can influence them. Most shareholders in public companies hold non-controlling rights given the less than 50% stake they own in the companies.
Understanding Non-Controlling Interest
In most public companies, the number of outstanding shares is so large that no single investor can influence senior management. Likewise, the ownership structure is so robust such that there are thousands of investors with ownership stakes in the company. Given the ownership structure, it is common to find investors with 5% to 10% non controlling interest having a massive influence on the running of the company.
Similarly, a 5% to 10% non-controlling stake in a big public company can entitle an investor a seat on the board of directors. In this case, an investor would be able to influence management decisions despite having a non-controlling stake. A seat in the board could allow an investor to push for changes at shareholder meetings through lobbying.
Non Controlling Interest Example
Companies also acquire stakes in other companies which can either be controlling or non-controlling. Suppose company XYZ acquires 80% of the outstanding stock of company ABC. Because it owns more than 50%, it assumes a controlling role.
In this case, company XYZ can consolidate company ABC financial results with its own. Conversely, net income is allocated to the parent company and non controlling shareholders in proportion of ownership percentages, which is 80% to XYZ and 20% to ABC.
When it comes to shareholders’ equity, non-controlling interest is normally recorded in the parent company balance sheet. However, it is separate from the parent’s equity. Likewise, the amount of consolidated net income attributable to parent entities is consolidated in the income statement.
Companies have a choice on what figure to show on the balance sheet when it comes to non-controlling interests. Firstly, they can recognize the NCI as a percentage of the equity that the majority does not own. In this case, NCI will appear as a percentage of identifiable fair value for net assets.
Secondly, it is possible to recognize NCI at its fair value. The fair value is arrived at by using valuation methodologies such as the use of multiples. The fair value must also come with some goodwill on the NCI stake.
Types of Non Controlling Interest
Upon investing in a company, investors are normally granted a set of rights tied to the stakes they own in the business. The rights may include a right to cash distributions in the form of dividends. A shareholder may also have a right to vote in major company decisions, which include acquisitions or mergers. Therefore, corporations issue different classes of stock with varying rights of shareholders.
The two types of non-controlling interests: direct and indirect.
Direct non-controlling interest is where an owner is entitled to a proportionate share of equity recorded by a subsidiary. These distributions include equity distributions as well as pre-acquisition and post-acquisition amounts. An indirect non-controlling interest on the other hand refers to the ownership of a proportionate share post-acquisition equity only.
Public companies must be transparent about ownership structures in their rankings. This is the only way investors would be able to understand the impact of non-controlling interest in a group‘s financial position as well as financial results and cash flows. Likewise, the information helps shed more light on the risks that a business faces crucial for making investment decisions.
Summary
A non-controlling interest refers to an ownership structure whereby an investor owns less than 50% stake in a company. It also refers to the ownership stake in any subsidiary whereby a company owns under 50% of the shares of the company.