What is equity? Learn the definition of equity in business and real estate
You may have heard the word equity in the workplace, or from family and friends buying a home or investing in a company. But what exactly is equity? Well, it depends on who you ask. Let’s break down the different types of equity, from shareholder equity to homeowner’s equity and more.
Table of contentsWhat is equity?What is equity for corporations? What is the difference between book value and market value?What is equity compensation for employees?What is home equity?
What is equity?
Equity is a financial concept that can mean different things depending on who you’re talking to. The basic equation for equity is the value of an asset (or assets) minus liabilities. For example, if your bike is worth $100, but you borrowed $60 from your friend to buy it, you have $40 in equity.
Of course, equity can get a lot more complicated than that. Here’s what equity can mean in different contexts:
In business, equity can refer to several things, but the most common is shareholder equity. This is the amount of money that would be distributed to shareholders if a company liquidated all of their assets and paid off all their debts.
In real estate, equity refers to home equity, or the difference between the current market value of a home and how much the homeowners owe on their mortgage.
What is equity for corporations?
In a business context, equity can refer to shareholder equity, owner’s equity, or private equity.
Shareholder equity in publicly traded companies. For publicly traded corporations, equity usually refers to shareholder equity (aka net assets). Shareholder equity is equal to the company’s total assets minus total liabilities, calculated on a balance sheet each quarter. This is the amount that would be distributed to the company’s shareholders if the company’s assets were liquidated and all of its debts were paid. It includes both tangible and intangible assets, like stock. The part of shareholder’s equity that is reinvested in the company is called retained earnings.
Owner’s equity. Sole proprietors also have equity, usually called owner’s equity. If you own your own business, owner’s equity also includes money that you invested in the business. You’ll have to subtract money that you took out of your business, and any debt you owe. If you have shareholders, owner’s equity is what’s left over after paying the shareholders.
Private equity. Private equity is investment in a private company—that is, a company not traded on a stock exchange. Private companies don’t have shareholders, so private equity is generally discussed in the context of funding (à la venture capital) or buying and restructuring private companies as an investment strategy. Private equity is something that only accredited investors with more than $1 million in net worth can partake in.
What is the difference between book value and market value?
Although the basic equation for equity is simple, calculating equity for a business can actually get pretty complicated. For example, should the value of an asset be determined by how much you paid for it, or by its current market value? The answer is both.
Accountants call these different ways of calculating equity the book value and market value of an asset. The book value of an asset is based on the original cost of the asset, adjusted for depreciation or other changes. The market value of an asset is how much the asset would be worth if it was sold right now.
What is equity compensation for employees?
If you’ve been offered equity as part of a compensation package, what you’ve actually been offered is shares of stock, or options to buy shares of stock. Your personal equity in the company relates to the number of shares you have, and the total number of shares that have been issued. For startups, which are usually low on cash, equity compensation is a good way to supplement cash salaries for employees, while saving cash.
Employers often use equity compensation to encourage employees to stay at the company. Most equity compensation happens on a vesting schedule, which means that you won’t receive your stock options or grant until you’ve worked at the company for a set number of years.
A stock option agreement gives you the right to purchase a certain number of shares at a discounted rate, during a set timeframe. You have the option of buying some, all, or none of the shares you’ve been offered.
When it comes to comparing compensation offers, there are a couple of ways to think about the value of the equity you’re awarded. A higher number of shares doesn’t necessarily mean more equity. Ask the company what percent of the company your shares represent (based on the total number of shares) and the current valuation of the company to get a clearer picture. You’ll also want to take into account the vesting schedule, how long you plan to stay at the company, and your own prediction for the company’s success.
What is home equity?
In real estate, home equity refers to the amount of your home that you actually own. It’s calculated by finding the fair market value of your home and subtracting how much you owe on your mortgage. If you’re a homeowner, you gain equity when your home increases in value and as you pay off your mortgage. Home equity isn’t just important when it comes time to sell—it’s also a popular way to borrow money.
You can use your home equity to get a home equity loan, also known as a home equity line of credit or second mortgage. When you get a home equity loan, an appraiser will assess the value of your home. You can then use the equity you have in your home to borrow money. Traditionally, this loan is for a lump sum to pay for a large expense. A home equity line of credit is a type of home equity loan that allows you to borrow smaller amounts over a set amount of time.
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