Minority Interest on the Balance Sheet
Investing Lesson 3 - Analyzing a Balance Sheet
When analyzing a company's balance sheet, another item that warrants closer inspection is known as minority interest. The minority interest section refers to the equity of the minority shareholders in a company's subsidiaries, something that tends to occur for obvious reasons when dealing with holding companies. Put another way, minority interest represents the minority stockholders' share of the assets and liabilities of a subsidiary.
(A subsidiary is a company controlled by another company through ownership of at least a majority of the voting stock.)
Beginning in the years 2008 and 2009, the Financial Accounting Standards Board (FASB) introduced a massive change to how minority interest was classified on the balance sheet by requiring companies to list minority interest under the shareholder equity section and not the liabilities section where it had previously found its home. This was a major shift in accounting policy and means that for annual reports and Form 10-K filings after this date, you'll need to look further down the balance sheet to find the minority interest section. It also means you'll need to be aware of this when studying or analyzing older annual reports, as the minority interest section will appear as a type of debt. While both positions can be justified (the old thinking was that minority interest was "owed" to the minority stockholders, the new thinking is that the minority stockholders aren't owed anything, they own it, so it is appropriate to label it as an equity allocation), I believe the move to the equity section is a more intelligent presentation of economic reality.
An Example of How Minority Interest Works
The best way to demonstrate how minority interest works is to highlight a real-world example from a company we've used several times throughout my previous articles in this investing lesson, Berkshire Hathaway. Perhaps the most famous holding company in the United States, if not the world, the investment vehicle of billionaire Warren Buffett has made minority interest a key strategic weapon in its never-ending quest for intelligent acquisitions.
Buffett will find an attractive business, often family-owned or controlled by a handful of people, and then offer to acquire at least 80% of the stock. (The reason 80% is important is because that is the line at which the current corporate tax rules in the United States mean that the acquired business will be treated as a fully consolidated subsidiary and the parent holding company won't have to pay taxes on dividends from that subsidiary.) However, any remaining minority stake in the hands of the non-controlling stockholders has to be reflected in Berkshire Hathaway's financial statements - that is where minority interest comes into play.
A Look at How the Minority Interest of Nebraska Furniture Mart Was Carried on Berkshire Hathaway's Balance Sheet
In 1983, Nebraska Furniture Mart in Omaha, Nebraska, was the most successful home furnishings store in the United States. Its gross annual sales exceeded $88.6 million and the company had no debt. After noticing how successful the furniture business was, fellow Omaha native Warren Buffett approached the owner, Rose Blumkin, and offered to buy the company from her.
Due to fights with her children and grandchildren, Rose leapt at the chance to sell the empire she had built from nothing.
She had started with no money, had fled to the United States to escape the Nazis, and couldn't even read or write English even after becoming one of the richest women in her state. The transaction would allow her to remain in charge of the business she loved, continue to hold a meaningful stake, and raise a large amount of cash for estate planning purposes. Almost immediately, she offered to sell 90% of the privately held Nebraska Furniture Mart stock to Berkshire Hathaway for $55 million.
The next day, Buffett walked into the store and handed her a check. This made NFM a partially-owned subsidiary of Berkshire. Since subsidiaries are controlled by their parent company, accounting rules allow for them to be carried on the parent company's balance sheet1. When Berkshire Hathaway bought its 90% stake in Nebraska Furniture Mart, it was able to add the assets and liabilities (again, there were none of the latter due to Blumkin's philosophy of living debt-free) of the furniture giant to its own balance sheet.
This presented a problem. Berkshire Hathaway could now consolidate Nebraska Furniture Mart's balance sheet with its own balance sheet, but, technically, it didn't own all of Nebraska Furniture Mart. Remember, Rose Blumkin sold 90% of her company. She kept the other 10%. That means that 10% of the current assets, inventory, property, plant, and equipment, and all the rest belonged to her.
To adjust for this, Berkshire Hathaway had to calculate Rose's share of everything and put it under the minority interest section of the balance sheet. Since this was before the 2008 and 2009 accounting rule changes, back then, minority interest was shown as a liability (debt) on Berkshire Hathaway's balance sheet. Today, if you look at Berkshire Hathaway's balance sheet, among its many minority interests consolidated under the shareholder equity section are the shares of Nebraska Furniture Mart owned by Rose Blumkin's heirs. (These days, Berkshire Hathaway owns 80% of Nebraska Furniture Mart and the Blumkin family owns 20% following the latter's decision to exercise an option to repurchase 10% of the company on top of the 10% they originally retained at the time of the acquisition.)
When looking at the minority interest section of the balance sheet, it is unlikely management will segregate the specific firms in which minority interest is held for you. For that, you will need to investigate the legal structure of the parent business, finding out exactly how much it owns of each subsidiary. You will sometimes encounter a situation where one publicly traded business controls an enormous portion of another publicly traded business, perhaps through the pink sheets. In these situations, it is actually possible to invest in the minority interest stake directly. It can be difficult to do, especially for non-experts, but it presents interesting opportunities from time to time.
To learn more about minority interest, I write in-depth about some of the accounting considerations in Investing Lesson 4: Minority Interests - The Cost Method, Equity Method, and Consolidated Method. It is something you will need to understand if you hope to value firms that have a lot of investments in other companies.
1.) A company can integrate the balance sheet of its subsidiary if it owns 80% or more. It can report earnings of the subsidiary if it owns 20% or more.