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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Equity is ownership of the business. Not all equity is the same, and the exact terms depends on the deal being made.
Equity essentially always involves some claim on the profits generated by the business. If the business makes $1 million in profits, someone with 25% equity is entitled to $250,000. It also typically involves a claim on the assets of the company. If for some reason it was sold or shut down (outside of bankruptcy), they would get a portion of whatever it sold for, either as a whole company or as leftover pieces. Note that buying a certain amount of equity often depends on the company’s valuation. The more a company is “worth,” the more expensive any piece of equity. This is why the investors on Shark Tank will often comment that a pitch is claiming a valuation that is too high. The lower the valuation, the more equity they can buy for the same amount of money.
Equity also implicitly involves the right to *control* the business, though how exactly depends on the corporate governance. In principle, if you sell 1 person a 51% share (2 people a 26% share, etc.) in your company, they can outvote you when it comes to questions of how the company should actually be run. You would maintain your equity (and hence your right to profits and assets), but may get no say in how the business runs.
The people appearing as “sharks” on a show like Shark Tank are unlikely to become personally involved in the governance of the companies they invest in, but they may have employees who *will* wield that ownership share to change how the business is run. However in some sense, this is the point. The people who appear on Shark Tank are looking less for investment dollars and more for the boost in notoriety and distribution that comes from partnering with a “celebrity investor.” This is why they’re usually pitching apps and home gadgets and not, like, manufacturing car parts or managing real estate.
Equity is ownership of the business. Not all equity is the same, and the exact terms depends on the deal being made.
Equity essentially always involves some claim on the profits generated by the business. If the business makes $1 million in profits, someone with 25% equity is entitled to $250,000. It also typically involves a claim on the assets of the company. If for some reason it was sold or shut down (outside of bankruptcy), they would get a portion of whatever it sold for, either as a whole company or as leftover pieces. Note that buying a certain amount of equity often depends on the company’s valuation. The more a company is “worth,” the more expensive any piece of equity. This is why the investors on Shark Tank will often comment that a pitch is claiming a valuation that is too high. The lower the valuation, the more equity they can buy for the same amount of money.
Equity also implicitly involves the right to *control* the business, though how exactly depends on the corporate governance. In principle, if you sell 1 person a 51% share (2 people a 26% share, etc.) in your company, they can outvote you when it comes to questions of how the company should actually be run. You would maintain your equity (and hence your right to profits and assets), but may get no say in how the business runs.
The people appearing as “sharks” on a show like Shark Tank are unlikely to become personally involved in the governance of the companies they invest in, but they may have employees who *will* wield that ownership share to change how the business is run. However in some sense, this is the point. The people who appear on Shark Tank are looking less for investment dollars and more for the boost in notoriety and distribution that comes from partnering with a “celebrity investor.” This is why they’re usually pitching apps and home gadgets and not, like, manufacturing car parts or managing real estate.
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.
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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