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Equity Capital: Meaning, Types, Characteristics, Calculation

Published On Dec/07/2024

Equity capital refers to the extent of ownership that you have in a certain corporation as one of its shareholders. As per the equity capital definition, it represents the residual claim that you have over, as the shareholder, the company’s assets after deducing all the debts. In other words, equity capital is essentially the difference between the company’s total assets and liabilities.


Equity capital – explained


Equity capital or equity finance is one of the most important sources of funding for a business organisation. Many companies, especially large corporations, raise their equity by issuing shares of stocks to the investors. When you purchase these shares, you essentially invest in the company, and you become a part owner of the company, and your ownership is limited to the extent of the shares’ value that you hold.


As a shareholder or investor in the company, you are entitled to receive profits or dividends and other capital gains if the company is sold.


Equity capital – important characteristics you must know


  • Residual claim

    As an equity capital holder, you would have the last claim on the company’s assets after all the debts are settled. This means if the company where you hold equity capital becomes bankrupt and it is to be sold, the equity shareholders would be last in line to be repaid their investment.


    And, if the company’s assets are not enough or does not have enough funds left after settling all the debts, you may not receive any compensation for your investments.


  • Risk and returns

    Expert investors worldwide have corroborated that investing in equity capital is one of the riskiest investments; it is riskier than debt capital investment. However, you must also know that this investment has a higher return potential.


    As an equity shareholder of the company, if the organisation makes a profit, you would be eligible to get valuable returns from both the capital appreciation of the stock value (i.e., increase the share prices) and the dividend income.


  • Control

    As an equity shareholder of a company, you would have certain exclusive privileges and rights over others. For example, you would have voting rights. This gives you the power to have a say in the functioning of the organisation.


    The number of votes you have is typically proportional to the number of shares you own in the company.


Calculating the equity capital value – The formula used


The equity capital value is also known as ‘market capitalisation,’ and its calculation process is quite simple. The calculation involves using a simple formula wherein the current price of the company’s stock is multiplied by the number of fully diluted common shares outstanding trading the market.


The formula for equity capital value calculation is:

Equity Capital Value = current price of the stock x total value of the outstanding diluted shares


The formula for equity value calculation for a publicly traded company is:


Equity Capital Value = latest closing price of the stock x total value of the outstanding diluted shares


Suppose a company named John Doe Ltd has 30,000 diluted shares outstanding, and the current price of the stock is Rs. 780, then the equity capital value calculation will be


Equity value = 780 x 30,000 = 23,400,000


Types of equity capital


As mentioned earlier, equity capital is a primary source for raising capital for businesses. There are two types of equity capital, which are:


  • Preferred shares/stock

    The preferred shares or stockholders do not have any voting rights in the company. However, they have other preferential rights, like a higher claim on the company’s assets. Even in the case of bankruptcy, they are guaranteed to receive a dividend payout.


  • Common shares/stock

    This is the most common and basic type of equity capital. Common stockholders have voting rights, and they are entitled to a share of the company’s profits through dividends. However, they also have the last claim on the company’s assets if the company files for bankruptcy.



Equity capital – reasons why it is so important


  • Funding source

    Equity capital is one of the primary sources of funding for a company. It gives the company the necessary funds to grow or expand the operation, enter into a new market, cater to a larger audience, etc.


  • Signalling effect

    When the company has a strong equity capital base, it sends out a loud and clear message to all the investors, i.e., the equity stockholders, that the company is managed well and has excellent growth prospects, which lures more investors.


  • Interest Alignment

    The equity capital aligns with the interests of the shareholders and the management. The stockholders are incentivised to see the company grow and succeed because the value of their investment is tied to the company’s performance.


Conclusion


Equity capital is a basic financial concept, and if you want to understand what it is and its importance, you must know that it is a critical source of funding for businesses. If you are a business owner, especially if you own a start-up or aspire to start an enterprise, you must know that having a strong fund base is critical to keep the business running for a long.


If you cannot raise funds through equity capital, you can consider applying for a business loan with any leading NBFCs (non-banking finance companies) like Udyog Plus, which is an integral part of Aditya Birla Finance Limited. It has a reputation for offering a range of business loan solutions; you can get a loan of up to Rs. 2 Lakh with no documents and at the most affordable interest rate.


Also, you get flexible repayment and extended terms, and the easy online application and quick approval process ensure that you have a smooth borrowing experience.