Equity position refers to an investment made by a third party in a business in exchange for stock. Such a position may be taken by a third party for a variety of reasons, including the following:
- Expectation of a return. The third party may believe that it can earn a generous return by buying shares in the business.
- Converted debt. The third party may have concluded that the convertible debt that it holds in a business represents a worse return than the return to be gained if the debt is converted into stock.
- Alternative payment. The third party is a creditor of the business, and elects to accept stock in settlement of the debt. This situation usually arises when the business is in such poor financial condition that there is no other reasonable alternative. If so, the third party is making the best of a poor situation, and is hoping to mitigate its loss.
An equity position represents less than a 100% share of the stock of the business issuing the shares. Part of the intent of the third party in buying the position may be to gain some measure of control over the business, in which case the percentage of ownership represented by the position may be of some importance. Also, it is useful to look at the terms associated with the sale of stock (which are likely to have been negotiated specifically with the third party). The terms may include:
- Board seat. A sufficiently large equity position may entitle the third party to a seat on the board of directors.
- Voting rights. The third party may obtain special voting rights, such as being able to approve or disapprove of any proposed sale of the business.
- Registration rights. The business may be required to have the shares registered with the Securities and Exchange Commission within a certain period of time, or else additional shares must be issued to the third party.
- Warrants. The business must issue a certain number of warrants to the third party along with the shares.