WTF is Equity????? - Part 3

Ok, so we have established that Equity is your investment into YOUR business and it is an important aspect of financing your business.

We have also established that bringing in more Equity means having to share your business with other people. Its kind of like bringing another person in to tell you how to live your life (why would ANYONE want to do that???).

Ok, but what we still have not explored is how Equity works out in the stock market.

First off, let us take a look at your normal business. It starts off as a normal single-owner business and then said single owner finds some partners to expand his business and they grow larger. So lets say the business grows EVEN larger, it needs more sources of finance. Debt is expensive, so said owner gets EVEN more people to contribute money to the business.


However, getting people to come in and buy your shares can be tricky business, because, first of all, how do you value shares in your business and second of all, you can't exactly open up a shop by the side of the road and put up a sign saying "BUSINESS SHARES HERE! CHEAP!".

In order to get around these tricky issues, many countries around the world have at least one Stock Market, or Share Brokerage. These markets are basically places where companies can sell their shares to the public. The public then can buy and sell those shares based on the market price.

Ok, now we are on to advanced equity studies. So, lets consider for a moment that a share in a business is a commodity (you know, like fish, rice, gas and birth control pills) and that its price in the market is determined by the buyers and sellers in the market. Imagine that the price of a company's share represents how much people want to buy/sell it. A high priced share means that more people want to buy it, a lower priced share means that more people want to sell it.

In the very beginning when a company puts its stocks up for sale (an activity called Listing or the Initial Public Offer (IPO)), its shares are sold for a nominal share price (as determined by the company and their advisors) and then the shares hit the market and are then subject to market fluctuations, with the closing price at the end of the trading day representing whether the investors (the people who buy and sell on the stock market) think the share is worth buying or selling. Note that each share is typically priced between $1 to $10 (with some going higher/lower), however also note that each Investor needs to buy a minimum of one 'block' of shares which can range from 1000 to 10,000 shares a block, so unless you have some serious dosh, take your money somewhere else.

So, by the end of the day, the company has a whole lot of money (from the investors who bought their shares). But remember, each share represents an ownership in the business. So, in return for getting cold, hard cash from their investors, the businesses have an obligation to give each investor a certain amount of dividends for each share they hold. While businesses don't HAVE to give dividends every year, businesses that are really bad at giving out dividends do tend to get a bad rep on the market.

So with each share they hold, investors hold a voting interest at the company's annual general meeting (AGM), where important decisions are made regarding the company's future (theoretically speaking). Each share gives the invesotr one vote. The more shares you hold, the more votes you control. So basically the richer investors get to stomp all over the poorer ones, yay for capitalist democracy. But that is how the system works (with some variations depending on which country you are in).

In most cases, the family which started the business will try to hold a controlling stake (the MOST shares) in the business, but as time goes by, many families will slowly relinquish their control to other investors who have a lot more money. Note that when I say investors, I don't necessarily mean individuals, but I mean BIG INSTITUTIONS WITH CRAP-TONS OF MONEY (think Governments, International Banks and MNCs). It is also worth pointing out that many investors like to buy their shares cheap and sell them high, thus generating them some profits in the exercise rather than rely on dividends for income. In fact, there are a TON of strategies for investing in the stock market but this is an ACCOUNTING blog, not a 'How-to-get-rich' blog. Search the web for more stock-investing strategies ya greedy lil nut.

So there you go, your quaint little business you started as a means of telling your Boss to piss off has turned into a giant corporation which you don't quite own anymore... heck it probably isn't even YOUR business based on shareholding alone.

So that pretty much concludes our little series on equity, hope this has been eye-opening for y'all. Next time we will look at more mundane topics in Accounting like Creative accounting and Convergence. Hooray.