What It Is:
Put simply, equity is ownership.
In the trading world, equity refers to stock. In the and corporate lending world, equity (or more commonly, shareholders’ equity) refers to the amount of capital contributed by the owners or the difference between a company’s total assets and its total liabilities.
In the world, equity refers to the difference between an asset’s market value and the debt owed on the asset.
How It Works/Example:
The two most common types of equities traders encounter are common stock and preferred stock. Share certificates bearing the name of the shareholder, the number of , and the name of the company represent these equities, or . The number of a is authorized to issue is outlined in its corporate charter. When a company decides to sell additional to new or existing shareholders, this is sometimes called raising equity.
Although shareholder rights vary by company, one of the most prominent characteristics of equity is that it entitles the owner to vote on certain matters and to do so in proportion to the number of he or she owns. The company’s articles of incorporation and bylaws determine the number of votes each is entitled to.
As you can see in the sample for XYZ Company, equity is generally broken out into the par value of the , any additional paid in capital, and any retained by the company.
Why It Matters:
Equity holders enjoy voting rights and other privileges that only come with ownership, because equity represents a claim on a proportionate share of a company’s assets and lenders’ claims, but only equity holders can truly participate in and benefit from growth in the value of the enterprise.
Some financial instruments have equity characteristics but are not actually equity. Convertible debt instruments, for example, represent loans that convert into when a company (the borrower) crosses certain thresholds, thereby turning a lender into an owner in certain events. also act like equity in that their value changes with the value of the underlying , but the holders generally do not have voting rights and are not eligible to receive the dividends or other distributions made to bona fide equity holders.
It is important to understand that although balance sheet equity represents the company’s net worth, the company’s shares are ultimately worth only what buyers are willing to pay for them.