What is Equity Investment?
Equity investment is the amount invested by investors in the shares of companies that are publicly traded on a stock exchange. The shareholders profit from their holdings in the form of dividends or a growth in the value of the stock.
Understanding Equity Investment
Equity investments play a very important role in providing the necessary capital funding for a business, and they very well represent the ownership interest in a particular venture. This source of funding may come from the public through the issue of sharesIssue Of SharesShares Issued refers to the number of shares distributed by a company to its shareholders, who range from the general public and insiders to institutional investors. They are recorded as owner's equity on the Company's balance sheet.read more or even from private equity and venture capital players. They do come a long way in having to provide the necessary growth capitalGrowth CapitalGrowth Capital, also called Expansion capital, is the amount of money offered to the fast-growing businesses requiring finances to expand their operations or new market ventures. All in all, it helps facilitate target firms for accelerating their growth rate. read more to help a business undertake the necessary funding for its expansionary activities.
However, there appears to a significant dilution of stake when a company goes public or offers to unload a stake to a venture capital firm. In such a case, the owner tends to lose control and may have a lesser say as to how exactly a business has to be run and may lose out in this regard. The burden of disclosures increases when a company goes public with the requirements to be fulfilled.
Nevertheless, equity investments tend to be solid bedrock providing the necessary cushion and capital for any business to undertake its expansionary activities. They encourage and also facilitate cross border and also institutional investing through the purchase of the necessary stake, and all of this does go a long way in developing the integrity and soundness of the financial markets.
Types of Equity Investments
Given below are types of equity investment –
- Ownership Stake: Direct investment by an individual/owner into the business that he/she owns.
- Venture Capital/Private Equity: An investment by venture capital/private equity funds taking stakes in start-ups and mature companies.
- Public Investment: Investment by the general public into the shares of publicly traded companiesPublicly Traded CompaniesPublicly Traded Companies, also called Publicly Listed Companies, are the Companies which list their shares on the public stock exchange allowing the trading of shares to the common public. It means that anybody can sell or buy these companies’ shares from the open market.read more.
Examples of Equity Investment
Example #1
Given below are some of the examples of equity investment
- Owner’s investment in his business
- Investment in shares of a public company
- Acquisition of stake in another company through merger
- Venture capital investment in startup
- Private equity investment in mature companies
Example #2
Mr. Kevin starts his business targeting a capital of $10000. He decided to borrow 40% of the total capital as debt. Find out his equity stake.
- Total Capital=10000
- Debt=10000*0.4=4000
Calculation of Equity Stake
- Remaining Equity Stake = 10000 – 4000
- =6000
Advantages
The following points illustrate how equity investments tend to be beneficial
- Economic Growth – When an owner invests money in any start-up or business to provide goods and services, there tends to be economic growth in the country. New jobs will be created, better goods and services will be provided, and all of this directly boosts the GDP of the country.
- Builds Transparency – When a company decides to raise money from the public, it does so by listing itself on any prominent exchange in the country. When this is done, the listing requires certain disclosures on the part of the company. Hence this tends to bring about transparency about the business, and this, in turn, builds confidence in the investing public and thus promotes the integrity of financial marketsFinancial MarketsThe term "financial market" refers to the marketplace where activities such as the creation and trading of various financial assets such as bonds, stocks, commodities, currencies, and derivatives take place. It provides a platform for sellers and buyers to interact and trade at a price determined by market forces.read more.
- Provides Capital for Growth – When a venture capital firm provides the necessary funding for any company that has funding requirements, such acts on the part of the PE/VC firm tends to build the necessary growth capital for it to expand its reach and foothold, which would not have been possible if the necessary influx of capital funding was not provided.
- Reduces Monopolistic Power When there is equity funding to start a similar business, there will be a reduction in monopoly power in the hands of a few players. This will ensure a better choice of goods and services for the customers and services. Thus a single firm will not abuse its monopolistic power and rather tend to bring about more efficiency and better products and services owing to competition in the market.
- Facilitates International Investment – When a company tends to be listed, it provides all the necessary information on the exchanges, and there is sufficient disclosure. The foreign companies can now decide regarding the amount it wants to invest, the stake it wants to take in any other company, etc. as it can now have all the desired information available in the marketplace publicly and will not be much of a problem.
- Promotes Institutional Holding – When a company lists itself on a stock exchange, it will now increase its visibility to further institutional investors like mutual fundsMutual FundsA mutual fund is a professionally managed investment product in which a pool of money from a group of investors is invested across assets such as equities, bonds, etcread more and hedge funds, which can now take stakes in the company through buying equity shares in those companies. In this manner, institutional holdings, too, will be promoted.
Disadvantages
Given below are a few pointers as to how equity investments may have certain disadvantages
- No Magnification of Returns through Leverage – When a firm tries to take on leverage, it does tend to maximize its return along with the requisite risk through the borrowing of debt. However, if the company solely relies on equity as a source of financing and never resorts to any amount of debt, then it will not gain any advantage owing to leverage, and returns will not be maximized with limited capital and the remaining coming from debt capital, which would be the case of leveraged business.
- Requires Disclosure – Listing warrants sufficient disclosure from the company, with regard to all details such as financial informationFinancial InformationFinancial Information refers to the summarized data of monetary transactions that is helpful to investors in understanding company’s profitability, their assets, and growth prospects. Financial Data about individuals like past Months Bank Statement, Tax return receipts helps banks to understand customer’s credit quality, repayment capacity etc.read more, and other financial data which would have required no such disclosure, had the company remained private. The business secrets would now have to be revealed, and the business may not be able to enjoy confidentiality that it had enjoyed maintaining earlier when it had a private status.
- Dilution of Stake – When a company offers shares for subscription or invites a venture capitalVenture CapitalVenture capital (VC) refers to a type of long-term finance extended to startups with high-growth potential to help them succeed exponentially. read more firm to take a stake in the business, there happens to be the dilution of the stake of the business. The control of the business will now be in the hands of other outside entities, and the original owner will tend to miss out on the control and his portion of the stake, which will now get diluted and get distributed to others in the company.
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