Key Takeaways

  • Equity represents ownership in a company, distributed through different forms like common stock, preferred shares, and retained earnings.
  • Common stockholders have voting rights and the potential for higher capital gains but are last to be paid during liquidation.
  • Preferred shareholders have priority over dividends and liquidation payouts but usually lack voting rights.
  • Contributed surplus refers to amounts paid by investors over the par value of stock, impacting a company's financial structure.
  • Retained earnings are profits kept in the business for growth instead of being distributed as dividends.
  • Treasury stock is stock a company buys back, reducing the number of outstanding shares.
  • Additional types of equity include restricted stock, stock options, and founder’s equity, each serving different corporate and investor needs.
  • Different equity accounts like owner's capital, owner's withdrawals, and accumulated other comprehensive income (AOCI) impact how businesses report equity.
  • You can find an attorney on UpCounsel if you need assistance understanding the types of equity and how they apply to your business.

Types of equity are different forms of shares or ownership available in a company. Some corporations will offer differing levels of equity to attract investors with wallets of all shapes and sizes. 

What Is Equity?

Equity is the ownership an investor has in a corporation, also called their share. The income of a corporation is divided into shares after any company financial obligations or debts have been paid off. 

The price of a share or equity depends on a few different factors regarding the business and its income. This price is the value determined for a share by considering the earning potential of the business. The factors considered when determining a company's earning potential include:

  • The state of the economy in the corporation's particular industry.
  • The state of the general economy on a national and international level (depending on the size and reach of the corporation).
  • Projected earnings.
  • Projected growth.
  • Development stage.
  • Financial ratio analysis.

When a corporation is in the startup phase, the money given by shareholders and owners to get things up and running and to afford ongoing business operations is also called equity. 

The total equity of a limited liability company (LLCs) refers to the value of the assets left over once any liabilities are paid and recorded. LLCs can determine their equity, also called net worth, by subtracting their liabilities from their assets. 

There are a few different types of equity including:

  • Common stock
  • Preferred shares
  • Contributed surplus
  • Retained earnings
  • Treasury stock

Other Common Forms of Equity

Equity can take several other forms beyond common stock and preferred shares, particularly in startups and growing businesses. These include:

  • Restricted Stock: Shares awarded to employees that are subject to vesting conditions based on performance or time.
  • Stock Options: Rights granted to employees or investors to purchase stock at a predetermined price after a vesting period.
  • Founder’s Equity: Ownership stakes given to early founders in exchange for their initial contributions, typically involving greater risk but larger reward potential.
  • Equity Compensation: Startups often offer equity (like stock options or restricted stock units) as part of compensation packages to attract and retain top talent.

These types of equity are crucial for motivating employees, raising capital, and aligning interests between shareholders and company management​​.

Common Stock

The ownership of a corporation is represented by common stock (also called common shares). This type of equity affords its holders the right to vote and a right to certain company assets. Common stock value is determined by multiplying the par value of the stock by the total number of outstanding shares. 

The regular income of a corporation is distributed to the common shareholders through capital gains and dividends paid out share by share. 

Common stock owners have quite a few responsibilities within the company including:

  • Board elections
  • Officer appointments
  • Auditor selections
  • Determining dividend policies
  • General corporate governing

Investors who own common stock are meant to have a somewhat controlling hand in the overall direction of the company. If someone wants to be involved in a company only at a financial level, common stock isn't a good fit for them. 

Common stockholders accrue greater capital gains than preferred shareholders as the market price of the company's stock increases. 

If a corporation is dissolved, common shareholders have some important rights like limited liability protection from creditors, residual claims to income and assets once other claims and debts are paid off. 

Preferred Shares

Preferred shares are offered to investors by companies with defined dividends and common stockholder shares. 

If the operations of a company are wound up, the owners of preferred stock will have any obligations the company owes paid to them. On the occasion that dividends are suspended from payment to stockholders, preferred stock dividends are usually paid out before common stock. 

Sometimes corporations will add different features to their stockholder agreements for preferred stock to make it more appealing to investors. Things like convertibility and call provisions are commonly included to make the preferred stock attractive. Many investors like when preferred shares can be converted into common shares. 

Preferred stockholders do not usually have any rights or responsibilities within the company operations. They don't vote in officer or board elections. The dividends for preferred stock accumulate throughout the years if they aren't paid on a yearly basis. If an investor owns a preferred dividend, they are guaranteed dividends. 

Participating Preferred Shares

A specialized type of preferred stock, participating preferred shares allow holders not only to receive their fixed dividends and investment return but also to participate in any remaining proceeds distributed to common shareholders after liquidation preferences are satisfied. This dual benefit makes them highly attractive to investors, especially in high-growth companies​.

Contributed Surplus

Money that is paid by investors for stock that goes over the par value of the shares is called contributed surplus or additional paid-in capital. This amount can change as the company experiences gains and losses from selling shares and other types of income or financial instruments.

Other Types of Equity Accounts

In addition to contributed surplus, businesses maintain other equity-related accounts that impact how ownership is tracked and reported, including:

  • Owner’s Capital: Contributions made directly by owners into the business. Common in sole proprietorships and partnerships.
  • Owner’s Withdrawals (or Draws): Money taken out of the business by an owner for personal use, reducing total equity.
  • Accumulated Other Comprehensive Income (AOCI): Gains or losses not included in net income, such as foreign currency adjustments or unrealized gains/losses on securities​.

Tracking these accounts accurately ensures a clear picture of a business’s financial health and owner interests.

Retained Earnings

Any company income that is not paid out to stockholders as dividends is called retained earnings. Basically, anything a company can save at the end of a year after all financial obligations are met, they can use to invest or save for future needs. 

Treasury Stock

If a company chooses to buy back any stock from common stockholders, it is deducted from the total equity of the business and called treasury stock. 

Frequently Asked Questions

  1. What are the main types of equity?
    The main types of equity include common stock, preferred shares, contributed surplus, retained earnings, treasury stock, restricted stock, stock options, and founder’s equity.
  2. What is the difference between common stock and preferred stock?
    Common stock typically carries voting rights and greater capital gain potential, while preferred stockholders receive fixed dividends and priority in liquidation but usually lack voting rights.
  3. How does contributed surplus affect a company?
    Contributed surplus reflects additional amounts investors pay above a stock's par value, strengthening a company’s equity position without impacting retained earnings.
  4. What are retained earnings used for?
    Retained earnings are profits kept within the business to fund growth, pay down debt, or save for future opportunities, rather than being distributed as dividends.
  5. Why would a company buy back its own stock?
    A company might buy back its stock to increase share value, return value to shareholders, or consolidate ownership by reducing the number of outstanding shares.

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