In financial terms the word ‘equity’ describes the value of a business once any liabilities are deducted from its assets. The more equity a business has, the more valuable it is.
Assets are things that the business owns which have a value, such as property, cash, equipment, copyrights, branding, or money owed to you by customers
Liabilities are something that you need to pay in the future, such as tax, loan repayments, salaries, and suppliers
It’s important to remember though, that a business usually isn’t worth just the equity on the balance sheet. There can be much more value, such as the company’s potential growth, market opportunities, or its customer base and brand loyalty.
What are equities?
In its simplest form, equity means the value of a business. This value is split up amongst shareholders when the company issues shares.
Although the term “equity” relates to the value of a business, “equities” is a word that relates to shares.
So, you can own equities in a business and as a result, you’ll own part of the equity of the business.
Using equity in a company
The equity or ‘value’ of a company can be used as a way to find investment, or even to reward and motivate employees. This is because having equity in a company means that you own part of it – also known as being a shareholder.
The more profit a company makes, the more funds available for making dividend payments.
The more equity you own in the business, the larger your portion of those funds will be.
Shareholders might also have the option of selling their shares for a profit at a later date, although some companies use a special shareholder’s agreement to limit who they can be sold to.
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Giving shares to employees
Some companies issue shares to employees as a reward for good performance, or offer them at a special purchase price. This can be very attractive because it enables employees to share in the profits that they help to make.
If the company is still quite young or has lots of potential to grow, then you might even use this as an incentive to recruit talented people. These are broadly known as Employment Related Securities (ERS) schemes, although there are lots of different types to consider.
Selling equity to raise funds
When you own shares in a business, then you own equity and a share of the profits. If the business does well, then the profits grow, and so does the equity value. A limited company which needs to raise money to finance further growth might consider selling equities (shares) in the company.
Every business is different, so this depends on what you and your company hope to achieve by doing so. Some companies create different types of shares, sometimes known as share classes or ‘alphabet’ shares because of how they’re recorded.
This enables them to issue or create shares whilst controlling what the shareholder is entitled to. For example, giving them a smaller cut of the company’s profits, or removing their right to vote on big company decisions.
Just be aware that share structures can get quite complex, so always take advice if you’re not sure!
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About The Author
I'm an experienced and fully AAT and ACCA qualified accountant, who is enthusiastic about helping business owners succeed. I also love cooking and needlepoint (at different times!). Learn more about Beth.