Types of Equity: Everything You Need to Know
Types of equity are different forms of shares or ownership available in a company. 3 min read
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
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 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.
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.
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.
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.
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