I’m on a kick of watching business investment shows. The investors ask for certain percentages of the business, but what does that actually get them? What’s the difference between a 5% stake and a 25% stake? Do they take a profit share, do they also take on a percentage of the businesses debts? What is equity in layman’s terms?
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Businesses have assets (stuff they own) and liabilities (stuff they owe). Assets include things like cash on hand, ‘accounts receivable’ (customers’ lines of credit), equipment, buildings, land: basically anything that is or can be turned into cash. Liabilities are the opposite, anything that has to be paid at some point (mortgage, rent, wages, ‘accounts payable’ – the company’s own lines of credit).
On a Balance Sheet, Owners’ Equity is found by subtracting the liabilities from the assets so it’s the net worth of the business as it were.
This isn’t necessarily the same as the VALUE of the business: an investor may be willing to pay more than the equity is “worth” now because they see the prospect of the business growing in the near future. Similarly, a business in decline may not have an owner be able to sell shares for what the equity is worth; it’s really a snapshot on the day the balance sheet was made.
Typically, the owners are responsible for liabilities in the event that the business can’t pay them (though bankruptcy protection laws in certain jurisdictions can mean that the individuals themselves can’t be pursued). Profit share takes place through a dividend, usually a percentage of the profits is distributed on a per share basis (so proportional to the quantity of equity owned). It’s up to the top management of the individual business to decide whether or not to issue a dividend, and how much.
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