Non-Controlling InterestAn Ownership Stake In A Corporation That Holds Little To No Influence Over Business Decisions

A business may be owned by one or many individuals. If a business has only one owner, then it’s a sole proprietorship.

If a business has more than one owner, then it may either be a partnership or a corporation.

The thing with partnerships though is that almost all the time, each partner (owners of a partnership) has significant influence over major business decisions.

With corporations, that’s always not the case. Additionally, corporations typically have multiple owners – much more than a typical partnership.

Add to that the transferrable nature of ownership in a corporation, and it’s often the case that a lot of shareholders (owners of a corporation) don’t have significant influence or control.

So how can a shareholder have significant influence or control over a corporation’s business decisions?

Well, it will depend on how many shares the shareholder holds.

For example, if a shareholder holds at least 50% of the corporation’s outstanding shares, then that shareholder technically owns at least 50% of the said corporation.

With such a huge percentage of ownership, it wouldn’t be unnatural to expect that such a shareholder will hold significant influence over business decisions.

But what happens to the rest of the shareholders? In most corporations, a bulk of their shareholders don’t hold enough shares to exert enough influence.

Rather, what these shareholders hold is non-controlling interest. This means that the portion of ownership of these shareholders is too small to have any influence over business decisions.

In this article, we will be discussing what non-controlling interest is.

How does one define non-controlling interest?

What are its effects on a corporation’s valuation?

How does a business account for it?

We’ll try to answer these questions as we go along with the article.

What is Non-Controlling Interest?’

Non-controlling interest (a.k.a. minority interest) is an ownership stake in a corporation that is less than 50%.

Additionally, this ownership stake gives the shareholder little to no influence at all on how the corporation operates.

This criterion is important as less than 50% is a wide range of percentages.

In some cases, a 5% to 10% ownership stake may already give the shareholder enough influence over business decisions such as pushing for a seat on the board or advocating major changes at shareholders’ meetings.

Do note that non-controlling interest doesn’t automatically mean that the shareholder doesn’t have voting rights.

It only means that its influence isn’t enough to significantly affect business operations and decisions.

In contrast, a controlling interest gives the shareholder significant influence over any business decision.

By definition, controlling interest means that the shareholder owns at least 50% of the corporation’s outstanding shares.

However, controlling interest can still be acquired even with less than 50% as long as the shareholder holds a significant portion (usually 50% and up) of the voting shares.

This only happens though if the corporation has shares that don’t carry any voting power.

A non-controlling interest still grants the shareholders some benefits such as the right to receive dividends if the corporation declares and distributes a dividend.

It also gives the shareholder certain audit rights as well as the right to participate in the sale or merger of the corporation.

Direct and Indirect Non-Controlling Interest

Non-controlling interest may either be direct or indirect depending on certain circumstances:

Direct Non-Controlling Interest

Non-controlling interest is direct when the shareholder gets his/her share directly from the subsidiary corporation.

For example, if you purchase 1% of company A’s total outstanding shares, then your ownership stake is a direct non-controlling interest.

A direct non-controlling interest receives a proportionate share of all the equity that is recorded by the subsidiary corporation.

This should include both pre-acquisition and post-acquisition amounts of the equity balance.

Indirect Non-Controlling Interest

Non-controlling interest becomes indirect when the ownership stake is acquired by the shareholder indirectly through having an ownership stake in the subsidiary company’s parent company.

In other words, the shareholder indirectly owns the subsidiary company.

For example, you own shares of company A.

Company A also owns 70% of the shares of company B.

Since you own a certain percentage of company A which partially owns company B, you indirectly become an owner of company B also.

If the percentage of ownership does not provide significant influence over business decisions, then it’s indirect non-controlling interest.

Like with direct non-controlling interest, indirect non-controlling interest receives a portion of the subsidiary’s equity.

However, unlike direct non-controlling interest, indirect non-controlling interest only receives a portion of the subsidiary’s post-acquisition equity only.

Accounting for Non-Controlling Interest

Whoever has a controlling interest in the subsidiary company will have to consolidate its financial statements.

This means that the parent company will combine its financial statements with its subsidiary company (or companies).

The parent company’s percentage of ownership of the subsidiary company won’t matter as long as it’s enough to secure a controlling interest.

If the parent company owns 100% of the subsidiary company’s shares, then consolidating the financial statements will be relatively easier.

The parent company does not have to account for non-controlling interest.

However, if the parent company owns less than 100% of the subsidiary company’s shares, then it will have to account for non-controlling interest.

It should appear on the consolidated balance sheet as non-controlling interest (an equity account). The income statement must also allocate a proportionate amount of net income for non-controlling interest.

Do note that when consolidating financial statements, the effects of any transactions between the parent company and subsidiary company, as well as those between the parent company and the non-controlling interest must be eliminated.

Those the hold non-controlling interest in the subsidiary company will either the cost or equity method.

A shareholder that holds 20% or less ownership will use the cost method, in which the non-controlling interest is treated as an investment and is recorded at cost.

A shareholder that holds more than 20% but less than 50% ownership will use the equity method.

Under the equity method, the shareholder records a percentage of the subsidiary company’s income as its own income.

Under these two methods, the shareholder does not report non-controlling interest in the balance sheet or income statement.