Equity Investment Meaning
Equity Investment refers to buying shares in a particular company and, thereafter, holding it in order to gain ownership interest that can be sold later to generate reasonable returns depending on its investment objectives.
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 companies.
Examples of Equity Investment
The following are examples of equity investment.
Equity Investment – Example #1
Given below are some of the examples of equity investment
Equity Investment – 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 of Equity Investment
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 markets.
- 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 funds 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 of Equity Investment
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 information, 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 capital 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.
Conclusion
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 shares or even from private equity and venture capital players. They do come a long way in having to provide the necessary growth capital 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.
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