What is Equity Explained

It is the owners’ interest in all assets after all liabilities are paid. Equity is also known as ownership equity, and risk capital. It is usually the difference between the market value of the property and any outstanding encumbrances. Legally, it can be either common stock, preferred stock or any hybrid thereof. Equity is vital to capitalizing a business as it has a long-term horizon and does not have a contractual return.  If the company is highly successful, then the equity has a large return.  If the company underperforms, then the equity may have no return.  Equity is distinctive from loans in that it does not have contractual repayment rights for the principal.  If the equity is preferred equity, then there will be a dividend that often accrues.  Proper equity capitalization allows a company to make long term investments which is the lifeblood of corporate growth.    Equity is used to compensate lenders for extra risk.   If a loan amount is higher than customary, the lender may request an equity warrant giving them shares in the company.   This equity warrant provides an extra return kicker to the investor thereby incentivizing them to make the loan.  Equity options are used to compensate senior employees as incentive compensation.   Equity is a valuable security conferring upside potential to the holder in all scenarios.