What is the significance of investor influence?
The level of investor influence a company holds in an investment transactionInvestment MethodsThis guide and overview of investment methods outlines they main ways investors try to make money and manage risk in capital markets. An investment is any asset or instrument purchased with the intention of selling it for a price higher than the purchase price at some future point in time (capital gains), or with the hope that the asset will directly bring in income (such as rental income or dividends). determines the method of accounting for said private investment. The accounting for the investment varies with the level of control the investor possesses.
What are the varying levels of control?
An investor can hold a majority ownership or minority interest in a company it owns or has invested in. If it holds a minority interest, this control can be further divided into two levels, where the investor either has minority active or minority passive control.
#1 Majority ownership
Majority ownership exists when an investor holds more than 50% of a company’s shares. This gives the investor effective control of the company. Investments in this company are then accounted for using the consolidation methodConsolidation MethodThe consolidation method is a type of investment accounting used for consolidating the financial statements of majority ownership investments. This method can only be used when the investor possesses effective control of a subsidiary, which often assumes the investor owns at least 50.1%. Note that having exactly 50% of a company’s shares does not necessarily mean effective control for an investor, as another investor holding the other 50% would result in a split.
#2 Minority – active
A minority active interest exists when the investor holds 20-50% of the company’s shares. This gives the investor the ability to influence management decisions, but not to control them entirely. Investments of this type are accounted for using the equity method.
#3 Minority – passive
Finally, a minority passive ownership interest exists when the investor holds less than 20% of the company’s shares. This gives them no significant influence over the company. Investments in this company are accounted for using the cost methodCost MethodThe cost method is a type of accounting used for investments, where the investor holds little to no influence over the investee. Ulike the consolidation method, the terminology of “parent” and “subsidiary” are not used since the investor does not exert full control. Instead, the term “investment” is simply used or the market method, and may be classified as publicPublic SecuritiesPublic securities, or marketable securities, are investments that are openly or easily traded in a market. The securities are either equity or debt-based. or marketable securities.Marketable SecuritiesMarketable securities are unrestricted short-term financial instruments that are issued either for equity securities or for debt securities of a publicly listed company. The issuing company creates these instruments for the express purpose of raising funds to further finance business activities and expansion.
Ownership guidelines
It is important to note that the classifications above are simply guidelines to classify the degree of influence an investor possesses over a company.
In reality, there may be circumstances where these guidelines don’t apply. For example, if an investor owns less than 20% of a company but holds significant influence in it, then it may use the equity methodEquity MethodThe equity method is a type of accounting used in investments. This method is used when the investor holds significant influence over investee, but not full control over it, as in the relationship between parent and subsidiary. This differs from the consolidation method where the investor exerts full control to account for its investments in said company.
In another example, if an investor owns a 51% share in a company, but does not exercise effective control over it, then it may not use the consolidation method to account for its investments.
Additional Resources
See the following resources from CFI to learn more about equity investing and accounting.
- Private equityPrivate Equity Career ProfilePrivate equity analysts & associates perform similar work as in investment banking. The job includes financial modeling, valuation, long hours & high pay. Private equity (PE) is a common career progression for investment bankers (IB). Analysts in IB often dream of “graduating” to the buy side,
- Investment methodsInvestment MethodsThis guide and overview of investment methods outlines they main ways investors try to make money and manage risk in capital markets. An investment is any asset or instrument purchased with the intention of selling it for a price higher than the purchase price at some future point in time (capital gains), or with the hope that the asset will directly bring in income (such as rental income or dividends).
- Public securitiesPublic SecuritiesPublic securities, or marketable securities, are investments that are openly or easily traded in a market. The securities are either equity or debt-based.
- Consolidation methodConsolidation MethodThe consolidation method is a type of investment accounting used for consolidating the financial statements of majority ownership investments. This method can only be used when the investor possesses effective control of a subsidiary, which often assumes the investor owns at least 50.1%
- Equity methodEquity MethodThe equity method is a type of accounting used in investments. This method is used when the investor holds significant influence over investee, but not full control over it, as in the relationship between parent and subsidiary. This differs from the consolidation method where the investor exerts full control
- Cost methodCost MethodThe cost method is a type of accounting used for investments, where the investor holds little to no influence over the investee. Ulike the consolidation method, the terminology of “parent” and “subsidiary” are not used since the investor does not exert full control. Instead, the term “investment” is simply used
