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Definition and the different forms of equity in Business

money, equity, finance, loan, capital

Definition of Equity:

Equity stands for the worth of an individual involved in a business venture (business owners, shareholders) or the worth of a business based on what the business owns and owes. Equity help individuals involved in business to know what they can lay claim to in the business they are involved in, and helps businesses know if it’s going forward or if it’s stagnant or sliding backwards.

Equity for businesses can be positive or negative depending on the increase or decrease in assets and liabilities.

Forms of Equity in Business:

When you talk about equity, it exists in different forms which are as follows:

Equity as it concerns single business ownership

As a small business owner or a sole proprietor, your equity can be arrived at by subtracting any money you borrowed to start up or run the business from the total business worth.

Equity = business worth – how much you owe

Consider this example: Chidinma owns a small shop where she sells children wears. The current business worth is $5,000 of which $2,000 is her personal investment into the business, while the other $3,000 is money borrowed from a bank. Her equity in this business is just her original $2,000. If along the line, she experiences a lose in the business and the value of her goods and business reduces from $5,000 to $3,000, her equity is now $0. However if she’s able to grow her business with the $3,000 left to $6,000 as well as paying off the bank loan she owed, her equity becomes the entire $6,000 which is equivalent to 100% ownership.

Equity as it concerns multiple business ownerships

If you are involved in a partnership business, a company or a startup requiring multiple investors (or shareholders), equity here represents how much each shareholder or investor is bringing into the business. It is usually as derived as a percentage of each shareholder’s contribution to the overall funds required in the business.

As an example: Let’s say Olu, the founder of OPQ tech started his company with $10,000 which has now grown in value to $45,000 but now wants to expand and requires about another $45,000. He gets three investors who wants to invest $5,000, $30,000 and $10,000 respectively. Olu can take up a maximum percentage (let’s say 55%) equity while leaving the rest percentage (45%) for the three investors to share based on their investments.

Using the formula:

Percentage equity = (individual investment/ funding required) * sharing percentage

First investor,
Percentage equity = (5,000/45,000)*45 = 5%

Second investor,
Percentage equity = (30,000/45,000)*45 = 30%

Third investor,
Percentage equity = (10,000/45,000)*45 =10%

So in summary, Olu owns 55% of the business, First investor owns 5%, Second investor owns 30% while Third investor owns 10%.

Equity as worth of a business

The worth of a business is also referred to as the business equity. It is the difference between what brings in money to the business (assets) and what takes from it (liabilities).

The business equity can be calculated as:
Business Equity = Assets – Liabilities.

For example:

If IJK company procures a delivery van for product delivery, that’s an asset, and if it owes a loan, that’s a liability. A company with assets of $50,000 and liabilities of $48,000 is worth only $2,000. That’s the company’s equity as well as value.

Business equity increases as the business assets grows and decreases as the business incurs more liabilities. When a business equity is positive, we say the business is growing in value, and the reverse is the case likewise.

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