Stocks

What is Equity?

Simply put, owning equity in a company means you own a part of that company. Your equity stake (a piece of the company) will therefore be recognized on the company’s balance sheet.

Total Shareholders’ Equity represents the amount that would have to be paid out to all company’s shareholders in the case where company debt was paid off, and the assets of that company were sold or liquidated.

Types of Equity

Generally, the capital of a company consists of a combination of equity and debt. Equity is the money invested by the shareholders, and debt is the money that the company borrowed. Equity is often divided between common shares and preference shares.

Both types of shares represent a piece of ownership in a business. However, there are some key differences.

Firstly, common shareholders usually have the right to vote on different corporate policies and influence the direction of the company. In contrast, preference shareholders do not typically hold voting rights and, therefore, cannot vote on corporate matters.

Preference shareholders usually enjoy fixed dividends, and these are paid out before common stock dividends are issued.

In the event that the company declares bankruptcy, preferred shareholders have a claim to the company assets that are more senior to that of common shareholders. This means that preferred shareholders will be paid before common shareholders, and as a consequence, common shares are riskier than preferred shares.

Another type of stock is the convertible preferred stock. These are preferred shares with an embedded option for the stockholder to convert them into a predetermined number of common shares. It is important to note that if a preferred shareholder chose to convert their shares into common shares, then all the rights that come with holding a preferred share end. The shareholder will stop receiving fixed dividends and will no longer have a more senior claim to company assets. They will now have voting rights and will be able to benefit from stock price appreciation based on the features of a common stock.

Public Vs Private Equity

Public companies are companies whose shares are publicly traded. Their shares are freely available to buy and sell on stock exchanges or over-the-counter (OTC) markets. Private companies are companies whose shares are not publicly traded. They are most of the time owned by a very small number of people, usually their founder(s).

Because public companies are traded on stock exchanges, they have to meet strict filing requirements, such as annual reports, major events and proxy statements. This is something that private companies do not have to worry about, as their requirements in terms of reporting are much more lenient.

It is far easier to exit from an equity position in a public company than in a private company. Owned shares in publicly traded companies can freely be sold at the prevailing market price, while shares in private companies can only be sold if you find an interested buyer. At Crowdbase, we operate a Bulletin Board, where investors in private companies can find interested buyers to exit from their private equity positions.

Since the shares of a publicly traded company have a visible market price, simply multiplying that price by the total number of issued shares should give you the valuation of the company. For private companies, things are more complicated than that. Valuing a private company is very difficult because the market price of its shares is not directly observable.

A private company can become a public company with an Initial Public Offering (IPO). An IPO offers the opportunity to existing shareholders in the company to exit from their investments, realising any potential gains, as the share price post-IPO is usually much higher than what existing investors paid to acquire those shares.

Crowdfunding campaigns mainly target private companies and provide access to investors to acquire equity stakes in these private businesses. Investing in a private company usually offers higher upside potential than investing in a public company, as it is typical that the private company is quite smaller in size than the public company, and therefore has more room to grow.

Valuation

How would you know if the share price of a company is representative of its potential?

Business valuation is a critical part of the investment process which needs to be considered before making investment decisions. A valuation of a company determines the fair value of the business by taking into consideration a multitude of factors. Some of these factors include and are not limited to:

• Analysis of the company’s management
• The current market value of assets
• Future projected earnings
• Company’s capital structure (equity and debt composition)

Company valuations can be determined using a lot of different methods. The main methods for determining the value of a private company include comparison with companies of similar size in the same industry, discounted cash flow models, and precedent transactions analysis. These methods (and more) are used by Crowdbase to perform an independent valuation analysis for every business on the platform, and help investors assess for themselves whether they are getting a fair deal for their money.

Pre-money and post-money are two critical concepts in valuation. The pre-money valuation is the valuation of the company prior to receiving the proposed investment. The post-money valuation is the pre-money valuation plus the amount of the proposed investment. The equity percentage you as an investor will receive in the company is calculated based on the post-money valuation. Let’s give an example to help you better understand this concept.

Company ABC is raising equity capital through a crowdfunding campaign. The target investment amount is set at €200,000. After Crowdbase’s due diligence and analysis, we decided to set the pre-money valuation at €800,000. Therefore, the post-money valuation will be €1,000,000 (= €800,000 + €200,000). The total equity stake in the company that crowdfunding investors will receive will be 20% (=€200,000/€1,000,000). An investor who invested €1,000 through this crowdfunding campaign, will receive 0.1% of the company.

What if you don’t know any of this? Can you still be a successful investor?

Yes, you can. However, as history has proven many times, it is essential for investors to perform their own research before making investment decisions and not take the word of others for granted. These decisions can drastically impact your long-term financial plans.

With this investment fundamentals course, we hope to make you better equipped to understand the potential risks and rewards of the investment opportunities on our platform. In this way, you can make your own decisions that appeal to your own preferences and risk appetite.