Equity Capital: Meaning, Types, Characteristics, Calculation
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.