Equity

Equity is the English word for ownership capital. It refers to the share of a company that truly belongs to its owners. It’s calculated simply: everything the company owns, minus everything it owes. Someone who buys an apartment for 300,000 euros and takes out a 200,000-euro loan for it has 100,000 euros of equity in it. It works the same way with companies, except that ownership is often divided into small pieces. At publicly traded companies, these pieces are called shares.

Why founders prefer to give up shares rather than take out loans

A young technology company usually has no revenue at the start, but high costs. A bank would hardly lend it money, since a loan has to be repaid with interest. That’s exactly what a company without revenue can’t manage. So instead, the founders sell shares to investors. These investors don’t get money back, but rather a piece of the company.

For investors, this is a bet. If the company goes bankrupt, their stake is gone. If it grows big, the stake can multiply many times over. Early backers of companies like OpenAI or Nvidia have earned a multiple of their investment this way. This prospect of large profits is the reason investors take on the high risk in the first place.

Equity is also a means of payment. Start-ups can’t pay experienced developers a Google-level salary. Instead, they offer shares that could be worth a lot later. When news reports say an employee got rich through an IPO, it’s almost always equity behind it.

How the pie gets divided anew with every funding round

At the start, a company often belongs one hundred percent to its founders. If it needs money, it issues new shares and sells them to investors. This increases the total number of shares. The percentage ownership of all previous owners shrinks. This effect is called dilution.

That sounds worse than it is. Although the percentage decreases, the company is worth more thanks to the fresh money. Ten percent of a company worth one billion is significantly more than one hundred percent of a company with no capital. Founders therefore accept dilution deliberately.

It’s important to distinguish this from debt capital. A lender receives fixed interest and is paid first in the event of bankruptcy. Equity holders stand at the very back of the line. They only receive something once all debts have been paid. In return, their upside is unlimited. Employee shares are often tied to vesting periods: anyone who leaves before four years have passed loses part of them.

Equity in headlines about AI companies

The term constantly appears in business news. When Microsoft invests billions in OpenAI, it’s about equity: money in exchange for shares and thus for a say. Phrases like “investor secures 20 percent” also describe nothing other than an equity stake.

A related term is private equity. This refers to shares in companies that are not traded on the stock exchange. So you can’t simply buy them via an app. The counterpart is public equity, meaning shares of publicly traded companies. Relevant for employees are stock options, a right to buy shares later at a fixed price.

A common misconception: equity on paper isn’t money yet. As long as the company isn’t publicly listed or sold, the shares can hardly be turned into cash. Many start-up employees hold paper worth hundreds of thousands of euros in theory and still live frugally. Only an IPO or an acquisition turns the stake into real money.