What is equity?
The business definition of equity varies greatly depending on context. It can mean your company’s sense of justice and fairness and how they are reflected in your brand’s values. It can refer to the equitable treatment your team can expect when they work for you, the charitable endeavours you undertake, or even describe how your business raises capital to fund new projects.
Broadly speaking, however, the meaning of equity in the business realm is similar to its meaning in personal finance. A company’s equity means how many of its component assets are owned by the company, rather than leveraged with debts like business loans, vehicle financing, mortgages etc. It is the total value of your company’s assets, minus the sum of its liabilities.
To put it another way, if your company were to go out of business tomorrow and all of your assets were to be liquidated, your equity would be the amount that is divided between shareholders after your creditors have been satisfied.
Examples of equity
Now that we’ve looked at the broader definition of equity, let’s illustrate this with some common practical examples and the difference between them.
Equity may refer to a shareholder’s stock or other security that represents their ownership interest in your company. If someone has an investment in your business, they expect to see a return on that investment in the form of dividends from the company’s profits. Thus, the more equity a company has, the more profitable that company is perceived to be.
Outside investors will often use a company’s shareholder’s equity to determine whether the purchase price of its stock is reasonable or expensive.
Equity finance is when a company finances its capital investments not with a business loan, but by selling a stake in the company in return for a cash investment.
This may represent more favourable terms for the business. Unlike a loan, equity finance does not need to be repaid. Instead, investors recover their investment in the company gradually through dividends or by selling their shares to another investor.
Ownership equity refers to the amount of capital that is repaid to a company’s shareholders if the company is declared bankrupt and its assets are liquidated.
In this instance, the company will first have to make repayment arrangements with its creditors. This is arranged by an administrator. What remains after the company’s liabilities have been repaid is called ownership equity, liable capital or risk capital.
Real estate equity
If your company mortgages one or more business premises, there will be a loan-to-value (LTV) ratio that determines the value of the property in relation to the value of the debt that the property (or properties) represents to the company.
In this context, equity is used to describe the difference between the property’s fair market value and the outstanding value of the mortgage/s.
Private equity refers to the evaluation of businesses that are not yet publicly traded. This is usually carried out by outside investors or other companies considering merger or acquisition. In this context, the book value is determined by deducting the company’s liabilities from its assets.