Depending with the context, equity has been found to have varying meaning. In finance, equity refers to the ownership of assets after liabilities and debts have been settled. In trading, equity refers to stock or ownership of shares in a public trading company.
On the other hand, private equity refers to ownership interest in a private company which is not traded publicly. When it comes to margin trading, it’s the value of securities found in a margin account less the amount borrowed from the brokerage firm.
In finance, equity is important as it helps to represent the real stake that one has in a company whether private or publicly traded. Shares are used to represent the stake’s real value owned by an investor and that is why shareholders are concerned about the performance of the company.
Investors who own shares in a company usually enjoy capital gains and dividends at the end of the financial year.
Furthermore, being a shareholder of a company bestows one the right to belong and vote in a Board of Directors.
Types of Equity
Here is an in depth look at equity as described in finance.
1. Private Equity
As said earlier, private equity refers to an investor’s interest in a private company. This interest comes in form of funds which are invested directly into the private company with the goal of financing it. As a result, the company is able to meet its objectives.
Investors can include institutions like pension funds, university endowments and insurance companies. They can also include angel investors who are basically individuals with a high net worth. Angel investors can be composed of members from the same family, friends and even relatives.
One thing you need to note is that private equity is provided by investors to a private company at different levels of the company cycle. Investing is divided into the following:
This is funding provided at the early stage of investing. At this stage, investors usually request for an optimized product, user base and business model that is supposed to generate long term profit. The amount raised during this stage ranges between $2 million to $15 million.
This stage helps to take a business to the next level. Once funded, the company is able to expand its market reach. It also means that the funded company has already built a winning product and it has a team of talented experts. Capital raised during this stage ranges between $ 7 million to $10 million.
At this stage, the company is already successful which means it has the ability to acquire other companies. This is where hedge funds, investment banks, private equity and big secondary market groups come into play.
There are three major types of private equity and they include:
Leveraged Buyout Funds
This type of private equity is used to acquire controlling stakes in companies. Investors usually acquire a controlling stake on their own or they may partner with stable companies. A combination of debt and capital are used to finance such a transaction. This means that companies use part of their funds together with borrowed money in order to complete the acquisition.
Venture Capital Funds
Also known as VCs, they invest in minority stakes in emerging companies also referred to as start-ups. This happens in high end growth sectors like bio-tech, technology and the internet. Two types are available – early stage and late stage VCs. The funds provided enable start-ups to maximize their growth by aiding in the recruitment of talented work force and training on how to expand their businesses. Examples of VCs include Kleiner Perkins, August Capital and Andreessen.
Growth Equity Funds
This type of equity is provided to companies that are mature, stable and looking to enter new markets. Growth equity funds are known to invest much more than VCs. Examples include JMI and Summit Partners.
2. Stockholder’s equity
Also referred to as shareholder’s equity, it represents the stake one has in a publicly traded company. It is usually calculated by this simple formula:
Equity = Assets – Liabilities
This type of equity is used to purchase assets that are utilized by the company in running its operations. The second part of equity also referred to as retained earnings helps the company build itself overtime. Retained earnings do grow larger as the company continues to re-invest a portion of its net income.
There comes a time when the accumulated earnings surpass equity thus making it to be the source of stockholder’s equity.
Equity is a vital source for any company whether it’s just starting or it has been in existence for several years.
For start-ups, equity helps to ensure that their goals and objectives are realized while for mature and stable companies, equity helps to purchase a controlling stake in other companies and gain entry into emerging markets too.