What is non-controlling interest?

Companies need to keep track of all the investors who have bought or sold their shares. The aim behind the move is to know who the company's part owners are and how the company will distribute the profits in case it declares a dividend. On the investors' part, becoming part owners comes with numerous benefits, the most important being voting rights. However, the ownership may come with non-controlling interest where the investors have no way to control the direction of the company.

This article will help you understand the non-controlling interest definition and how it can affect your investments.

What is non-controlling interest?

Non-controlling interest, also known as minority interest, is where shareholders (entities who buy the shares of a company and become part owners) hold less than 50% of the total outstanding shares of the company. Since non-controlling interest gives the shareholders no voting rights, they have no say in the decision making of the company. The non-controlling interest is calculated at the NAV (net asset value) of entities without accounting for the voting rights of the shareholders.

Almost all the shareholders who buy shares of a company from the secondary market are classified as holding interest, which is always non-controlling interest. Only when the shareholders have 5%-10% holdings in a company, which is considered large, can they push for voting rights and a seat on the board of the company.

The opposite of non-controlling interest for the shareholders is when a shareholder holds more than 50% of the total outstanding shares of the company. The situation is called controlling interest and provides shareholders with voting rights to impact the company’s decision making.

Understanding non-controlling interest

If any entity buys more than 50% of a company, it is automatically deemed as the controlling owner and can influence the decision making of the company. However, if an entity such as a shareholder buys less than 50%, they may be given non-controlling interest with no say in the company’s decision making.

companies grant a slew of rights to the shareholders when they buy their stocks. However, the companies are entitled to issue different classes of shares, with some coming with voting rights while some do not. If the entity that has purchased the shares is considered to be a non-controlling interest, it has no right to influence the decisions taken, even if they may hurt the company.

Example of non-controlling interest

Suppose a company is for sale and another company XYZ buys 70% of the company while PQR buys the remaining 30%. The bought company is then called the subsidiary of XYZ and PQR and its assets and liabilities represented on the balance sheet are adjusted as per the fair market value. These values are used on the consolidated financial records of the two companies in the proportion of their holdings.

However, as PQR holds less than 50% of the subsidiary, its holding is deemed a non-controlling interest and does not entitle the company to have a say in the subsidiary’s decision making. XYZ would be solely responsible for making the critical decisions as it holds a controlling stake.

Types of non-controlling interest

As companies can issue different classes of stocks, they all come with different shareholder rights. In the case of non-controlling interest, the classes are of two types:

• Direct Non-Controlling Interest: This type of non-controlling interest receives a share of all the recorded equity of a subsidiary in the proportion of the percentage of holdings. It includes both pre and post-acquisition amounts.
• Indirect Non-Controlling Interest: This form of non-controlling interest receives a share of all the recorded post-acquisition equity of the bought subsidiary. No amount is received for the pre-acquisition equity.

Calculating the share of equity

When calculating the non-controlling interest share of equity, the consolidated equity of the subsidiary is considered rather than the recorded equity. Hence, when calculating the direct non-controlling interest and indirect non-controlling interest, adjustments are made to remove unrealised profits or losses that arise from various transactions. Furthermore, investors need to understand how the company is approaching non-controlling interests. It is critical for measuring the effects of the non-controlling interest on the consolidated financial results, cash flows and overall risks.

Final Word

Ownership does not mean that a shareholder can influence the decision making of the company. As the companies may have numerous classes of shares, the investment may come with non-controlling interest, without any voting rights or the possibility of company impact. Hence, it is vital to understand the structure of non-controlling interests and how they can affect the shareholders' investments.

If the shareholder is not an active investor with 5%-10% of the holdings, it is more than possible to get an issue of non-controlling interest. For any further queries, you can head to IIFL’s website and read the previous financial blogs.