Minority Interest in Enterprise Value Calculation

Why is Minority Interest added to Enterprise Value?

When a company owns more than 50% (but less than 100%) of a subsidiary, they record all 100% of that company’s revenue, costs, and other income statement items, even though they don’t own all 100% of it.  Therefore, when you look at a company’s EV/EBITDA multiple, minority interest (the value of the subsidiary not owned by the parent) has to be added to EV, since EBITDA includes 100% of the revenue and expenses from that subsidiary.

 

minority interest in enterprise value to ebitda

 

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What is Enterprise Value?

Enterprise Value or EV is a measure of a company’s worth. As a measure of company worth, it is superior to other measures such as just Equity Market Capitalization and also includes the Market Value of Debt and Minority Interest. Enterprise Value is often termed as the takeover price because, in the event of a takeover, EV is the selling price of the company.

The formula for Enterprise Value is as follows:

Enterprise Value = Market value of common stock + Market value of preferred equity + Market value of debt + Minority interest – Cash.

 

What is Minority Interest (Non-Controlling Interest)?

Minority interest, or non-controlling interest (NCI), represents an ownership stake of less than 50% in a company (hence the term minority, or non-controlling). For accounting purposes, minority interest is classified as a non-current liability and shows up on the balance sheet of the company that owns a majority interest in the company.

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Impact of consolidated reporting requirements

As per U.S. accounting rules, when a company owns more than 50% of another company, then the parent company must consolidate its books of account.

If company XYZ owns more than 50% (say 80%) of company ABC, then as per U.S. accounting rules, the financial statements of XYZ reflect all the assets and liabilities of ABC and 100% of the financial performance of ABC.

Thus, whether XYZ owns 50.1% or 100% of ABC, the financial statements of XYZ will show 100% of the assets and liabilities of ABC and 100% of the Sales, Revenue, Costs, Profits/Loss, etc. of ABC.

However, since the parent company (XYZ) does not own 100% of the subsidiary (ABC), XYZ’s income statement will specify that amount of net income that goes to ABC. This amount is the Minority Interest and reflects the book value (not market value) of the subsidiary (ABC) which the parent (XYZ) does not own.

 

Why is Minority Interest included in Enterprise Value calculation?

Enterprise Value is primarily used in Valuation Ratios such as EV/Total Sales, EV/EBIT, and EV/EBITDA.

Consider the example given above where XYZ owns 80% of ABC. As discussed above, because of accounting regulations, the consolidated financial statements of XYZ will reflect 100% of the Total Sales, EBIT and EBITDA, etc. of the subsidiary ABC even though XYZ only owns 80% of ABC.

For these ratios to be meaningful, the numerator must be adjusted to allow for an “apples to apples” comparison between EV and Total Sales, EBIT, and EBITDA, etc. This is done by adding to Enterprise Value the equity value of the subsidiary that the parent company does not own (the minority interest).  This results in both the numerator and denominator of the various valuation ratios accounting for 100% of the subsidiary company in terms of equity, Total Sales, EBIT and EBITDA.

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Minority Interest alternative: adjust the income statement instead

Another way in which we could arrive at a similar result is if we were to only include that proportion of Total Sales, EBIT and EBITDA in the valuation ratios that the parent company (XYZ) owns in ABC.

If we do not wish to add the minority interest to Enterprise Value, we would only include 80% of ABC’s Total Sales, EBIT and EBITDA in the calculation of the various valuation ratios.

The problem with this second method lies in the fact that as per U.S. accounting regulations, companies are only required to supply one consolidated Financial Statements and not provide separate financial statements of all its subsidiaries.

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Summary of minority interest in enterprise value

  1. The aim of adding minority interest to EV is to facilitate an “apples to apples” comparison between EV and figures such as Total Sales, EBIT and EBITDA.
  2. The equity value shown in the consolidated financial statement will always show the value of the parent company’s stake in its subsidiaries. Thus if the parent company owns 80% of its subsidiary and its subsidiary is worth $1,000, then the equity value reflects 80% of $1,000, or $800.
  3. A problem arises because according to accounting regulations, the parent company must show 100% of all other figures related to its subsidiaries if it owns more than 50% of its subsidiary.
  4. Thus the parent company can’t reflect 80% of figures such as Total Sales, EBIT and EBITDA. This creates a problem regarding the calculation of various valuation ratios such as EV/Total Sales, EV/EBIT, and EV/EBITDA, because the numerator only reflects 80% of the subsidiary whereas the denominator reflects 100% of the subsidiary.
  5. It is usually not possible or practical to adjust the denominator because companies don’t disclose enough information. Therefore, we adjust the numerator to reflect 100% of the subsidiary.

 

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