If you have equity in a business, it means that you have ownership of part of a business, depending on the size of your equity. So if you have 5% equity in a business, then you own 5% of that business. Equity can essentially be worked out by subtracting the liabilities of a business from the assets, and from there you can work out the portion that you own of the remaining amount. Below, we look at the ins and outs of equity.
Why is equity important?
Equity, also called equity financing, is the raising of capital or investment through the selling of shares or ownership within a business. The alternative is offering equity to members of your team who, rather than investing in your business, will be offering their services instead to help the business grow and increase revenues.
Equity gives entrepreneurs and small business owners a way to scale their business without parting with much-needed cash, especially in their early years.
What equity will mean for a business
For a bootstrapped business that is not seeking external investment, but is instead offering equity to their employees, co-founders or one of the early team:
For the business owners
They may be able to offer equity in return for a lower salary each year, which will help them retain much needed cash. They will most likely find that they get more effort and commitment from the employees who have equity as they have a personal stake in the business.
However, on the flip side, it may mean that the business owners are forced to part with a large chunk of cash further down the line when the employee trades their equity in. But, if this employee has been integral to the growing of the business, then this should be well deserved.
For the equity holders
The employees or workers with equity will have a direct stake in the business, giving them a real reason to go the extra mile each and every day.
A downside is that they may have to take less salary, or potentially even no salary, in return for equity, and there is no guarantee that the equity will turn into anything should the business fail. They would also need to fund themselves in the meantime should they be taking a lower salary, which could be hard if they are fully focused on the startup.
For businesses that are offering equity in return for investment:
For the business owners
This is a typical way for a business to raise investment should it need it, and they will trade some of their business away in order to receive funding to grow. Again, it means that they can hold onto much-needed cash, which can be vital in the early years of a business.
However, business owners do not always have as much control over how much of their business they have to give away, especially if they desperately need the money. Investors will typically take a larger percentage of a business in return for investment. Should the business grow to be of high value, then this will be a profitable venture for both the business owner and the investor, but if this is not the case, it can be costly for the company founder.
For the investor
This can be a great move for investors as a way to generate passive income, and hugely successful businesses like Uber, Air bnb, and Dropbox have come from investment platforms. There is no guarantee that they will get a return on their investment, but they only need one investment to be successful to provide them with their necessary returns.
The benefits of equity
As a business owner, there are many benefits for equity. You will not need to repay anything at any time, and there is a much lower risk of bankruptcy involved, but you will, of course, be giving away part of the ownership of your business.
While some believe the private equity market can be associated with greed, it can be an extremely profitable and lucrative move if the business continues to grow, and is a good route to go down should you need to save cash within your business.