Equity Capital: The Nature, Risk, and Reward

Equity capital is the remains in the way of assets after all debts and other charges are accounted for. Hence, equity capital sometimes called residual capital. It serves as the financial foundation of a company. Indeed, one can not launch any sort of business venture without equity funds.

As we all know, there are two basic methods in which a company can raise funds, it can borrow or invest. Suppliers of debt capital are primarily concerned with the safety of their principal and obtaining a stated return on the rental of their funds, one which commensurate with the risk they are taking.

This condition does not hold true of the investor who is willing to advance equity funds. He may like to get as much assurance as possible. But he knows that he is taking all the chances. In fact, he runs the risk in the hope he may capture most of the rewards.


Risks and Rewards

Individuals who provide the equity capital own the company. They are called shareholders, since their proportionate interest in the company is evidenced by the number of shares of stock they hold.

There is a pivotal role because without the kind of risk capital they are willing to advance, few businesses, if any, could ever hope to get off the ground.

Creditors rightfully regard equity funds as a cushion. If the business should fail, or otherwise encounter a stretch of diversity, equity capital eases the blow for those companies which have advanced the luckless firm credit. In term of its call on the underlying assets of the corporation, equity ranks at the bottom of the ladder. Consequently, a firm with an ample equity base is viewed with considerable favor by others with which it does business.

The advantage of a ompany having sufficient equity is no different than it is for the family planning to buy a house. Virtually without exception families seeking a mortage to purchase a dwelling will find the search correspondingly easier with the higher the down payment they are willing or able to make. The larger the possible equity, the more willing the lender becomes. Moreover, the larger the potential investment in the house, the less the cost of borrowing funds.

In business, the story is much the same. The larger the risk assumed by the shareholders, the more agreeable lenders are to provide funds or credits. This is as it should be. Creditors generally regard equity capital as a safety shield. It is not one which is unbreakable, as many creitor who has lent not too wisely learned to his sorrow. But it does, within bounds, offer a measured degree of safety.

If a business goes under, the equity supplier of capital stands to lose only any possible opportunity for appreciation but his investment as well. But there is a brighter side to the picture. For no seasonesd businessman willingly put money into an enterprise expecting to lose it. What attracts him in the first place is the opportunity to see his capital appreciate. This happen when business succeeds.

Thus, while there is no guaranteed return on equity funds, and creditors seem to get all the protection, the shareholders are rewarded by enjoying a position that will enable them to profit the most. As business prospers and grows, its equity is bound to swell. As a result, the value of the onwers’ holdings, apart from any dividend payment that may be received, appreciates. It is this factor, despite the recognizeable risks, which enables companies to obtain equity capital.