Funds provided by a company’s owners in exchange for evidence of ownership.
In Limited Liability Companies, equity holders are called Members. In Corporations, equity holders are called Shareholders. Equity can take many forms. Cash is the most common form of equity, but working capital (working for little to no pay) is also a very common form of investment for equity.
In the startup world, equity is often used to describe not only the money put in to a company by the owners (equity capital), but also those who have ownership in an entity. Equity holders, have the most to gain if a business succeeds and the most to lose if it fails.
Equity holders are not guaranteed any return on the money (or other type of investment) they put into an entity. They share in the profit or the loss of a business. Equity holders may receive money back if the company is doing well, but can also be required to place more money into a business if there is a financial need in the business (this is called a capital call).
Equity holders are the last to receive money if a company is ever liquidated. That means if a business fails, and it has $100,000 in liabilities, and $100,000 in remaining cash, all of the creditors would be paid. The equity holders, however, would not receive anything.
The opposite is also true.
If a business shuts down (for any reason) and all of the assets are liquidated leaving the company with $1,000,000.00 in cash. The creditors would receive their money back. The equity holders, however, would split the rest of the money based on the percentages of equity held by each owner. That is true even if the equity holders each only put $100 into the company.
In each of the examples above, the business owed $100,000 to creditors. In each of the examples above the creditors received their money. The equity holders, however, lost everything in the failure, but received a large benefit in the success of the business.
Equity holders are not guaranteed any return. That means that equity holders have the most risk in any startup, but with great risk also comes great reward. Creditors will receive their money plus whatever interest they agreed to whether the business is wildly successful or not. Creditors do not have as much risk because they are receiving that interest and they will be paid before the equity holders. Equity holders, however, will reap the rewards of a wildly successful startup.