Equity is a necessary part of a business—from someone’s side hustle to the largest corporations, every business has equity from the moment it’s formed.
What you might not know is that equity operates as both a measurement of financial health and a tool businesses use to inject capital into their business.
So no matter the size of the business, you need to understand what equity is, how it's measured, and the ways you can use it to help hit your growth goals.
Definition of equity
Equity is the value of ownership in an asset or business.
You may hear it refer to somebody owning a stake in a company as part of their investment portfolio. When this happens, the buyer is essentially purchasing a portion of the ownership of an asset or business.
In business, you’re the one who is portioning up ownership among different stakeholders. In this case, you’re more concerned about the value you’re generating for the ownership as opposed to the value you get from ownership.
What is equity in business?
In a business context, equity is one measure of how much a business is worth—its assets minus liabilities. If you sold off the company's total assets (everything it owns) and paid off its total liabilities (everything it owes), what you'd have left is the ownership equity in the company.
Each of these numbers—total assets, total liabilities, and equity—are reported on a company's balance sheet.
Whether it's the value of a sole proprietor's operation or a publicly traded Fortune 500 company, all businesses have some amount of equity (whether positive or negative).
The key difference comes down to who the equity belongs to. A sole proprietorship's equity belongs to the individual who owns the company, while the value of the publicly traded company is spread out among everyone who owns stock in the business.
How to calculate business equity
The business equity equation is:
For home equity, start with the market value of the home and subtract the remaining balance on the mortgage (the amount that's still owed on the home).
For business equity (including private equity), start with the market value of the business assets and subtract its liabilities.
Assets and liabilities are reported on a business's balance sheet.
Types of equity in business
There are many types of business equity—what it's called is generally determined by the business structure and financing.
Owner’s equity
Found in: sole proprietorships, partnerships, some limited liability companies (LLCs)
Owner's equity refers to the value of the company to the owners, as measured by the market value of the business assets, subtracting liabilities.
In a sole proprietorship, the entire value belongs to one business owner.
In a partnership, the total value is divided among the owners based on the partnership agreement—each partner gets their stated share.
Shareholder equity
Found in: public companies, corporations
Shareholder equity is held through shares of a company, whether through shares of private equity or stockholders' equity through a company's stock.
These shareholders own a given percentage of the business, which gives them claim to that percentage of the value the business would generate if it liquidates all of its assets and paid off all its debts.
Some shareholder equity may be paid out as dividends to the shareholders—what remains is known as retained earnings.
Is equity good or bad in business?
In accounting terms, equity represents a company's net worth—the value that would be returned to shareholders if all assets were liquidated and all debts paid. Positive equity means the business owns more than it owes, which is generally considered healthy.
However, in business, equity also refers to raising capital through additional ownership stakes in the company, whether that means bringing on investors or selling stock. Whether this type of equity is "good" or "bad" can be a more nuanced question.
For one thing, the valuation of net assets (and therefore total equity) can be difficult. The book value of intellectual property, for example, may not be a fair assessment of its market value. Venture capitalists often face these kinds of challenges.
Different investors may also have different priorities and time horizons. While some might focus on quarterly results, others may be more interested in long-term growth strategies. It's important to understand potential investors' expectations and how they align with your company's goals—as well as the potential effect that new shares and investors may have on your existing ownership structure.
When a business raises capital by issuing new shares, existing ownership stakes may be diluted, meaning current shareholders will own a smaller percentage of the company. The extent of dilution and its implications depend on factors like share class, preemptive rights, and anti-dilution provisions.
And common stock typically comes with voting rights, allowing shareholders to have a say in major company decisions. As more voting shares are issued, decision-making power becomes distributed among a larger group of stakeholders.
Before raising equity capital, be sure to think through the implications. Key considerations include voting rights, dividend policies, board representation, and how new investment might affect your control and strategic flexibility. While there's no universal 'right' approach to equity structure, it should align with your business strategy and growth plans.
Examples of equity in business
Let's look at some common examples of how equity changes in a business.
Raising investments
A business is looking to raise money to upgrade the equipment they use in their operations. They need $10,000 for the purchase, which they raise by selling $10,000 in common stock.
At the point of sale, assets increase by $10,000 due to the cash they gain from the sale, so equity increases by $10,000 as well.
Equity + $10,000 = (Assets + $10,000) - Liabilities
The same amount, $10,000, is added to each side of the equation.
Paying out dividends
In a given month, a business has generated $10,000 in net income. It decides to keep the money in the business as retained earnings.
With the $10,000 generated, $5,000 will be kept on hand to cover expenses while the other $5,000 will be used to pay down a credit card balance.
The equity equation looks like this:
Equity - $10,000 = (Assets - $10,000) - Liabilities
Since both sides of the equation decrease by $10,000, the equation holds.
Generating retained earnings
In a given month, a business has generated $10,000 in net income. They decide to keep the money in the business as retained earnings.
With the $10,000 generated, $5,000 is going to be kept on hand to cover expenses while the other $5,000 will be used to pay down a credit card bill.
The equity equation is affected as such:
Equity + $10,000 = (Assets + $5,000) - (Liabilities - $5,000)
Equity + $10,000 = Assets + $5,000 - Liabilities + $5,000
Equity + $10,000 = Assets - Liabilities + $10,000
Once again, the equation holds because both sides are increasing by $10,000.
Equity vs debt financing
Equity is sometimes used as an alternative to debt financing for injecting money into a business. One isn’t inherently better than the other—knowing which one is right for you requires understanding the differences.
Debt financing means taking on credit as a loan or line of credit—you borrow money with the intent to pay back the balance in full with interest. How much you need to pay back is clearly documented before any agreements are signed.
Raising funds through equity means selling an ownership stake in the business. Depending on the type of share or stock sold, the buyer may be entitled to dividend payments or voting rights.
You don’t “pay back” equity in the same way you pay back debt. In fact, some cases of selling equity don’t require payouts at all as the buyer benefits through capital gains (the increase in value of the share or stock).
However, if you’re paying dividends, you’re committing to paying shareholders based on business performance. If the business starts generating more profit, you’re paying more in dividends.
There are also restrictions on what kinds of businesses can sell equity. For example, pass-through entities like partnerships or sole proprietorships cannot sell equity.
When choosing between selling equity or using debt financing, you should think about the following factors:
- Are you eligible to sell equity in the business?
- What is your credit history and what options are you eligible for?
- Are you willing to dilute ownership and potentially lose some control of the business?
- Will the costs of paying out dividends outweigh the costs of a loan or line of credit?
- How does each option fit into your long-term strategy?
Generally speaking, early-stage businesses look to raise funds through investment because they have fewer cost-effective options for debt financing. Late-stage businesses with a consistent cash flow are more likely to use debt financing since they can manage the payments and won’t dilute ownership.
Equity and your day-to-day operations
Equity is just one way of understanding a business’s financial health. But to develop equity, you need to think about optimizing your day-to-day operations and maximizing profits.
BILL Spend & Expense helps you do just that. Featuring seamless, automated accounts receivables and payables, budgeting tools, and full visibility into how money enters and exits the business, you can spend less time generating numbers and more time crunching them.
BILL customers saved time and money by making the switch*. Reach out for a demo to see how we can help you.
*Based on a 2021 survey of over 2000 BILL customers
