What Is Equity?

Equity, also known as shareholders’ equity (or owners’ equity for private companies), represents the amount of value that would be returned to a company’s shareholders if all of its assets were sold and its debts settled. In the context of an acquisition, equity refers to the value of the company after subtracting any liabilities that are not transferred with the sale.

Equity can also represent the book value of a company and may be used as a form of payment in kind. It reflects the ownership portion of the company, represented by shares held by investors. Analysts often use shareholder equity, which appears on a company’s balance sheet, to assess its financial health.

How Shareholder Equity Works?

The concept of shareholder equity is simple: it is the difference between a company’s total assets and its total liabilities. By subtracting liabilities from assets, this equation provides a clear view of a company’s financial situation, which investors and analysts can easily understand.

Equity is capital raised by a company to acquire assets, fund projects, and support operations. Companies can raise capital by issuing debt (loans or bonds) or equity (selling stock). Equity investments are attractive to investors because they offer the potential for capital gains and dividends, as well as voting rights on corporate matters and board elections. These benefits ensure shareholders remain engaged with the company.

Equity can be either positive or negative. Positive equity means that a company’s assets exceed its liabilities, while negative equity means the opposite, indicating that liabilities surpass assets. Prolonged negative equity can lead to balance sheet insolvency. While shareholder equity is a useful indicator, it should be analyzed alongside other financial metrics for a more comprehensive understanding of a company’s financial status.

Formula for Calculating Shareholder Equity

To calculate shareholder equity, use the following formula based on the accounting equation:

Shareholders’ Equity = Total Assets − Total Liabilities

This calculation can be done using a company’s balance sheet by following these steps:

Find the company’s total assets.
Identify total liabilities listed separately.
Subtract liabilities from assets to determine shareholder equity.
Remember that total assets will equal the sum of liabilities and shareholder equity.

Another way to express shareholder equity is through the company’s share capital and retained earnings, minus the value of treasury shares. However, the assets minus liabilities method is more common as it provides a clearer view of financial health.

Components of Shareholder Equity

Retained Earnings: These are the net earnings not paid out as dividends but reinvested in the company. Over time, retained earnings accumulate and may surpass the original capital invested by shareholders. For many long-established companies, retained earnings are the largest component of shareholder equity.

Treasury Shares: These are shares that a company has repurchased from its shareholders. Companies buy back shares when they feel they cannot deploy the available equity capital in ways that will deliver the best returns. Treasury shares are recorded in a contra account, reducing total equity. These shares may later be reissued to raise funds if necessary.

In essence, shareholder equity represents the net assets of a company—the amount left for shareholders if the company liquidated its assets and paid off its debts.

Example of Shareholder Equity

In its 2023 annual report, Apple reported shareholder equity of $73.812 billion, which includes common stock and additional paid-in capital. Of the 50.4 million shares authorized, Apple had issued about 15.5 million shares.

Apple also reported an accumulated deficit of $214 million and an accumulated other comprehensive loss of $11.4 billion. Compared to the previous year, Apple’s shareholder equity increased from $50.672 billion to $62.146 billion.

Other Forms of Equity

Equity has broader applications than just measuring corporate ownership. It generally refers to the value remaining after debts are subtracted from the value of an asset.

Some variations of equity include:

Securities: Stocks or other ownership interests in a company.
Real Estate: The difference between the current market value of a property and the outstanding mortgage.
Bankruptcy: In a liquidation, equity represents the funds remaining after paying off creditors, often referred to as ownership equity or risk capital.

Private Equity

Private equity refers to equity investments in companies that are not publicly traded. Without a market price to determine its value, private equity requires other valuation methods. It can be used to finance a business by issuing shares through private placements, and investors in private equity often include institutions or accredited individuals.

Private equity may also involve leveraged buyouts (LBOs), where a private equity firm provides a loan to acquire another company or division. The assets or cash flows of the acquired company typically secure the loan. Mezzanine financing may also be used in these transactions, involving a mix of debt and equity.

Private equity plays a significant role at various stages of a company’s growth. For instance, early-stage companies often rely on venture capital from angel investors and venture capitalists (VCs) who seek equity in exchange for funding. Well-known companies like Google, Apple, and Amazon all received venture capital funding in their early stages.

Types of Private Equity Financing

Venture Capital (VC): VCs provide capital to early-stage companies in exchange for a minority stake, often taking a board seat to guide the company. VCs typically exit within five to seven years, hoping for significant returns.

Leveraged Buyouts (LBOs): A common private equity financing method where a company acquires another using a combination of debt and equity.

Private Investment in Public Companies (PIPE): In a PIPE transaction, private equity firms, mutual funds, or other accredited investors purchase discounted shares of a public company.

Private equity is generally restricted to accredited investors with a high net worth, although private equity exchange-traded funds (ETFs) can offer access to broader audiences.

Home Equity

Home equity refers to the ownership portion of a home that a person has after subtracting the outstanding mortgage debt. Home equity typically increases with mortgage payments and increases in property value. It is often a homeowner’s most significant source of collateral, allowing them to take out loans against their equity.

For example, if Sam owns a home valued at $175,000 and owes $100,000 on the mortgage, he has $75,000 in home equity.

Brand Equity

Brand equity refers to the value derived from a company’s brand, which may include both tangible assets (such as property) and intangible assets (such as brand reputation). Over time, advertising and customer loyalty can build a brand’s inherent value. For instance, people may choose to buy Coke over a store-brand cola, even at a higher price, because of the brand’s reputation.

Negative brand equity, though rare, can occur when a brand suffers from poor publicity, leading consumers to prefer generic products over the brand itself.

Equity vs. Return on Equity

Return on Equity (ROE) is a performance metric that measures how well a company uses its shareholder equity to generate profits. It is calculated by dividing net income by shareholder equity. ROE is a useful indicator of a company’s ability to turn equity into profits.

While equity represents ownership in a company or asset, ROE provides insight into how effectively that equity is being used to create value for shareholders.

Conclusion

In finance, equity represents ownership in an asset after liabilities are accounted for. It reflects the value belonging to shareholders in a company, whether it’s through shareholders’ equity, home equity, or brand equity. By analyzing equity and related metrics, investors can make informed decisions about a company’s financial health and potential for growth.