What are the types of equity?
Equity represents ownership in a company, providing shareholders with voting rights and a claim on profits. The main types of equity include:
- Common equity: Shares that give investors voting rights and dividends, subject to the company's performance.
- Preferred equity: Shares offering fixed dividends and priority over common equity in profit distribution and asset liquidation.
- Private equity: Investments in private companies not listed on public exchanges, often involving significant ownership stakes.
- Public equity: Shares traded on stock exchanges, allowing investors to buy and sell ownership in publicly listed companies.
Each type offers unique benefits and risks, catering to diverse investment strategies and enhancing a company's overall corporation structure.
Factors affecting market value of equity
Several factors influence the market value of equity, including:
- Company performance: Profits, revenue growth, and overall financial health directly impact investor confidence and stock prices.
- Market conditions: Economic indicators, interest rates, and market trends can cause fluctuations in equity values.
- Industry trends: Sector-specific developments, such as technological advancements or regulatory changes, affect the perceived value of companies within that industry.
- Investor sentiment: Market psychology, including investor perceptions and reactions to news, can drive stock price movements.
- Corporate actions: Decisions like mergers, acquisitions, stock splits, and dividend announcements can significantly alter a company's market value.
Features of equity
Feature
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Description
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Ownership
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Equity represents ownership in a company, providing shareholders with a stake in its assets and earnings.
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Voting rights
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Common shareholders typically have voting rights, allowing them to influence corporate decisions, such as electing the board of directors.
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Dividend entitlement
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Shareholders may receive dividends, which are a portion of the company's profits distributed periodically.
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Residual claim
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In case of liquidation, shareholders have a residual claim on assets after debts and liabilities are paid.
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Marketability
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Equity can be bought and sold on stock exchanges, providing liquidity to investors.
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Potential for appreciation
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Equity investments can appreciate in value over time, offering the potential for capital gains.
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Risk
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Equity investments are subject to market risks, including volatility and potential loss of capital.
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No fixed returns
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Unlike debt instruments, equity does not offer guaranteed returns; dividends and capital gains depend on the company's performance.
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Limited liability
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Shareholders' liability is limited to their investment amount; personal assets are protected in case of company failure, typical of a limited liability partnership.
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Advantages of investing in equity shares
Advantages of investing in equity shares include:
- Potential for high returns: Equity shares offer significant growth potential through capital appreciation and dividends.
- Ownership and voting rights: Investors gain ownership in the company and can influence major decisions through voting rights.
- Liquidity: Equities can be easily bought and sold on stock exchanges, providing investors with liquidity.
- Dividend income: Shareholders may receive regular dividend payments, offering a source of income.
- Diversification: Equities can diversify an investment portfolio, spreading risk across different sectors and companies.
- Inflation hedge: Historically, equities have outpaced inflation, preserving and increasing purchasing power.
Disadvantages of investing in equities
Disadvantages of investing in equities include:
- Market volatility: Equity prices can be highly volatile, leading to significant short-term losses.
- Risk of capital loss: There's no guarantee of returns, and investors can lose their entire investment if the company performs poorly.
- Dividends not guaranteed: Unlike fixed-income securities, dividends on equities are not assured and can be cut or eliminated.
- Emotional stress: The constant price fluctuations can lead to stress and emotional decision-making.
- Company-specific risks: Factors such as management decisions, competitive pressures, and operational failures can adversely affect stock performance.
- Dilution: Issuance of additional shares can dilute the ownership and value of existing shares.
What are the components of Shareholder equity?
Shareholders’ equity comprises:
- Share capital: This includes common and preferred shares, along with paid-in capital. Paid-in capital, also known as contributed capital, represents the amount investors have contributed for common shares beyond their par or stated value
- Retained earnings: This consists of accumulated earnings from previous years, combined with the current year’s after-tax net income, minus any dividends distributed to shareholders
- Common stock: Shares issued to investors in exchange for capital.
- Preferred stock: Special class of stock with priority over common stock.
- Retained earnings: Accumulated profits retained in the business.
- Additional paid-in capital: Capital raised through stock issuance above par value.
- Treasury stock: Shares repurchased by the company.
- Accumulated other comprehensive income: Unrealised gains or losses not included in earnings.
Example of shareholder equity
Let’s understand how to calculate shareholders’ equity using a sample balance sheet for a company as of 31st March 2025.
Consolidated balance sheet of the company
Assets
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Amount (in Rs. lakh)
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Current Assets
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Cash and equivalents
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1,800
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Inventories
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620
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Short-term investments
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900
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Receivables
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1,150
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Prepaid expenses
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1,430
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Total Current Assets
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5,900
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Long-term Assets
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Property and Equipment
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3,750
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Goodwill
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2,950
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Total Assets
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12,600
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Liabilities
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Amount (in Rs. lakh)
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Current Liabilities
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Accounts payable
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5,200
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Short-term borrowings
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160
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Total Current Liabilities
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5,360
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Long-term Liabilities
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Long-term loans
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840
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Deferred tax liabilities
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1,020
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Other long-term liabilities
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280
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Total Liabilities
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7,500
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Shareholders' equity calculation
We use the formula:
Shareholders’ Equity = Total Assets - Total Liabilities
= Rs. (12,600 - 7,500) lakh
= Rs. 5,100 lakh
Steps to calculate shareholders' equity:
Identify total assets: Add all current and long-term assets as shown in the balance sheet.
Identify total liabilities: Add all current and long-term liabilities.
Apply the formula: Subtract total liabilities from total assets to arrive at shareholders' equity.
Other forms of equity
Beyond shareholder equity, there are several other forms of equity relevant to the Indian context. Employee equity is prevalent, often through Employee Stock Ownership Plans (ESOPs) or stock option programs, which are increasingly popular in Indian startups and established companies alike. Founder equity holds significant importance, delineating the ownership shares among the initial creators of a business, a crucial aspect in India's vibrant entrepreneurial landscape. Debt-to-equity swaps are pertinent given India's dynamic financial sector, where companies may convert debt into equity to manage debt burdens or facilitate growth. Lastly, community equity has cultural resonance in India, particularly in cooperative societies and community-driven enterprises, where stakeholders share ownership and decision-making, reflecting India's diverse and inclusive approach to business and society. These various forms of equity underscore the multifaceted nature of ownership and value distribution within Indian organisations.
Private Equity
Private equity involves investment in privately held companies or the acquisition of public companies with the intention of taking them private. In India, private equity has become increasingly prominent in the investment landscape, particularly in sectors such as technology, healthcare, and consumer goods. Private equity firms typically provide capital in exchange for ownership stakes, often seeking to add value through operational improvements, strategic guidance, and eventual exit strategies such as IPOs or sales to other companies.
Home equity
Home equity refers to the value of ownership that homeowners have in their homes, calculated as the difference between the property's market value and the outstanding balance of any mortgages or loans secured by the property. In India, home equity is a significant aspect of personal finance and wealth management, serving as a potential source of funding for various purposes such as home renovations, education expenses, or investment opportunities. Home equity loans or lines of credit allow homeowners to access this equity by borrowing against the value of their property, providing flexibility and liquidity.
Brand equity
Brand equity encompasses the intangible value and perception associated with a brand, including its reputation, recognition, and customer loyalty. In India, brand equity holds immense importance in the competitive marketplace, influencing consumer behavior and purchase decisions across various industries. Building and maintaining strong brand equity involves consistent branding efforts, quality products or services, effective marketing strategies, and positive customer experiences. Well-established brands in India command premium pricing, enjoy customer trust, and often expand their market presence through brand extensions and partnerships, showcasing the enduring power of brand equity in driving business success.
How equity works?
Equity can be obtained by purchasing shares directly from the company or from other shareholders in the secondary market.
Unlike loans, equity financing does not require repayment with interest. Instead, shareholders share in the company's profits and potential losses.
However, giving up ownership in the company can mean diluting control and sharing future profits. This is where business loans come in. While equity financing provides capital without the obligation of repayment, business loans offer funds that need to be repaid with interest. By using a business loan instead of equity financing, companies retain full ownership and control.
How to calculate equity?
Calculating equity is crucial for understanding the ownership stake in a company. It is calculated by subtracting the company's liabilities (what it owes) from its assets (what it owns).
The formula is:
Total equity = Total assets – Total liabilities
Assets include things like cash, inventory, equipment, and property, while liabilities encompass debts, loans, and other financial obligations.
Why is equity important?
Equity is crucial as it signifies ownership and financial stability for businesses. It helps attract investors and raises capital for expansion, innovation, and daily operations. With equity, businesses retain control and flexibility in decision-making. Additionally, equity reflects confidence in the company's future prospects. A business loan complements equity by providing additional funds for growth initiatives without diluting ownership. It offers immediate capital for acquisitions, equipment purchases, or working capital needs, enabling businesses to seize opportunities and achieve their goals while preserving equity ownership and control.
Conclusion
Understanding equity in all its forms, whether shareholder, brand, or home equity, is essential for assessing a business’s value and financial position. It not only reflects ownership but also influences strategic decisions around fundraising, control, and long-term growth.
While equity financing gives access to capital without debt, it often involves sharing ownership and future profits. In contrast, using a business loan allows companies to raise funds while retaining full control. To make informed decisions, it's important to understand the applicable business loan interest rate and how it affects overall repayment and cost of capital.
By balancing both equity and debt smartly, businesses can fuel expansion, preserve ownership, and build long-term value effectively.
