What is Equity in Business?
Written by Team 365 finance
‘Equity’ is a term you’ll hear a lot in business – especially when it comes to assets and financing.
Understanding what it means and how to use it can help you grow your business more effectively. Discover the meaning of equity in different business contexts and how to use it to your advantage in this complete guide.
What Does Equity Mean in Business?
‘Equity’ has slightly different meanings depending on the business context. The classic equity business definition is when it refers to a company’s value. Here, ‘equity’ is the total value leftover once all assets have been sold and all debts paid off.
‘Equity’ can also refer to the proportion of ownership that someone has in an asset or business. For example, if you take out a loan on a car, you build equity with each monthly payment until the loan is fully repaid and the car is yours. Alternatively, investors can buy shares (or equity) in different companies, becoming co-owners and entitled to a portion of the profits.
How to Calculate a Company’s Equity
It’s straightforward to calculate a company’s equity. All you have to do is use the formula below:
Equity = Total assets − Total liabilities
Calculating your total liabilities tends to be much easier since loan repayments are often calculated ahead of time. All you have to do is add up all your debt to find the total figure.
Assets, on the other hand, can be trickier since you have to make assumptions during the process. Just because you bought a particular asset for a certain price doesn’t mean it’ll be worth the same after you’ve used it. Assets can either depreciate (lose value) or appreciate (gain value), so you need to factor in these changes.
Assets can also lose or gain value at different rates, so make sure you follow industry norms when calculating their value, and be transparent about your approach. Lenders and investors might want to get into details and it’s important to be able to walk them through your thinking.
Don’t worry about counting every penny, though. These assumptions mean there’s some room for error as long as your calculations are reasonable and well-informed.
Can Equity Be Negative?
Equity can be negative if your total liabilities are greater than the total value of your assets.
Negative equity isn’t necessarily a bad thing and can be common in new businesses before they’re able to buy assets and repay their loans. However, it can be a worrying sign for lenders and investors if it persists, so business owners need to have a plan to address their negative equity.
Types of Equity in Business
There are a few different types of equity in business. Below are the main forms of equity you need to know for everyday business environments:
1. Private Equity
Private equity, also known as ‘owner’s equity’, is the ownership that someone has over their assets and how much they’re worth once all their debts are settled. You can use the formula above to calculate your private equity sum.
You may also hear about ‘private equity firms’ or ‘private equity businesses’. These are usually investment funds that buy and restructure companies.
2. Shareholders’ Equity
Like private equity, shareholders’ equity is the value that the owners of a company would generate if they sold off all its assets and repaid all the debts.
The phrase ‘shareholders’ equity’ is often used when referring to businesses with more than one owner/founder, since ‘private equity’ is typically associated with single-person companies. However, the terms mean exactly the same thing and are often used interchangeably.
3. Brand Equity
Brand equity is different from the types of equity we’ve discussed so far.
Brand equity is the value that a company generates through its advertising activity. This is because popular products with a recognisable name, logo and design are more valuable than generic goods in the same category. Companies create brand equity by providing superior product quality and memorable marketing campaigns to make their goods stand out and build positive relationships with customers.
How Is Equity Used by Businesses?
Equity is something that you can use to your advantage. For example, businesses can use their assets (and the equity they hold over them) to secure more favourable loan terms by offering them as collateral. If businesses can’t pay back their debt, they can offer an asset of equivalent value as payment instead
Businesses can also sell ownership shares, known as equity financing, to raise investment capital and grow their business, as we explain below.
Equity Funding and Equity Financing Explained
Companies (not sole traders) can sell shares to investors to raise investment capital. If you’re looking to grow your business using equity financing, you’ll need to know the difference between different types of investors:
1. Venture Capital
Venture capital (VC) is money provided by investors known as ‘venture capitalists’ (VCs). VCs purchase equity in companies to help them grow and, in return, are entitled to an equivalent share in the profits.
Venture capital helps you to avoid debt and grow your business with fewer liabilities.
VC isn’t suitable for every business model, so it may not be an available option to you.
Investors gain a portion of ownership over your business, which can mean cooperating with someone to run your company and giving away some of your profits.
2. Angel Investment
Angel investors are a type of venture capitalist that specialise in working with startups and other early-stage businesses.
Angel investors offer more than just money since they can help with scaling your business and help it grow more efficiently. This can be especially useful if your business idea will become highly competitive or your business model needs to grow to a certain size before it’s profitable.
Because they come in so early, angel investors can end up holding a sizable stake in your business later on, which can limit your financing options if you need or want to sell equity at some point in the future.
3. Crowd Funding
Equity financing doesn’t have to come from a single investor with deep pockets. Businesses can also sell shares to lots of small investors (including family and friends), in a process called crowdfunding.
Modern crowdfunding platforms let you make a single business pitch, helping you to save time from meeting lots of investors individually and going over the same details about your business.
Selling to inexperienced investors can create problems since investing comes with risks as well as benefits. This is especially true if your investors are close family and friends.
Small investors don’t always have the same access to capital as large investment companies or serial entrepreneurs, so you might lose out on larger sums to grow your business.
How to Sell Business Equity
Once you’re proficient in the different equity meanings in business and the different types of equity you’ll come across, you can start selling equity in your business. To do this, you’ll need to either approach an angel investor or venture capital firm, or use a crowdfunding platform and explain your business idea and how it can grow.
Interested investors will then ask how much money you need or want, and how much equity you’re willing to give away. It’s crucial to ensure your business’ valuation is reasonable (if optimistic) at this stage since wild estimates can undermine your credibility.
Be careful to maintain the largest equity share in your business for as long as possible. Otherwise, you’ll forfeit a growing share of your profits to other people and even risk losing executive control over your business.
‘Equity’ versus ‘Return on Equity’
Since equity’s meaning in business is about value, investors will often ask about their ‘return on equity’. Return on equity (sometimes shortened to ‘ROE’) is a metric for your company’s financial performance.
It’s calculated by taking your shareholders’ equity (using the formula above) and dividing it by your net income, creating a fraction or percentage value. This calculation shows how effective your business is at generating returns for your investors and helps investors identify high-value business opportunities.
Grow Your Business with Flexible Financing from 365 finance
Equity financing is a great way to scale your business, especially if you land the help of an angel investor. However, equity financing comes with drawbacks, like profit sharing and diluted ownership.
If you’re looking for investment capital to grow your business, we have just the thing. At 365 finance, we offer up to £400,000 in revenue-based funding. With no APR, fixed monthly payments and a 90% approval rate, it’s the perfect way to invest in your business.
Head to our website to learn how it works or speak to our team to find out more and apply today without affecting your credit score.