Equity: everything you need to know

Equity is important because it provides a good overview of the financial health of a company, and can be used to generate funds and investments into the company for achieving growth and expansion. Equity is sold in the form of shares to investors, who in turn generate income for the company.

Shareholder equity can be negative or positive. If the equity is positive, this means that the company has enough assets to cover its liabilities. Conversely, if a company’s equity is negative, its liabilities exceed its assets.

A shareholder’s equity can help determine the health of a company, and when used alongside other tools, investors can accurately analyse an organisation’s financial wellbeing.

Equity doesn’t only evaluate a company’s health. In more general terms, equity is the degree of ownership found in any asset, either in a company or personally, after deducting all debts. The following are variations of company equity:

• Any stock or other securities that represent ownership in a private company are called private equity.
• On all company balance sheets, the number of funds contributed by shareholders, including earnings or losses, may also be called a stockholders’ equity.
• When it comes to margin trading, or borrowing money from a broker to trade an asset, the value of securities in a margin account minus what the account holder borrowed from the brokerage, is equity.
• When a business is declared bankrupt and goes into liquidation, its equity is the amount of money remaining after the business pays back its debts to its creditors. This type of equity is known as ownership equity or liable capital.

Private equity

Publicly traded investments show the market value of equity as seen through the company’s share price and its market capitalisation. However, for private entities, this market mechanism doesn’t exist, meaning they must use other forms of valuation to determine their value.

Private equity refers to the wealth of companies that don’t trade publicly. The same accounting equation applies in private equity, which is: value – liabilities = equity.

Privately-held companies can seek investors by selling their shares to private equity funds. These private equity investors can include institutions such as pension funds, university endowments and insurance companies.

Private equity is also often sold to funds and investors who specialise in direct investments or those that engage in leveraged buyouts of public companies. Leveraged buyout transactions occur when a private equity company receives a loan from one or more banks or other investors to fund the acquisition of another company. Cash flow or company assets of the target company can be used to secure the loan.

Private equity can come at different points in a company’s life. In most cases, young companies with no revenue or earnings won’t be able to afford to take out a loan and scale their business. For this reason, these companies usually get their capital from friends, family, or business people, known as angel investors.

Venture capitalists receive a minority stake in the business at an early stage, in exchange for providing private equity finance. They usually invest when a company has created a product or service that’s ready to be brought to the market. They may take a seat on the board of directors to ensure they have an active role when it comes to company growth.

Home equity

Home equity, or property equity, is the value of the interest you own on your home. Suppose you take the market value of a property and deduct any borrowed money attached to it, such as an outstanding mortgage amount. In that case, the leftover portion is the equity you own.

The amount of equity you own in your home fluctuates over time, based on mortgage repayments and any market forces that might impact the value of the property. For example, the deposit you put down entitles you to some equity in the house, which increases as you pay off your mortgage.

You can have both positive and negative equity in a property. Positive equity is a good thing, as it means your house is worth more than your mortgage, with negative equity being the opposite (more on negative equity shortly).

For example, say the market value of your house is £250,000, and you bought the house with a £30,000 deposit and got a mortgage for the remaining £220,000. This means the property is worth more than your mortgage debt, giving you positive equity.

You can also see positive equity as a good long-term strategy to build wealth. By gradually making mortgage repayments, you are increasing your share of equity in the property. The following table takes a quick look at the pros and cons of positive equity.

Negative equity, on the other hand, happens when the value of your property is less than the mortgage secured on it, something which is usually caused by falling house prices and more commonly experienced by those with interest-only mortgages.

For example, say you bought your property for £250,000, using a £30,000 deposit and taking out a £220,000 mortgage. Since then, the value of your property has decreased to £200,000. As this is £20,000 less than your mortgage, it places you in negative equity.

The main threat posed by negative equity is that you might find it difficult to sell your home. You may be able to move and transfer your negative equity over with you if you can find a negative equity mortgage, but these types of mortgages tend to be quite rare and not a lot of lenders offer them. Securing a negative equity mortgage will also be dependent on the following factors:

• How much negative equity you have
• The value of the property you wish to move to
• If you are up to date with your existing mortgage
• How much deposit you’re able to raise for the new property

The table below considers the pros and cons of negative equity:

Brand equity typically measures the perceived value of a brand, or its social value, often from a consumer point of view.

A corporation’s equity can also include tangible assets, such as property, as well as intangible assets, such as a company’s reputation and brand identity.

Negative brand equity also exists and is exemplified when you would be willing to pay more for a generic or store-brand product than you would for a well-known brand name. Negative brand equity is rare and usually occurs because of bad publicity, such as product recalls or a public relations crisis.