The Importance of Equity

When an investor’s fund represents the leftover interest in assets of an organization, which has been spread amongst individual shareholders of common or preferred stock, is known as equity. Whenever a business is setup, its owners invest some funds in the business to finance its day-to-day operations. This creates a liability on the business in the form of capital because the business has a separate identity from its owner’s altogether. 

Business, for the purpose of accounting, is considered as a sum of liability and asset. This is also known as the accounting equation. After all the liabilities have been accounted for, the positive remainder is used by the owner’s interest in the business.

This definition is useful in the understanding of the liquidation process in case of bankruptcy. Initially, all the secured creditors are paid against the proceeds from the assets. Thereafter a series of creditors who are ranked in the sequence of their priority have the next claim or rights on the residual proceeds.

The ownership equity is the last or residual claim against these assets which are paid only after all other creditors are paid to. Normally in such cases where creditors even cannot hold enough money to pay their bills, not even to reimumbrse the owner’s equity.

Therefore the owner’s equity is reduced to zero or negligible. The ownership equity is also popularly known as a risk capital or liable capital.

When an individual or a firm buy and hold shares of a particular stock in a stock market, it is known as equity investment. They do so in anticipation of income from various dividends and capital gains as the value of the share increases. Equity holders receive voting rights, to exercise their vote on candidates for board of directors in the company they have a stake in. They can also allow certain major transactions and residual rights that they share in the company’s profits as well as in recovering some part of the company’s assets in the event that it folds, though they generally have the lowest and backward priority while recovering their investment.  This also means that the acquisition of equity participation in a private limited company or a startup company.

When investment is made in an infant company, it is known as a venture capital investment and is generally regarded as a high risk than investing in listed concerned situations. These equities which are held by private individuals are often known as mutual funds or other forms of collective investment schemes, many of which have its prices quoted and listed in financial newspapers or magazines.

These mutual funds are managed typically by prominent fund management firms. Such holdings allow various individual investors to get a variety of funds and get the skill of the professional fund managers in charge of the funds. As an alternative, which is generally followed by large investors and pension funds, they hold shares directly in an institutional environment.

Many clients who hold their own portfolios are known as segregated funds which in contrary are the pooled mutual fund alternatives.

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