Equity capital definition
/What is Equity Capital?
Equity capital is funds paid into a business by investors in exchange for common stock or preferred stock. This represents the core funding of a business, to which debt funding may be added. Once invested, these funds are at risk, since investors will not be repaid in the event of a corporate liquidation until the claims of all other creditors have first been settled. Despite this risk, investors are willing to provide equity capital for one or more of the following reasons:
Owning a sufficient number of shares gives an investor some degree of control over the business in which the investment has been made.
The investee may periodically issue dividends to its stockholders.
The price of the shares may appreciate over time, so that investors can sell their shares for a profit.
From a valuation perspective, equity capital is considered to be the net amount of any funds that would be returned to investors if all assets were to be liquidated and all corporate liabilities settled. In some cases, this may be a negative figure, since the market value of company assets may be lower than the aggregate amount of liabilities.
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Accounting for Equity Capital
From an accounting perspective, equity capital is considered to be all components of the stockholders' equity section of the balance sheet, which includes the par value of all stock sold, additional paid-in capital, retained earnings, and the offsetting amount of any treasury stock (repurchased shares).
Debt Financing
An alternative form of capital is debt financing, where investors also pay funds into a business, but expect to be repaid along with interest at a future date. A variation is convertible debt, where investors can convert their debt holdings into the shares of the borrower; this is a valuable option for investors when the borrower has a strong upside to its projected profitability.