The word ‘equity’ is used a lot in business – especially if you watch BBC’s Dragon’s Den. During the programme, you’ll see entrepreneurs asking the dragons for investment in exchange of equity in their business.
But what does the word really mean? This changes slightly depending on where it’s used: in accounting it means one thing, but something different in the stock market, for example.
What you need to know about equity in business
The basic definition
Equity, according to the Latin from which it derives, is ‘of being equal or fair, impartiality’. It has morphed over the years to mean several different things, as you’ll find if you check out the Cambridge English Dictionary. Overall, however, the root meaning is the same: it’s all about ‘equal and fair’ ownership.
By the late 17th century, the word expanded to include an ‘equitable right, that to which one is justly entitled’. This includes shares in a company, which means owning a share, or proportion, of the business.
Owner’s equity means what you, as the owner of a company, physically owns once all debts and liabilities are paid off.
One way to explain owner’s equity is:
Owner’s Equity = Net Assets. It can also be phrased as Assets – Liabilities.
This only applies to sole traders, as corporations use the term ‘retained earnings’, while partnerships use ‘partners’ equity’.
Overall, it boils down to the same thing: what is left for the owners (or shareholders) once all outstanding debt and liabilities are paid.
Equity in investment
Equity investments can be made by anyone wanting to buy a share in a publicly-owned business. This can include buying:
- Shares in a business through a broker on a stock exchange, such as the FTSE.
- Buying ‘micro-shares’ via an app such as Robinhood.
As the value of the business increases, so does the value of your equity. Ideally, you will sell your equity when it is more valuable than when you bought it. But that isn’t always the case. Remember, investments can go down as well as up!
As we’ve seen in Dragon’s Den, the ‘dragon’ chooses to invest a sum of money and in return receives a ‘share’ in the business. That share is a proportion of the equity in the business, which is usually a percentage.
As they do this in private businesses not listed on stock exchanges, it is called ‘private equity’. This is a popular way to fund startups. Fundraising this way can be carried out in a variety of ways. For example, individuals can choose to invest funds personally to someone they know. An increasingly popular way these days is to buy equity through crowdfunding sites, such as seedrs.com
Other uses of the word
Outside of the business world, equity is used in other ways. Essentially, however, the overall meaning is the same: it’s a percentage that you personally own in something. For example, if you are buying a house, you will probably own equity within it. That means once your mortgage and all interest is cleared, what is left is what you own. That percentage is your equity!
If you are thinking of raising funds for your business and need to know more about equity, contact our team today.