Introduction to Equity

What is Equity?

Equity, in simple terms, represents an ownership stake in a company. It signifies the portion of the company that an individual or entity owns.

Owner's/Founder's Equity

For a privately held company, owner's equity (often synonymous with founder's equity, as founders are typically owners) is calculated as the difference between a company's assets and its liabilities.

• At Incorporation:

  • When a company is first incorporated, a face value for each share is set, with a minimum floor (e.g., one rupee in India).
  • The initial value of the company is determined by the total pool of assets brought in by founders, friends, and family.
  • This total value is then divided among the initial owners based on agreed-upon percentages. For instance, it's common for founders to hold 30-40% equity, or to split it equally (e.g., 50-50 for two founders).

• As the Company Grows:

  • As a company matures and its perceived value increases (e.g., through product development, service creation), new owners may join.
  • Ownership (equity) is exchanged for capital infusion from investors, such as angel investors or institutional investors. This means a portion of the company's ownership is given to these investors in return for their financial contribution, which helps the company grow.

Calculating Equity Value

Equity value can be understood at any stage of a venture's journey:

• Formula: Equity Value = Company Assets - Company Liabilities.
• Example: If a company's total value (assets) is 100 crores and it has debts (liabilities) worth 20 crores, then the residual value, which belongs to the owners (equity), is 80 crores. If an individual has 50% ownership, their equity stake is worth 40 crores.

Equity as Residual Value

Equity represents the residual value of a company that goes to the owners after all liabilities have been paid off. This is particularly relevant in scenarios like liquidation:

• Liquidation Example: If a company is liquidated with assets worth 40 crores and liabilities of 5 crores, the remaining 35 crores is the residual value. This 35 crores would then be distributed among the owners based on their respective ownership percentages.

In essence, equity is the tool that facilitates company growth by allowing ownership stakes to be exchanged for capital, and it represents the ultimate claim owners have on the company's value after all debts are settled.