Equity, also known as shareholders' equity or owners' equity for privately owned corporations, is the amount of money that would be returned to a company's shareholders if all of the company's assets were liquidated and all of its debts were paid off. In the event of an acquisition, it represents the value of the company minus any liabilities not included in the sale.

Equity in a company can come in different forms. To break this down, we will attempt to explain what some of the terms mean. The following are the most common types of equity:

Common stock

Common shares or common stock, reflect the first investment made in a business. With this equity, stockholders get certain asset rights. The common stock is recorded at its par value, often known as its face value. And the total capital of common stock may be obtained by multiplying the number of outstanding shares by their value. To clarify, owners of common stock have more influence over the business and its management.

Preferred stock

Preferred stock or preferred shares are issued to investors and offer a fixed dividend. In a corporate liquidation, preferred investors would get any amounts owed to them by the business before common shareholders. And if dividends were suspended for preferred shareholders owing to any reason, they would be paid first when the firm winds up.

The company might modify the features of preferred stock to make the agreements more attractive to prospective investors. For instance, it may have a call and convertible provisions. However, these shares do not grant shareholders rights to company operations or management. Neither do the shares guarantee any voting rights. The sole advantage is that when the company pays dividends, preferred shareholders’ payments take priority over ordinary shareholders.

As previously stated, when an investor purchases stock, they become a proportionate owner of the company based on the number of shares they acquire. There are three distinct ways investors can get paid from equity investments:

Dividend:

As a shareholder, the investor is entitled to a profit from the company's earnings if the company is profitable. If the company distributes these profits as dividends, the investor receives a predetermined sum for each share he holds. Note this depends on the percentage of profits after tax (" PAT") allocated to be distributed as dividends. e.g. A company whose PAT is $1,000,000 and a dividend allocation of 10% - $100,000 would be distributed as dividends to its shareholders based on their respective equity ownership.

Capital Gains:

An increase in the value of the company's share price enables the investor to profit from the sale of their holdings. Over several years, an investor may earn multiples on his initial investment if the share price continues to appreciate. In addition, if the company is publicly listed, this allows them to sell it instantly on a public exchange. However, this may be tricky in a private company and require a secondary sale or company buyback.

Share buybacks:

The company may announce it is buying back shares from its shareholders at a price more significant than the current market price. Although only some investors intend to sell shares, the repurchase window provides an opportunity to provide liquidity for investors.

Investing in a business in its early stages can be very profitable for investors. Early stage investments not only have the potential to provide substantial profits or returns that exceed the average returns of the broader market, but also offer investors the chance to participate in a company's development and share in its success as it grows.

Have you had a business idea you thought about but ended up shelving? Find a startup doing something similar and get on board. It will be worth the ride, even if your involvement is being an investor.