Context: Ownership
Equity refers to ownership shares in the company.
A company needs funds to start-up a company, they can raise funds either through debt or through selling equity, i.e. by selling part of the ownership shares of the company1 to some investor, who becomes a shareholder in the company.
This means that the company need not pay back the initial funds that were raised (as the shareholder already got the ownership in return of that money). The benefit that he reaps are through the company’s success, primarily:
- Dividends
- Capital Gains: The potential increase in the stock’s price, allowing the shareholder to sell their shares at a profit.
Context: Selling of Company
Think of equity as the value of a company in terms of money, if I were to sell everything in it.
So, if at present abc
company has 1 million worth of equipment, resources and products. Then the equity of this company would be 1 million2. Let’s call them assets.
But this is an incomplete definition, for we also have to account for any liabilities3 that will not be transferred4 with the sale5 of the company.
So, finally:
Though, we should also point out that some of the liabilities may be transferred with the sale and thus it would be accounted for by deductions in the assets portion of the sale.
Equity Example
Imagine a company called “Tech Solutions” is being sold. The total assets of the company (like real estate, equipment, and accounts receivable) are valued at $1 million. However, the company also has liabilities, such as loans or debts, amounting to $200,000.
Now, in the sale agreement, the buyer will not take over $100,000 of the company’s debt (this debt stays with the seller). This means the buyer will only take on $100,000 of liabilities.
So, the equity in this case is:
Equity = Assets - Liabilities (not transferred with the sale)
Equity = $1,000,000 - $100,000 = $900,000
The buyer would be purchasing the company based on this equity value of $900,000, assuming $100,000 in liabilities remain with the seller.
Footnotes
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This ownership share is sold typically in the form of stocks ↩
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The price I would be paid for selling this company ↩
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Liabilities can include some loans that the founder of
abc
had taken to start the company or to buy some machinery or to expand production. Anything that has to be paid out eventually by the seller ↩ -
Here it means that even if I sell the company, I, the seller will still be obligated to pay out the loans, and I can’t transfer it to the buyer. ↩
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I always thought of the word ‘sale’ as in some shopping market, where we say, this thing is being sold, or is on sale. But I think a better way to think of this is to see the pure grammatical meaning… “The selling of a company” or “Sale of a company” meaning, the act of selling that company. That’s all ↩