If you already invest or you’re planning to start investing, your main objective is most likely to be to earn a good return and grow your wealth. Equity investments are an option to consider if you want to diversify your portfolio or you’re thinking about investing in the stock market. On this page, you’ll learn what equity investments are, the different types of equity investments and why you may want to consider equities.
- With equity investments, you invest your money into a company by purchasing their shares in the stock market
- Stocks you own entitle you to a portion of the profits and assets made by the company
- The money you receive from equity investments will usually be in the form of dividends or profits made from selling shares
What’s on this page
What’s on this page
What does equity investment mean?
Equity investments mean you’re investing money into a company by purchasing their shares. Shares are small portions of a company, also known as stocks. Owning these stocks entitles you to a portion of the profits and assets the company makes. This is a common process that allows an individual or company to invest money into a private or public company and become one of its shareholders.
How do equity investments work?
An equity fund investment allows you to acquire partial ownership of a private company or a startup by owning some of their shares. Investors generally earn a return on their investment when a company they have shares in decides to distribute its proceeds after liquidating some or all of its assets. If the company has met certain obligations, they can then sell their shareholdings to other investors.
For example, let’s say a startup founder had an idea for a new product and wanted to create a company, but needed capital. A starting point might be for the founder to ask equity investors for funds. The founder would first have to convince these investors that the business idea can work and will be likely to bring growth.
The startup founder offers 10% of the company for £450,000. An investor counters the offer by asking for 30% of the business for a £450,000 investment. The founder agrees, and this means that the investor will own shares equivalent to 30% of the business.
What are the different types of equity investments?
There are several different types of equity investments, including the following:
- Common stocks – an investor holds shares in a company and earns a return through dividends. As an investor, you have little control, which is why some consider common stocks to be a risky investment, but common stocks can produce a high return over the short term.
- Purchasing preferred stocks – this is a stable equity investment with no power granted to you for your investment. You receive regular dividends which are independent from the market.
- Warrants – with warrants, common stocks are available for a specific time period. If these stocks aren’t purchased, they might become worthless, but may provide good returns when bought.
- Convertible debt – this is a type of bond without collateral that you can exchange for common stocks. This debt is often priced at a rate lower than the regular stock price.
- Equity line of credit – this is similar to a bank line credit, meaning you can purchase common stocks over a period of time. The advantage you can gain from this type of equity investment is that the stocks purchased are bought at a discounted price.
- Sales of restricted shares – this refers to the stocks in a company that can be transferred to another person once they’ve met certain criteria.
Why should I consider equities?
You can purchase shares from a company with the expectation (but not the guarantee) that its share price will increase in the long term. You may want to consider this type of investment if you think the company you’re investing in has the potential to grow. If you hold shares in a company that has seen significant growth, the value of its shares will likely increase too. If your shares increase in value, you can then sell them and earn a profit.
Equity investment strategies
Equity investment strategies vary depending on the company or different investment styles. The following are the most common investment strategies used in equity investing:
- Leveraged buy-outs are where a company wants to acquire another company. The equity investment for this type typically requires a significant amount of money.
- Venture capital is usually for small businesses or startups. This type of equity investment can have high returns, but also comes with high risks.
- Growth capital is designed for companies who are reconstructing or expanding their business. These are more reliable than other investments because the company may be well-established.
- Profit from a change in valuation relates to short-term investments that encourage investors to trade stocks continuously.
- Mezzanine capital is where the money is loaned for interest. The returns investors could earn using this type of equity investment strategy can range between 10% and 30%.
- Offshore equity investment is money invested in equities that are quoted offshore. Investors are exempt from tax, which is one reason to consider this option.
Investment banking firms often look at stocks in greater detail and may guide investors on the investment style it uses. There are three investment styles, and they are:
- Growth is where a company demonstrates higher growth and higher returns on equity investments.
- Value is based on low-value but high-dividend stocks. Managers often invest when the stock price is low but has the potential to earn good returns over the long term.
- Blend is an equity investment style in which the company may either display growth or value, and in some cases, it may display both.
How do I invest in equities?
There are a few ways you can invest in equities, and the most common way is using an online investment platform which offers equity funds or allows you to make equity investments. You’ll usually be asked to register and open an account. Once you’ve registered, you’ll be able to purchase stocks or shares of equity through a mutual fund or ETF by using a brokerage account.
What are the pros and cons of equity investing?
|There are times when high-performing companies offer their investors benefits or bonus shares.||You can't predict the rise or fall of stocks due to market risk, meaning investors stand to lose part or all of the value of their investments.|
|By investing in a company and acquiring shares, you’ll be an entitled shareholder which can give you a vote in official decisions.||A company’s credit risk is a factor to consider. You could be investing in a company that can’t pay back its debt.|
|An investor in equity shares owns assets of the company, which means you’ll receive part of the company’s income as dividends.||Liquidity risk may force you to sell your investment at a lower price.|
|As well as earning dividends, you can make capital gains depending on the rise and fall of the market price of your share.||Political risks often affect stocks, especially during a time of instability or a lot of political change.|
|Shares are liquid, which means you can transfer ownership at any time.||Currency can be a risk factor because the value of the returns from a company can vary depending on the currency.|
Alternatives to equity investments
Equity investments can provide strong returns, but it’s important to understand the risks that this type of investment can involve. These risks include losing some or all of the value of your investment, which might happen if a company you’ve invested in fails.
If you’re not comfortable with taking this amount of risk, you might want to consider other, safer alternatives to equity investments, such as savings accounts. Savings accounts are typically considered a much safer way to grow your money because with UK-regulated banks, your deposits are protected by the Financial Services Compensation Scheme (FSCS).
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