What is Equity in a Company in England and Wales?

If you own shares in a company, you may have come across the term “equity”. But what exactly does it mean?

This article will explain what equity generally means in the context of company shareholding. It will provide an introduction to the legal basis for equity, explain how your equity in a company can be valued and explore certain practical considerations.

The Meaning of Equity

Equity can be a vague term with different meanings depending on the context. 

At the most basic level, equity refers to a special form of ownership in an asset that entitles the owner to certain rights. The exact nature of these rights depends on what sort of asset you own. For example, equity interest in a company is quite different from equity interest in a house. 

In the case of owning a company, the value of your equity should roughly equal the value of the company’s shares you hold. More specifically, you can calculate the value of your equity by subtracting all of the company’s liabilities from the total assets to its creditors (e.g. banks, suppliers, and certain kinds of “quasi-equity” liabilities like payments owed to preference shareholders). The leftover amount is the company’s “equity”. The value of your share in the equity will then correspond to the percentage of shares you hold.

An Example 

Suppose you and three other shareholders own a company, WeCo Ltd. Upon its incorporation, each of you gave £5,000 to the company in exchange for 100 shares each. 

Let us say your company has produced its first annual accounts after a year of trading. Your company’s balance sheet states:

From a rote accounting perspective, the initial £15,000 the three of you invested in the company constitutes the equity in the company as of the end of the fiscal year. This is as far as your balance sheet is concerned. 

However, from a more general investment perspective, your equity is worth more than that. If you subtract the value of the current and long-term liabilities (£10,000) from your assets (£26,000), you would have £16,000. £15,000 of this is comprised of share capital, but your business would have an additional £1,000. In effect, the actual value of your equity in the company would be £16,000 divided by each shareholder (£5,333.33). 

This is, of course, a simplification. Indeed, you cannot in practice realise this value unless you take certain drastic steps, such as selling your shares in the company or winding it up. This is because much of the value lies in the company’s share capital, and the law restricts shareholders’ ability to move this money outside of the company, with few exceptions. 

The Legal Basis for Equity

Before we explain the importance of share capital, it may be helpful to understand the legal basis of equity. 

As you may know, a company is its own legal person. At the same time, companies are entities created to make money. The people who create the company give it money to trade with on the basis that they will be entitled to the profit the company produces. 

Importantly, from a legal perspective, a company’s assets cannot just move freely between its shareholders and the company because that would jeopardise the position of the company’s creditors. Additionally, different shareholders may have different rights in the company’s profits. For instance, one class of shareholders may have first rights to the company’s profits ahead of another class. 

This decision is a judgment call for the company’s directors to make. Note that directors can be liable if they make an “unlawful distribution”, such as paying a dividend when the company had not made a profit.

This differs from lenders, who are entitled to be repaid a fixed amount of money according to the terms of any debt agreement your company has entered into. Lenders also rank ahead of shareholders in the “order of priority”. This refers to the order in which those that have invested money into a company are entitled to be repaid. If they have good reason to believe they will not be repaid, they can take a debt action against your company and ultimately petition for your company to be wound up. 

Maintaining Your Company’s Share Capital 

Taking the above example, your initial investment (plus the other shareholders) of £15,000 constitutes the whole share capital. Calculating this figure is simple enough at this stage, but if your company grows and brings on more investors, the nature of your share capital can change. 

For instance, not all “shareholders” will hold shares in the company’s share capital. You might issue shares to private equity or venture capital investors that entitles them to a fixed percentage of dividend payments ahead of any dividend payments you make to yourself. These are called “preference shares”, and the law does not consider this part of your company’s share capital. 

What exactly constitutes share capital in your company can become a technical area of law. However, as a general rule of thumb, the company must maintain its share capital. This is because your amount of share capital gives creditors a rough idea of your corresponding assets. 

The most consequential effect of this rule is that you cannot generally demand your capital back from the company. Rather, you would need to find an investor willing to purchase your shares. There are some exceptions to this, such as certain procedures to reduce your share capital through buy-backs and court sanctions.

Key Takeaways

Equity is a way to refer to the inherent value of your shares in the company. Generally, if the company has made money since you obtained the shares, the equity value will increase relative to the amount of your initial investment. Likewise, if your company has lost money, your equity will decrease. 

You can measure equity as the total value of assets less all the company’s debts. This value can be divided by the number of shares issued, and then multiplied by the number of shares you hold to arrive at the figure. However, practically, there are limited ways to actually unlock the value of your equity because the law restricts when shareholders can receive money from the company. It must either turn a profit or enact certain procedures to reduce the share capital. 

If you need help understanding how your company’s share capital operates, our experienced corporate lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today at 0808 196 8584 or visit our membership page.

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