Sep 26, 2007

Why do we add back the minority interest when calculating the Enterprise value?

### What is Minority Interest?

Minority interest is an accounting concept that refers to a situation when a parent company owns over 50% of another firm. Due to the fact that the parent company has majority ownership of the subsidiary, it includes the assets, income, liabilities etc of the subsidiary in its balance sheet. However, if it does not own 100% of the subsidiary then it does not actually have claim to 100% of the financial performance, and whatever percentage it does NOT own must be subtracted as a liability.

### Adding Minority Interest in the Enterprise Value (EV) Formula

First, let's review the Enterprise Calculation.

The calculation for Enterprise Value is:

Market Capitalization + Debt + Minority Interest + Preferred Shares - Cash & Cash Equivalents

With that being said, minority interest is an important factor in Enterprise Value. If the company being valued has majority ownership in another company, whatever percentage it does NOT own must be added on to equity value because the parent company will not have all of the claim on assets, income etc of the subsidiary.

Another way to think of it is that since you are accounting for the full subsidiary throughout the financial statements - if we want to look at metrics such as EV/Revenue or EV/EBITDA the Enterprise value needs to account for the value of the main company and the subsidiary since the denominator accounts for the main company and the subsidiary. This allows you to compare apples to apples rather than apples to oranges.

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Region

Minority interest is part of the enterprise value. It could be thought of as the minority ownership in the company. Since you're trying to find the total value of the company(EV), then it clearly must be added in.

If you get a chance to take Business combinations and consolidations while in school, do it.

Bracketracer:

minority interest is part of the enterprise value. It could be thought of as the minority ownership in the company. Since you're trying to find the total value of the company(EV), then it clearly must be added in.

If you get a chance to take Business combinations and consolidations while in school, do it.

This is not right at all. Like I can't even fathom your logic behind thinking this. If you get a chance to take Business combinations and consolidations while in school, do it again.

when calculating Enterprise Value you're trying to find the total value of the company. Another way of thinking about it is what would you have to pay to acquire the company (acquisition value)? Thus, you need to include all minority interests in the company.

This is my understanding of it: When P owns 50%+ of S, it consolidates its financial statements and reports all of S's revenues, expenses, etc which is reflected in the denominator of multiples like EV/EBITDA and EV/Sales. So in order to make it more "apples to apples" you have to add back the minority interest in the numerator to account for all of S's value (since the denominator counts for all of S's operating results).

The above poster is right.

minority interest is the biggest scam that FASB has ever pulled.

Initially minority interest showed up in liabilities. So when you're looking at credit multiples: Liabilities / Equity or Liabilities/Total Capital, you would see that the ratio increases if you have non-controlling interest in a company (in this case, your 30%).

But in 2008 FASB changed it so that minority interest shows up in Equity instead of liabilities. This improves credit multiples: both assets and equity go up, and your % equity of your total assets goes up.

Thank you very much Asdfad123123. It is crystal clear now. Thank you very much lavak3. You response deepened my understanding of minority interest.

Thank you both of you.

sorry not into asian women.

usually you are trying to find the total value of the business, you should realize that any common share or equity analysis should then also reflect the minority interest adjustment (the equity value leftover isn't all yours, some goes to the minority interest holder). Usually just a rounding error, so doesn't matter. Matters only when minority interest begins to make up a big portion of the company

Blew my mind.

For those of you who actually want to learn something relevant to the banking trade, read this.

Array

subscribed.

Liked the analogy of a company that owns over 50% of another company but has no debt, while the sub has a lot of debt, to a private equity company. Definitely helped me better understand how PE works. Entire post was really helpful actually, would recommend anyone still going through interviews or otherwise to read it all.

Boom!

Start a blog.

"After you work on Wall Street it’s a choice, would you rather work at McDonalds or on the sell-side? I would choose McDonalds over the sell-side.” - David Tepper

Bumping.....just because

"After you work on Wall Street it’s a choice, would you rather work at McDonalds or on the sell-side? I would choose McDonalds over the sell-side.” - David Tepper

"Some purists would argue that the interest on excess cash is already incorporated into the FCF..."

Why would this be the case? In most cases, you are not considering interest income in FCF calculations so excess cash is not included in the EV which is the result of DCF. When constructing your cash flows, you are taking into operating revenues, operating costs etc so that your DCF result is the value of the operating assets, the EV.

Going to the equity value you add this cash as it was not already there in DCF in the first place. Additionally you would want to add any non operating assets and deduct any non operating liabilities, provided that these were not included in DCF in the first place. (i.e. cash from these assets/liabilities)

FCF by definition, is all the cash flow that is available to the owners of capital - the stock AND bond holders, excess or not. How we value the streams that make up the FCF is really at issue here. I understand what you are saying and don't disagree. I did point out that if excess cash was included in the FCF used to calculate the EV, then the discount rate would have to be adjusted. Ultimately you should get the same answer::PV of FCF(without interest from excess cash) @ discount rate + EXCESS CASH vs. PV of FCF(with interest from excess cash) @ adjusted discount rate + ZERO excess cash.

"Some purists would argue that the interest on excess cash is already incorporated into the FCF thus thereby making the "excess" not excess, but that is usually not very significant and distracting from the discussion. If this interest were a significant portion of the cash flows, one would have to consider the fact that the market would take this into account in determining the cost of capital to discount the company's FCF - the company's WACC would change, because a large component of its earnings and cash flow would be essentially be lower risk, and the market cap would still reflect the amount appropriately. But this still does change the fact that the "value of operations" should only include the level of cash that is required for operational needs."

The thing is that it's usually extremely difficult, if not impossible, to tell what is excess vs. what is not. That's really a subjective determination. So then when you are determining the what the appropriate discount rate should be, when you list out comps for your baseline assumptions, you'd have to try and isolate any "excess" they have may have as well, for the market returns will reflect that implicitly. At some point the value-add from the analysis approaches not worth doing it, unless it's patently obvious what the value drivers are. But yes, I agree I could have phrased it better in my post and thanks for pointing that out.

Bracketracer:
Minority interest is part of the enterprise value. It could be thought of as the minority ownership in the company. Since you're trying to find the total value of the company(EV), then it clearly must be added in.

If you get a chance to take Business combinations and consolidations while in school, do it.

This is wrong. Minority interest is NOT part of the enterprise value. EV is the market value of equity and net debt. Back to school for you
nystateofmind:
when calculating Enterprise Value you're trying to find the total value of the company. Another way of thinking about it is what would you have to pay to acquire the company (acquisition value)? Thus, you need to include all minority interests in the company.
This is wrong. What you have to pay to acquire the company is the equity value (plus any premium to induce the owners to sell) â€“ you do not need to include all minority interests in the company
napoleon:
usually you are trying to find the total value of the business, you should realize that any common share or equity analysis should then also reflect the minority interest adjustment (the equity value leftover isn't all yours, some goes to the minority interest holder). Usually just a rounding error, so doesn't matter. Matters only when minority interest begins to make up a big portion of the company
This is right but has nothing to do with the original question. The profit for the year is not the bottom of the income statement â€“ itâ€™s the profit attributable to equity holders.
wiseguy:
Why do we add back the minority interest when calculating the Enterprise value?
You donâ€™t add minority interest when calculating EV, you do it when calculating adjusted EV. This is to ensure that the numerator and denominator are consistent when calculation comps. Enterprise Value metrics are used to compare companies where you donâ€™t want the comparison to be distorted by different capital structures. Because of that, any multiple where the denominator refers to a line below EBIT (operating profit) is meaningless. For the same reason, any comparison using equity value (market cap) to compare numbers above EBIT is also meaningless.

In the consolidation of companies, you bring in 100% of the results of controlled companies. If one or more of these companies has minority interests, you need to either adjust the results (reversing out the share or revenue, costs, etc) to reflect the part of the company that does not belong to you (adjusting the denominator) or to add the value of the minority to the EV (adjusting the numerator). Of the two methods, the latter is easier â€“ which is why is the most common.

For the same reason, you need to adjust for associates and investments if you are looking above the Operating Profit line.

John Mack:
Bracketracer:
Minority interest is part of the enterprise value. It could be thought of as the minority ownership in the company. Since you're trying to find the total value of the company(EV), then it clearly must be added in.

If you get a chance to take Business combinations and consolidations while in school, do it.

This is wrong. Minority interest is NOT part of the enterprise value. EV is the market value of equity and net debt. Back to school for you

Wrong....

Enterprise value (EV), Total enterprise value (TEV), or Firm value (FV) is a market value measure of a company from the point of view of the aggregate of all the financing sources; debtholders, preferred shareholders, minority shareholders and common equity holders.

Bracketracer:

Wrong....

Enterprise value (EV), Total enterprise value (TEV), or Firm value (FV) is a market value measure of a company from the point of view of the aggregate of all the financing sources; debtholders, preferred shareholders, minority shareholders and common equity holders.

Sure - if you want to use Wikipedia as your reference point for financial analysis instead of actually thinking about what the purpose of a metric is for.

Word?

Fo sho

Surprisingly good read. Good job dave man.

Nice considerations. Should be helpful to all future monkeys when confronted with this question. Might actually bring up an interesting discussion instead of just ticking the formula box.

wasn't this already posted a couple days back? good stuff nonetheless

jec:
wasn't this already posted a couple days back? good stuff nonetheless

same guy, double post.

"After you work on Wall Street it’s a choice, would you rather work at McDonalds or on the sell-side? I would choose McDonalds over the sell-side.” - David Tepper

Good stuff!

Thank you for the explanation!

That is untrue. When going from equity value to enterprise value more than net debt is taken into account. Preferred shares and minority interest also must be included. When an acquisition occurs the acquiring company most often needs to take on the acquiring company's debt (thus simply adding a premium to the equity value is inaccurate). Yes, most acquisitions are reported based on some premium to equity value, but the company does in fact need to purchase their debt.

nystateofmind:
That is untrue. When going from equity value to enterprise value more than net debt is taken into account. Preferred shares and minority interest also must be included.
Yes - preference shares are classified as equity. Even if you want to take the intellectual high ground and call it debt, it's still included in one or the other.

For minority interest treatment, I'll refer you back to my previous point. What is the point of enterprise value? What is it used for?

nystateofmind:
When an acquisition occurs the acquiring company most often needs to take on the acquiring company's debt (thus simply adding a premium to the equity value is inaccurate).
Why does your point refute my point? When you acquire a company, all you have to do is buy the equity. There may be covenants that mean you have to play nice with the debt holders but you don't have to buy it unless there's an explicit clause that forces you to.

If you can really back this up then you should call up Blackstone and tell them where they've been going wrong.

nystateofmind:
Yes, most acquisitions are reported based on some premium to equity value, but the company does in fact need to purchase their debt.
No! You DON'T have to purchase the debt - it's all about the equity....

My understanding is that when a parent company owns over 50% of a sub company, 100% of the sub's financials are accounted for in the financial statements.

Since we use Enterprise Value to create ratios with other metrics (EBITDA, Sales, etc.), and EBITDA will contain 100% of financial info from the sub (though we do not own 100%), we need to add minority interest to our Enterprise Value so our ratio is consistent with respect to the numerator and denominator. It seems pretty counter-intuitive, but since our EBITDA figures are going to carry information "as if" we owned 100% of a sub, we have to have our Enterprise Value figure also carry this weight.

Let me know if that makes sense.

Makes sense thank tou - however if we were to use the ratio EV / REVENUE, the minority interests are not included in revenues and our ratio would be inconsistent?

I also found this way to understand it: company A owns 60% of company B (according to US law when a company owns more than 50% of another company, it has to consolidate all the financials) therefore in company A's balance sheet we see that under our assets we have 100% of company B even though we only own 60%.

Since assets = equity + liability ----> to make the balance sheet balance we have to have to add 40 of liability since we have 100 assets and 60 equity ----> 100 = 60 + 40

Therefore it's AS IF we borrowed 40 to buy 100% of company B, so treating the 40 as debt we add it to the EV.

However do generally laws in europe say that if ownership of a sub is greater than 50% then the parent must consolidate the sub's accounts? Or is it justba US law?

Thanks

frank90:
Makes sense thank tou - however if we were to use the ratio EV / REVENUE, the minority interests are not included in revenues and our ratio would be inconsistent?

I also found this way to understand it: company A owns 60% of company B (according to US law when a company owns more than 50% of another company, it has to consolidate all the financials) therefore in company A's balance sheet we see that under our assets we have 100% of company B even though we only own 60%.

Since assets = equity + liability ----> to make the balance sheet balance we have to have to add 40 of liability since we have 100 assets and 60 equity ----> 100 = 60 + 40

Therefore it's AS IF we borrowed 40 to buy 100% of company B, so treating the 40 as debt we add it to the EV.

However do generally laws in europe say that if ownership of a sub is greater than 50% then the parent must consolidate the sub's accounts? Or is it justba US law?

Thanks

IFRS has a similar treatment, they only differ on JVs and financial investments (e.g., held for sale, held for trading bla bla).

"After you work on Wall Street it’s a choice, would you rather work at McDonalds or on the sell-side? I would choose McDonalds over the sell-side.” - David Tepper

frank90:
Makes sense thank tou - however if we were to use the ratio EV / REVENUE, the minority interests are not included in revenues and our ratio would be inconsistent?

I also found this way to understand it: company A owns 60% of company B (according to US law when a company owns more than 50% of another company, it has to consolidate all the financials) therefore in company A's balance sheet we see that under our assets we have 100% of company B even though we only own 60%.

Since assets = equity + liability ----> to make the balance sheet balance we have to have to add 40 of liability since we have 100 assets and 60 equity ----> 100 = 60 + 40

Therefore it's AS IF we borrowed 40 to buy 100% of company B, so treating the 40 as debt we add it to the EV.

However do generally laws in europe say that if ownership of a sub is greater than 50% then the parent must consolidate the sub's accounts? Or is it justba US law?

Thanks

That seems an unnecessarily convoluted way to think about it. Basically the accounting rules just distort EBITDA by including amounts that don't flow up to the parent, and it just becomes quicker/easier to distort the numerator (EV) by an offsetting amount rather than to dig through and try to strip those amounts out of EBITDA, especially since a lot of companies won't report segment data that would allow you to do that.

Damn never used it before cheers

I see. So generally we would not expect listed companies to include minority interests in their balance sheet? How would your method work if we were touse EV / SALES?

Minority interest is included in the enterprise value in a market comp approach when calculating multiples to account for the fact that the subject company's operating statistic (Revenue, EBITDA, EBIT) include 100% of the affiliated companies operating result. The equity value used in the enterprise value represents the market price (minority, controlling interest) which already takes into account the fact that the company owns less than 100% of affiliated company (even though the income statement shows 100%). Rather than adjusting the subject company's operating statistic for the unowned portion, we just add the minority interest liability (which represents the unowned portion of the affiliated company's net income) to the enterprise value. The result is an enterprise value and operating statistic that represent 100% ownership in the affiliated company.

thanks - that was very informative.

Long story short - the adjustment for a minority interest should be made such that you're adding back the expense associated with a minority interest in order to derive the appropriate enterprise multiple (e.g., EV / LTM EBITDA) - this is, as John Mack pointed out, necessary to ensure the numerator and denominator are consistent.

I would not recommend, however, trying to reach an "adjusted" EV that includes payments made for a minority interest, since the book value of this minority interest is not marked to market.

Typically if you buy 100% of the equity with say cash then you would assume the debt of the target unless the seller is forced to retire debt prior to closing. When calculating an IRR on the transaction you would include both the cash consideration and the assumed interest bearing debt as this is the total amount of invested capital that is needed to generate the cash flows of the business.

wow- this question is getting a LOT more drawn out than it'ssupposed to be.

I thought that minority interest is supposed to be SUBTRACTED out of Enterprise Value, because it is equity that the firm does not own - correct?

To illustrate. If i'm Coke, and I purchased 60% of Coke 2.0, due to accounting rules i'm going to consolidate our balance statements, as if i owned 100% of Coke 2.0. In truth, that minority interest of 40% is something that I actually do NOT own - hence, should be subtracted out of Enterprise Value.

Am I wrong here?

If you are going to subtract out anything, you would subtract the 40% of Coke 2.0 financials on the I/S. This is not technically correct accounting, but occasionally a banker might like to see it this way.

Technically you add it. Much like how the operating metrics on one side are 100% consolidated, the ownership should be as well.

Think of it this way. Say I bought a new car, but I am a bit short even with financing. I let Rich Rachel go in with me and buy 40% of the steering wheel. What I (shareholders/debt holders) actually have a claim to is the car less 40% of the steering wheel, so that part of the car is not reflected in the lease (debt) or equity (down payment on the car) associated with the car. So if I add this debt and equity, I get the worth of the car less 40% of the steering wheel. To get the entire value of the car (firm value), I would have to add the part of the car Rich Rachel owns, which is her minority interest.

In other words, because Coke has over 50% of this entity, they control it and consolidate (much like I would still control all of the steering wheel). We are concerned with what the operations of the business (or horse power, etc.) is worth, so we have to add the minority interest (Rich Rachel) to get that.

no you add back minority interest... as mentioned, the EBIT number already includes a portion of what you do not own. if you subtract minority interest away, you get an artifically inflated EV/EBIT multiple...

By the way, John Mack is right on all of his points. You (John Mack) also gave a great explanation as to why Minority Interest is added back when using EV to calculate multiples (Revenue, EBITDA, EBIT multiples etc..) - thanks.

This may be a pretty stupid question but:

When calculating Enterprise value for Firm A.....

Is the minority interest portion of EV firm a's stake in subsidiaries / other companies or is it other companies' stake in firm A?

Thanks

Minority interest is a joint venture. So if Company A and Company B work together and make Comapny X, with A owning 60% and B owning 40%, A would view it as a minoirty interest on its books.

So when calculating A's EV, minority interest would equal 60% of company x. How would company b's EV be affected? Would the 40% stake be built into its market cap valuation and not its minority interest? A stake less than 50% isn't a minority stake right?

On the topic of acquiring debt...

Don't acquirers typically have to refinance the target's existing debt once the acquisition is complete?