What Is Equity in BusinessHere's the Different Types of Business Equity!

Written By:
Adiste Mae

Reviewed By:
FundsNet Staff

Understanding how equity works in the context of business is something that every business owner, or aspiring entrepreneur, needs to know and understand.

At the very least, you should aim to have a general understanding of equity and the various forms of equity.

In addition to equity, it’s essential to understand how a business is valued.

Even if you don’t plan on selling your business, there are many instances where being able to assign an accurate value to your business will be crucial, for example if you’re seeking financing, outside investment, or need collateral for a large purchase.

In any case, we’re going to be discussing business equity and explaining what this means.

We’ll also be going over the three primary types of equity and how they work, and discussing different ways to value a business.

Whether you’ve already launched your business, or you’re doing research and planning for an upcoming venture, you’ll want to stick around and learn the basics of equity in business and how it works.

You don’t necessarily need to get a degree in finance or an MBA in order to run a successful business, but knowing the basics is always going to be beneficial.

Learning new things and knowing more about how businesses work in general, including the different types of businesses and the terms that are associated with them is a big advantage.

Knowledge, even if it’s not directly related to your business, is still going to help you in the long run.

It helps give context to the business world, and you can draw the bits and pieces that are relevant to you.

Here’s what you need to know about business equity and some adjacent terms and information that will help you understand business and how to succeed as an entrepreneur.

What is Equity in Business?

Equity is the metric used to measure a business’ value by subtracting its liabilities from its assets.

Businesses have all sorts of assets ranging from real estate, proprietary tools and processes, intellectual property, cash on hand, inventory, and more.

Liabilities can include things like rent, wages they owe to their employees, business loans, and more.

Multiple owners can have stakes in a business’ equity.

In publicly traded companies, there are many owners who have small shares of equity in the business that belong to a much larger pool.

The value of the business is determined by the value that investors place on the company by trading shares in the business.

Taking the total assets and subtracting the total liabilities is one way to assess the value of the business by determining the overall equity.

One individual can own an entire business, or they can own a tiny share of it, and anywhere in between.

A business can have positive equity or negative equity.

If the business has more liabilities than assets, they have a negative equity.

If it’s the other way around, they have a positive equity.

It’s possible for businesses to flop back and forth between positive and negative.

Sometimes, a business can have negative equity but still be in an okay position, because they’re taking on liabilities in order to facilitate growth.

Different Types of Equity Explained

The two primary types of equity are owner’s equity and shareholder’s equity.

They are similar, the main distinction is that they apply to different types of business entities.

Those are the two types of equity that we’re going to discuss, but it’s worth mentioning that equity can also refer to other concepts such as “sweat equity”, and types of equity shares like ordinary shares, preferred shares, bonus shares, rights shares, and more.

Owner’s Equity

This type of equity refers to a privately held company where there aren’t shareholders.

A sole proprietorship, as the name implies, has one sole owner and that owner’s stake in the company is called owner’s equity.

Shareholder’s Equity

This type of equity often refers to publicly traded companies where people can purchase shares on the stock market, but it doesn’t only refer to that.

Private companies that aren’t publicly traded will still have shares and shareholders, and the shareholders are purchasing equity in the business when they negotiate a deal – for example through a private equity firm.

Private Equity

Private equity refers to an individual or a collective who use their assets to purchase equity in businesses that aren’t traded on the stock markets.

This is a form of investment that isn’t available to the general public, it requires a lot of capital and accreditation.

Private investors can seek out opportunities to invest in privately held companies that aren’t traded on the stock market, so they need to approach the owners of the business to make their offer directly, rather than buying or selling shares in the company on an open market such as a stock exchange.

This can lead to some great opportunities where private equity firms are able to get on-board and invest in companies that most people don’t have access to, or companies that are struggling that have high upside.

Equity Financing

This is an option for a business to get funded when they don’t necessarily have the option of going public.

It could be that they’re too small of a business, or the owner isn’t able to take out a sufficient loan from the bank.

The owner will have some equity in their business, and ideally an investor (like an angel investor or a venture capitalist) will see value and potential in the company and will choose to invest.

Their investment will give them some ownership over the company.

This is a long-term approach, since the investor can’t just turn around and sell their stake in the company on the market anytime they want.

If they believe in the business, and they believe in the owner,  they can offer to finance the growth of the business.

The owner will show a plan that demonstrates how they plan to grow the business, what they would do with the money, and so on.

In some cases, a business will have orders piling up that they can’t fulfill because they lack the capital to manufacture enough of their product at once.

This leads to having to take on a few orders, sell them, re-invest the profits into a larger manufacturing run, then selling those products, and rising and repeating.

The problem is that interest could die down if it’s taking too long to deliver, and this also leaves the door open for competitors to enter the market.

In cases like the one outlined above, financing or outside investment means the initial owner has a lower share in the total size of their business, but the idea is that it’s better to have a smaller piece of a giant pie, instead of the full pie that’s not able to meet demand or fulfill orders.

Final Thoughts on Business Equity and the Different Types

In its most simple form, equity simply means the assets of a business minus the liabilities.

If a business was liquidated and all of its assets were sold, the equity is the amount of money that would be returned to the shareholders or owner of the business.

There are less tangible things that can contribute to the value of a business, too.

For example, if the owner is very passionate and private investors see something special in them, this won’t necessarily show up on paper.

In any case, now you have a better understanding of what is equity in business, how it works, and the different types of business equity.