Equity Investment Basics

  • Companies raise capital in the form of either equity or debt.

 

  • Equity represents an ownership interest in a for-profit company where the net equity value of the company (i.e. total assets less indebtedness) and any ongoing profits are owned proportionately by the holders of the equity.  Equity securities are a form of permanent capital for a company.  

 

  • Debt, on the other hand, represents temporarily borrowed funds by a company and, in return for borrowing capital, debt terms include specific obligations the issuer must meet for the periodic payment of interest and the scheduled repayment of the borrowed funds (“principal”). 

 

  • U.S. companies are incorporated at the state level into “C” or “S” Corporations which issues shares or in the form of a Limited Liability Corporation, which allocates Membership Interests, which are sometimes also expressed in the form of Units.

 

  • Equity, shares or membership Interests, can be in either common or preferred form, the specifics rights of which are defined in the company’s Articles of Incorporation, if the company is a C or S Corporation, or in the company’s Operating Agreement, if the company is a Limited Liability Company.  

 

  • If a company is sold or must be liquidated, debt obligations are senior in liquidation priority (i.e. repayment) to equity securities.   If all of the debt obligations are not fully satisfied when a company’s assets are sold through liquidation, equity holders will receive nothing.

 

  • Preferred equity is senior in liquidation to common equity.  Preferred equity will typically have specific preferred dividend payment obligations as well as other preferred return on investment-related obligations which are in “preference” to common equity.  

 

  • Preferred equity is often the form of equity issued through private placement offerings by venture stage companies (i.e. pre-cash flow) or as part of a strategic plan by more mature companies needing expansion capital or acquisition finance.