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Understanding equity

Equity has different meanings depending on the context. Shareholder's equity is the most common type of equity - it represents the amount of money that a company's shareholders will get if all of the assets were liquidated and all the debt was paid off.

Equity can be found on a company's balance sheet. Analysts use this data to assess the financial health of a company.


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Formula and calculation for shareholder equity

Shareholders' Equity = Total Assets - Total Liabilities

The information for this formula can be found on the company's balance sheet by using the following steps:

  1. Find the company's total assets for the period.
  2. Find the total liabilities, listed separately on the balance sheet.
  3. Subtract total liabilities from total assets to find the shareholder equity.

A less common method to find the shareholder equity is the company's share capital and retained earnings less the value of treasury shares.


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Understanding shareholder equity

  • Equity is used as capital raised by a company, which is used to buy assets, invest in projects, and fund operations.
  • Investors typically look for equity investments as it provides a greater opportunity to share in the profits and growth of a company.
  • Equity represents the value of an investor's stake in a company and is represented by their portion of the company's shares.
  • Owning stock in a company gives shareholders the potential for capital gains and dividends.


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The components of shareholder equity

  • Retained earnings. It is the percentage of net earnings not paid to shareholders as dividends. You can also think of retained earnings as savings as it is put aside for future use.
  • Treasury shares or stock is the stock a company has repurchased from existing shareholders. Companies can reissue treasury shares back to stockholders when companies decide to raise money.


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Other types of equity

We can think of equity as a degree of ownership in any asset after deducting all debts associated with that asset.

Common variations on equity:

  • A stock or other security representing an ownership interest in a company.
  • On a company's balance sheets, the funds contributed by the owners or shareholders plus retained earnings (or losses).
  • In margin trading, the value of securities in a margin account minus the amount the account holder borrowed from the brokerage.
  • In real estate, the property's current fair market value less the amount the owner still owes on the mortgage.


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Private equity

Private equity is the evaluation of companies that are not publicly traded. Only "accredited" investors can access private equity, but regular investors can make use of exchange-traded funds (ETFs).

  • Private companies can find investors by selling off shares directly in private placements.
  • Private equity is often sold to funds and investors specialising in direct investments in private companies.
  • Private equity can also engage in leveraged buyouts (LBOs) of public companies - the company receives a loan from a private equity firm to fund the acquisition of another company.


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Venture capital funding

Usually, a new company with no revenue or earnings can't afford to borrow. It gets capital from friends, family, or individual "angel investors."

  • Venture capitalists (VCs) come into play when the company is ready to bring its product or service to market. 
  • VCs provide private equity financing in return for an early minority stake. They may take a seat on the board of directors for their portfolio companies.
  • VCs try to hit big early on and exit investments within five to seven years.


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Home equity and brand equity

Home equity is the value of a home minus the mortgage debt owed. A homeowner can use home equity to get a home equity loan - otherwise known as a second mortgage.

Brand equity. Assets may include tangible assets, like property, and intangible assets, like a company's brand identity. Brand equity measures the difference between the value of a brand and a generic version of a product, for example, Coke vs a store brand cola.


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