The term “equity” refers to shares of stock, or it often may refer to stock options. Stock options allow you to buy a specific number of shares at a certain price point after a particular amount of time. Stock options don’t represent ownership unless your right to buy them has vested.
In comparison, equity investment means ownership in a business. You buy equity after your stocks trade at a particular value. You do this with the hope the price will continue to rise, increasing the value of your position.
A share of stock represents a small percentage of ownership in a business. Most publicly traded companies are corporations, which issue a specific number of shares of common stocks. Every common stock share represents equal equity or ownership percentage.
So, if you buy shares, you take part in both losses and profits of that corporation. Also, you get to vote at annual meetings. Yet, you aren’t personally responsible for anything wrong with the corporation. That’s what happens when you have an equity position.
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What Are Stocks?
Stocks are a tradable form of equity. When you buy stock, you’re purchasing equity in a business from the person selling it. When you trade stocks, you’re selling that equity to another person.
Different people have different beliefs about different companies' present and future values. Stocks enable them to trade with others based on those different goals and opinions.
What Are Stock Options?
Stock options give an investor the right, not the obligation, to buy or sell stocks at an agreed-upon date and price. There are two types of stock options: calls and puts. Puts are bets that stocks will fall, and calls are bets they will rise.
What Is Equity?
Equity refers to ownership positions in a company. For example, if you have 40% equity in a company, that means you own 40% of that business, and you’ll get 40% of its profits.
Perhaps you’ve also heard about “home equity” and that you need to pay a 30% down payment on a mortgage to buy a house. Here, the bank tells you that you must purchase 30% equity in the home before they allow you to borrow money to buy the other 70% of that equity. Even then, the bank owns that 70% because you owe them money.
The more stocks you purchase in the stock market, the more equity you have in the company. With time, you’ll increase your equity by paying off the loan principal, getting 100% ownership of the house.
Equity Vs. Stock Options
Equity is daunting. Not all equities have tradable stocks, but all tradable stocks involve equity. At a high level, owning equity in private companies is a bet on the companies’ future success. They are referred to as ‘options’ because stock options don’t mean ownership in a company, but instead, they give you the option to buy a certain number of shares.
At a basic level, equity is ownership in a company. Shares are issued in a series and labeled as preferred or common.
Typically, employees get common stock. Common stock differs from preferred stock because it has no preferences, such as added-on perks accompanying shares.
Employees receive equity from the “option pool,” a specified amount of equity that employees can share. Unfortunately, there are no standard rules on how small or large an option pool can be.
While there are many ways to get equities as startup employees, the most common is via stock options. Stock options guarantee employees the opportunity to buy a set amount of stocks at a specific price, no matter the increase in value. The price at which you buy shares is called the “strike price.” When you purchase the shares at that price, you’re exercising your options.
Furthermore, when a company awards you equity, it might be taxable. The type of equity you get and what you pay for it influences the amount of tax you’ll pay. For instance, stock options awarded to an employee with a strike price equal to the fair market value aren’t taxable. However, an award of the actual stock is taxable if the employee doesn’t buy it from the company.
Final Thoughts
Equity is just another word to represent partial ownership of a company and refers to residual rights after subtracting all the debts associated with that company.
Thus, equity typically represents the shareholders’ stake in the business as identified on the business’s balance sheet. In comparison, stock options give you the right, but not the obligation, to buy or purchase stocks at a specific price or date.
