There are many avenues that a company explores to raise new funds, i.e., public issues, offer for sale, private placement of securities, rights issues, etc. Listed companies raise capital through the stock exchanges by an Initial Public Offering (IPO) or raising debt through non-convertible debentures or bonds. In both these methods, institutional investors and retail investors can take part.
Equity finance is a method adopted by companies to raise money by selling shares to financial institutions, which also fall under the broad spectrum of institutional investors and the public. The people or institutions that receive shares of the company are known as shareholders because they are now co-owners of the company in proportion to the number of shares held.
This is why equity is also called owner’s equity for unlisted privately held companies and shareholders’ equity for listed ones. The value of equity is reflected in the books of accounts and the balance sheet and is considered a reflection of a company’s financial strength. The definition of equity goes like this: if all the assets of a company are liquidated, and the total borrowings and debt were paid off, the remaining funds are called shareholders’ equity.
Shareholder Equity Explained
To understand the full importance of shareholder equity, it is necessary to understand the need for fresh capital. It is raised to fund the operations, purchase assets, or invest in and launch new projects. A firm typically raises funds by selling equity, which is stocks, or through debt financing, a form of a loan. However, investors usually prefer equity investments over a one-time grant of loans. This is because, as a shareholder, they become part owners and can share the fruits of growth and increased profitability.
Shareholders also take an active interest in the company. A well-run company functioning on the “follow us” principle with a heavy focus on creating shareholders’ wealth guarantees capital gains through increased market value and attractive dividends. It also gives them the right to have a say in the corporate actions through voting and take part in the Board Elections.
Whether positive or negative, shareholder equity is one of the indicators of a company’s financial health. Positive equity means that the total assets are more than the liabilities. Negative equity means that the total liabilities are more than the assets, and if this goes on, it denotes a state of insolvency. While it is true that equity in overall finances is not a sole indicator of financial health, it, along with a few other parameters, is what investors look at before putting their trust and money in a business.
Aspects of Shareholder Equity
When considering equities definition and equity financing, it is seen that they are centered on investors acquiring shares in a company and that the equity showed the business’ robustness. There are also several other aspects of shareholder equity.
Retained earnings that are a part of the net earnings and are not paid as dividends to shareholders are considered equity. Retained earnings represent profits plowed back into the company as savings against exigencies or investments for growth and development. As companies keep on reinvesting the profits, the accumulated figures become so large that they often exceed the shareholders’ original investment. Retained earnings are often the most significant shareholder equity component for a business that is old and established and running very well.
Treasury shares are another aspect and represent equity that has been purchased back from the shareholders. This is usually done when management wants to acquire greater control and use the available equity. These shares are noted in a separate account in the balance sheet called “treasury stock.” They can be re-issued to investors as equity whenever there is a need to raise funds.
Private Equity and Venture Capital
Private equity is another aspect within the ambit of equity in finance. While shareholders’ equity is publicly traded on stock exchanges, private equity shares are not traded or publicly listed. The investment is made by high-net-worth firms or individuals whose ultimate motive is to acquire a controlling interest in public companies and make them private through delisting. Private equity players are large institutional investors with a lot of financial clouts.
Venture capitalists provide finance to small businesses and startup companies similar to equity financing. Unlike equity investors who place their money in stable well-run businesses, venture capital is put in new and unknown businesses that might (or might not) make it big. Thus, the risk element is relatively high here. A business that is susceptible to high volatility and fluctuations, like real estate or a publishing family, finds venture capital a route to raise finances as they do not have easy access to traditional institutions for debt financing. The downside is that venture capitalists often acquire equity in the fledgling business and take charge of the affairs.
Public equity financing is very common among retail investors and financial institutions; however, it is not the case with private equity financing. Only “accredited investors” with a proven net worth of a minimum of $1 million are allowed to participate in venture capital or private equity partnership. Others have the choice of exchange-traded funds (ETFs) that are primarily focused on private business investments.
What does Equity in Finance Mean?
Equity in finance is when companies raise finance by selling shares to retail investors, institutional investors, and financial institutions. For well-run companies, the shareholders make a profit when the share’s market value rises on the stock exchanges. Shareholders are owners of the companies proportionately to the number of shares held by them. The value of the equity is reflected in the balance sheet.
What exactly is Equity?
Equity is the funds raised by a company for business growth and development, new projects, and unforeseen emergencies. The equities are raised through the public or financial institutions by issuing shares listed on a stock exchange. The people who receive shares are called shareholders, and they have a stake in the company in proportion to their investments. Their Return on Investment (ROI) is by annual dividends.
What is Equity with examples?
Equity is the investment in the company’s shares, and the investors are called shareholders as they have a share in the business. Equity financing is represented in the financial statements as total assets minus total liabilities. Here is an example from a company that is part of the publishing section of a well-known corporation. (30th September 2018 balance sheet)
- Total assets were $354,628
- Total liabilities were $157,797
- Total equity was $196,831
What is an Equity Financing example?
A young entrepreneur who wants to start a business has two ways to do so – debt and equity financing. Debt is borrowing money and paying interest up front. Equity financing is parting with a part of the company’s ownership in proportion to the number of shares issued. An advantage of equity financing is that the entrepreneur does not have to go into debt where the interest payout can be crippling. However, on the flip side, in equity financing, if the business is a success, the owner has to part with a share of the profits to the shareholders.