What is equity in business?

When people ask, “What is equity in business?”, it usually means the amount of money left if a company were to sell its assets and pay off all its debts. For investors, equity represents their ownership in a business once all of its obligations are settled.

Although “equity” can seem like it has different meanings, it boils down to the same idea: assets minus liabilities. In this article, we’ll discuss what equity means in business and how to calculate it. We’ll also discuss why equity is vital for a company, and how it’s used.

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What does equity mean in business?

In business, equity refers to the difference between the total value of a company’s assets and its liabilities. It’s essentially what’s left after a company pays all its obligations, such as bank loans and wages.

Equity takes on a secondary meaning once investors are involved. In this case, equity also refers to an investor’s ownership share in the business, relative to how much they’ve invested. The larger their investment, usually the larger their stake in the company.

Here’s what equity can mean based on the business structure:

• Shareholders’ equity: For publicly traded companies, shareholders' equity (or stockholders’ equity) is the value of an investor’s ownership based on the number of shares they own.
• Private equity: Private equity works similarly to shareholders’ equity, but for companies that aren’t publicly traded. Usually applies to private investors, such as venture capitalists and angel investors.
• Ownership equity (also known as owner’s equity): Ownership equity is the degree of ownership a business owner has after accounting for debt. This applies to small businesses with sole proprietorship; if there’s a partner, such as with limited liability partnerships, the term changes to partnership equity.

You can think of equity as a company’s net worth: it’s how much the business is worth after clearing all of its debts, regardless of how many owners or investors there are.

What is equity in simple words?

Equity, in simple words, means how much money you’ll get if the business were to shut down, sell everything it owns, and pay everything that needs paying.

The concept of equity applies whether you’re a shareholder in a publicly traded company, an investor in a private company, or own the business yourself.

How do you calculate equity?

The basic formula for calculating equity is:

Equity = Assets − Liabilities

Here’s how to use the formula:

1. Start by adding the value of all the assets, as indicated on the company’s balance sheet.
2. Next, add together all of the values listed in the “Liabilities” section.
3. Subtract the total liabilities value from the total assets value. The figure you get is the company’s equity.

Examples of assets include:

• Cash
• Inventory
• Accounts receivable
• Raw Materials
• Properties and equipment
• Intellectual property

Examples of liabilities include:

• Taxes
• Wages and benefits
• Bank loans and mortgages
• Accounts payable

Let’s look at this formula in practice, using Air France-KLM’s balance sheet from 2023 as an example. Their reported total assets were valued at 34.49 billion euros, while their reported liabilities for the year totaled 33.99 billion euros. Using the equity formula, we find that Air France-KLM’s equity for 2023 was 500 million euros.

Can equity be negative?

Ideally, a company should have positive equity, but sometimes it can be negative. Negative equity happens when a business has more debt than its assets can cover, or when the value of its assets has dropped significantly.

Negative equity usually means the company is in financial trouble, but it doesn’t always mean the end. For example, large corporations like Starbucks go through periods of negative equity as they take on debt to fund expansion plans. Strong profits earned after significant expansion help businesses reach positive equity again.

Why is equity important?

Equity shows the net worth of a business—what a company is really worth after paying off its debts. Positive equity means greater company control and financial stability for business owners. For investors, it means the business is performing well and can provide a good return on their investments.

Equity is also a good indicator of a company’s financial health because it shows that the company can handle its obligations just fine. When equity is positive, businesses can:

• Negotiate a better price during a merger or acquisition
• Secure loans with better terms
• Attract investors to fund growth
• Justify their share price in the stock market (for public companies)
• Sell a portion of that equity to private investors to fund growth

Negative equity might make lenders and investors hesitant, but it depends on what the company is planning for the future. If a company has negative equity because of debt to fund future growth, it must prove that the borrowing will lead to profits down the line.

Companies with a track record of bouncing back after a period of negative equity have a higher chance of attracting investors willing to take calculated risks.

How do businesses use equity?

Businesses typically use equity to raise funds for growth, and this process is called equity financing or equity funding. It’s when a company sells shares of its equity in exchange for cash. Unlike bank loans, equity funding doesn’t need to be repaid, but it does mean giving the investor an ownership stake in your business.

There are several types of equity funding:

• Angel investments: Angel investment means someone with a high net worth (i.e., the angel investor) invests their own money into someone else’s business in exchange for a minority equity stake. The angel investor will usually look for start-up or early stage businesses, and they advise new business owners to help them succeed.
• Venture capital: Venture capitalists (VCs) also focus on investing in new businesses but don’t use their own money like angel investors do. Instead, VCs use investment companies like pension funds to inject cash into start-up businesses. They can usually provide more funds than an angel investor but may also ask for a larger equity stake in return.
• Private equity: Private equity investors are similar to VCs in that they use funds from institutional investors, but they focus more on established businesses than start-ups. They invest a significant amount of money in exchange for a large equity stake in the company, and they eventually sell that stake to another private equity firm for a profit.
• Equity crowdfunding: Using FCA-regulated online crowdfunding platforms like Simple Crowdfunding or CrowdCube, equity crowdfunding is when you list your start-up or early stage business online to raise additional capital. During this time, the “crowd” can invest in your company in exchange for shares.
• Initial Public Offering (IPO): An IPO means you’re raising funds publicly on the market for the first time. This process is called listing or floating on the stock market, also known as the public market. The London Stock Exchange is the UK’s public market. Your business must already be well-established and have already gone through several rounds of private funding before going public.

Quickfire summary: what does equity mean in a business?

Equity in business means the value of the company after all of its assets have been sold and all debts have been paid. It’s basically a company’s net worth; the higher the equity, the stronger the business.

For investors, equity also means the degree of ownership they have in the company, which depends on how much they’ve invested. Its value is determined by how much is left after using all of a company’s assets to pay its debts.

To calculate a company’s equity, you subtract the total liabilities from the total value of its assets. Positive equity is when there’s money left after everything is paid; negative equity is when there’s not enough money to repay everything. You can find a company's total assets and liabilities from its yearly balance sheet.