What Is Equity?

In broad terms, equity refers to your ownership of an asset after taking away liabilities or debts. For example, if you own a $400,000 home but owe $300,000 for the mortgage, your home's equity is $100,000. In a company setting, your equity value may tie into how much of the company you own. Continue reading to explore what equity is, how it differs across industries, and what these variations may mean for you.

What is equity in finance?

In finance, equity usually refers to your ownership of a particular company. Companies often value equity in terms of stock options. When you own stock shares in a company, you own a proportional value of the company's assets, profits, and voting rights, depending on the type of shares you own. In some professional contracts, you may negotiate certain equity shares in the organization as part of your compensation for your role.

Equity as compensation 

Some companies choose to offer equity as a form of compensation for your professional performance. The practice may be prevalent among startups or companies with limited resources for high salaries. Stock options, including restricted stock units and performance shares, are ways an employer may offer equity to you. 

Employers may also use equity as compensation to incentivize employees to stay at the organization and invest in its success. If employees have a high stake in the company and receive rewards when it does well, they may be more engaged in helping the organization meet performance goals and continue to expand.

Read more: What Is Performance Management?

Types of equity

You can own many types of equity in a company, each with its benefits and considerations. Common types of equity you may choose to own include:

1. Common and preferred stock 

Several types of stock exist, including common equity and preferred equity. Common equity typically refers to a share in the company’s financial success and a stage in its governance, which includes the right to vote and contribute to governing decisions. Preferred equity typically refers to a stake in the company’s financial success but does not include voting rights or participation in the management of company decisions.

Preferred equity holders typically have higher claims on company assets than common equity holders despite not having voting rights. The company often pays preferred equity holders a fixed dividend before paying common equity holders. If a company liquidates, preferred equity holders have priority in asset distribution.

2. Restricted stock units (RSUs)

Restricted stock units (RSUs) are those given to employees on a vesting schedule, often based on length of employment or performance on the job. For example, when you begin a new job, your company may grant you 1000 restricted stock units. These stock units may be on a vesting schedule that grants you 250 units yearly. If you leave the company with this type of equity, you won’t receive the remaining balance of your stock units. 

3. Performance shares

Performance shares are a type of stock that organizations distribute based on company performance. Employers may consider this type of equity as a “bonus” granted to employees if they meet certain goals or the company hits a particular target. The idea is that this type of equity drives commitment to the company’s mission and continued success. 

4. Retained earnings

Retained earnings equity is the revenue left after a company pays dividends, debts, and interest. Organizations often reinvest this type of equity into the company to buy new equipment or make growth-enhancing changes. 

Pros and cons of equity as compensation

Consider several potential pros and cons of equity as a form of compensation, depending on your priorities. For starters, equity can accumulate into long-term wealth if you hold your shares over time and the company continues to increase in value. If you are dedicated to your company’s success and believe your company can achieve long-term growth, equity may appeal more to you than a fixed salary. Companies may prefer this arrangement if they cannot pay highly skilled professionals at or above market value but still want to attract top talent.

Equity-based compensation may have risks that salary-based pay does not. For example, the value of equity can fluctuate based on the market, and if the company issues a high volume of additional stock, your equity value may dilute. Your equity share can also lose value if the company underperforms or goes bankrupt. It’s essential to weigh the potential for high growth against the risks to ensure you are in a position of stability regardless of whether your equity increases or decreases in value.

Can I negotiate for equity?

Yes, you can negotiate for equity. When negotiating equity, you should thoroughly research the company to ensure this is a smart decision for you personally. You should also enter into negotiations with clear expectations surrounding the type of equity you would like to receive, how much equity you desire, timelines for renegotiations of additional equity, and a vesting schedule. 

It is also important to consider factors such as the company's financial aspects, including company valuation, investor types, and the number of investors. If you are still trying to figure out where to start, consider researching compensation packages at similar companies to determine the standard compensation package for similar positions.

When negotiating equity with a company, discussing potential exit strategies, including tax implications and regulatory considerations, can also be important. If another company acquires your company or you decide to leave your position, you want to be sure clear guidelines exist to ensure you receive the value of your shares. 

Next steps

Learning about professional markets, stocks, and types of compensation can help you navigate professional and personal finances. Consider taking top-rated online courses on online learning platforms such as Coursera to build your skills and knowledge and even prepare you to begin a new career in financial services. Start by taking courses such as Financial Markets by Yale University or Foundational Finance for Strategic Decision-Making Specialization by the University of Michigan to enhance your foundational skills.