The Ultimate Guide to Equity Management
What is Equity Management?
The equity of a company represents the amount of money the owners of a company would have if they dissolved their business by selling their assets and paying off their liabilities. Equity management is the process by which a company tracks and manages the ownership of the company with relation to stakeholders.
What is Equity?
Equity represents the amount of money the owners of a company would have if a company’s assets were liquidated, and its debt paid off in full. You can calculate equities by subtracting the total liabilities from assets.
If the equity is positive, the company has enough assets to cover the total amount of liabilities. If negative, you can deduce that liabilities are exceeding assets. It is optimal to have the highest equity possible, and negative equity is a cause of concern. Overall, equity of at least 50% of the total assets is ideal.
Liabilities
Liabilities are the factors that decrease a company’s equity. Think of liabilities as all the things that reduce your company’s profit, like debt and taxes. Liabilities can be categorized into two different groups: current liabilities and non-current liabilities.
Current liabilities represent money needed for operating expenses and debts payable within one year, whereas non-current liabilities are the ones repaid over a longer period. You should consider both current and long-term liabilities when calculating equity. What we have mentioned above paints a not great picture of liabilities. However, it is also important to keep in mind that while liabilities may decrease equity, they are essential for rapid expansion and growth of a company.
The Pre-IPO Regulatory Checklist
Learn MoreAssets
The things that add more value to your company are called assets. To be more precise, assets are elements that add economical value (either right now or in the future) to your company. Assets aren’t necessarily monetary but can also appear as physical equipment, real estate, or investments. Usually, assets will be listed on the balance sheet amongst information of how they’re being financed.
There are two types of important business assets: namely current and fixed. Fixed assets are non-current assets with a life of more than one year–typically plants, equipment, and buildings. On the other hand, current assets are assets that can immediately be turned into cash within a fiscal year. Current assets are cash and cash equivalents, accounts receivable, inventory, and prepaid expenses.
What do Equity Administrators do?
Equity administrators are at the very backbone of equity management and are responsible for handling equity management systems and processes that companies have in place. Here is a list of responsibilities that equity administrators are required to take care of:
Company Valuations (409a valuation)
It is imperative that a fair market price is determined for your company’s common stock before offering equity to potential investors. You obviously wouldn’t want to sell yourself short when raising funds, trying to exit your equity position. As such, equity administrator perform a 409A valuation to determine the share price. This also serves another purpose; it allows your company to qualify for an IRS safe harbor, in turn reducing risk. It should be noted that a 409A is required to be completed on an annual basis, or when a material event occurs.
Tracking Company Equity Transactions
Another one of the main tasks that equity administrators must take on is tracking all the shares of the company issued to investors–who has been issued shares, who has sold shares, etc. You should register this information in a safe place for future review and reference.
Shareholder Management
It’s common sense that the more you know about something, the more you want to invest in it. This philosophy applies to employees, potential investors, or current shareholders. A substantial portion of equity management lies within updating shareholders on the latest material information (any information that would impact a shareholder’s decisions). Information can be disseminated in a variety of ways, including quarterly reports, annual meetings, public announcements, emails, etc. The only requirement is that the information be available to everyone at the same time–this avoids potential insider trading.
Cap Table Management
Stock, equity grants, convertible notes, bonds, and warrants. The process of recording all of these securities and who owns them is also known as cap table management. A cap table (short for capitalization table) is a business evolution similar to a balance sheet except with different elements involved. In general, cap tables will include information such as shareholder info, rights to purchase equity, and the like–whereas balance sheets display assets and liabilities. Learn more about cap table management software to improve accuracy and reduce manual processes.
Maintaining Compliance
Companies in the United States are required to follow the Generally Accepted Accounting Principles (GAAP) when it comes to financial reporting. The company valuations, mentioned earlier, is a smaller subcategory of maintaining compliance. In the United States, maintaining compliance also means following ASC 718–a set of rules followed for reporting employee stock-based compensation. Other regulations may apply against equity, and equity administrators must inspect all laws to withhold taxes accurately.
Equity Management Software
Equity management software–also known as cap table management software –makes it easier for a corporation to have an overview of the current status of its equity. Used by businesses all over the world, equity management software executes some of the tasks that are undertaken by equity administrators.
Some of the features offered in equity management software include equity issuance and governance, cap table features, and growth/exit scenarios. Equity management software helps free up more spare time for equity administrators and managers by removing the process of involving legal teams for every issuance. Other key selling points of equity management software are that it saves time, eliminates human error, and reduces the cost of expensive personal reports.
Equity Management: Life Beyond the Spreadsheet
Watch WebinarDigital/Electronic Equity and Asset Management
Most companies, if not all, have transition to digital equity management. Digital equity management software has many benefits over its archaic paper counterpart–information is stored in a central location for everyone to view, updates are done in real time, and reports can be generated on the fly at the click of a button. Your ERP, accounting, or financial reporting software solutions may have equity management components built in however these often come with significant limitations.
Digital equity management often links to digital asset management software. Though the two are similar, the key difference is that digital equity management software measures equity, and digital asset software measures assets. These types of software pack all the information you need into a single program and make things much easier to manage.
What is Shareholder Equity?
Otherwise known as stockholders equity, shareholder equity is essentially the same as equity, except that it refers to a specific shareholder’s shares for a company. Some other ratios and terms can be used to further analyze this shareholder equity–one example would be return to equity (ROE), which refers to a company’s net income divided by shareholder equity. This information can later be used to determine how efficiently the equity is being used amongst investors for profit. You can find all the information necessary to calculate a corporation’s equity on its balance sheet.
Shareholder equity is important for potential investors in terms of how they view a business, in consideration of other factors. In general, negative equity would come across as risky and potentially damaging, but this impression may be able to be reversed with other metrics that demonstrate a more positive view of the company’s progress.
Key Considerations for your 409A Equity Valuation
Watch WebinarExamples of Equity Management
You may be confused thus far about the precise meaning of equity management. Here are two examples that you can use to better comprehend the term.
Bill owns a highly successful donut business. He’s got approximately $10 million in assets–including things such as brand reputation, property, equipment, etc. However, he also has $3 million in liabilities. This would signify that Bill has total equity of $10 million–$3 million = $7 million. This first example results in positive equity, suggesting that business is going well. If Bill liquidated all his assets and paid off his liabilities, he would still have $7 million for himself.
Harriet, on the other hand, is struggling a bit with her business. She has obtained $3 million in assets whilst simultaneously accruing $4 million in liabilities. This would leave her with total equity of $1 million, an example of negative equity. The negative number signifies that work needs to be done to make Harriet’s business into a profitable one. Harriet’s situation is sometimes referred to as a “balance sheet insolvency.”
The equity managers for Bill’s business might decide to invest a portion of his total equity after carefully considering many factors. On the other hand, the equity managers for Harriet might think of ways to recover her negative equity back to a positive one. In either case, the final objective is to grow the equity as large as possible while minimizing risks–something best analyzed using an equity management solution and/or equity management services.
Financial Planning and Equity Management
Financial planning is the analysis of the monetary requirements of the corporation, ranging from debts to sales and loans. Although this sort of planning is a year-round activity, greater emphasis is placed on financial planning during the latter part of a company’s fiscal year. (A fiscal year is a one-year period that a corporation uses for financial reporting, budgeting, and taxation). This sounds great, but you are probably wondering how financial planning ties into equity management, right?
Corporate financial planning will look at all of the financial aspects pertaining to a company trying to achieve its goals. One of the major items that the financial planning department looks at is funding growth. If a company has the cash flow to support growth, that is great–but rarely the case. Most companies fund their growth through equity financing (private placement or public stock offering) or by taking on debt. Both of these options will have an impact on a company’s equity over the long term. Seeing as financial planning ultimately ties back to information required to calculate your equity, it should come as no surprise that most equity management software is packaged with financial planning and reporting capabilities.
Equity Portfolio Management
Equity management and equity portfolio management are not the same thing, but they are closely linked concepts. Both fields require substantial knowledge across equity analysis and modern portfolio theory. You will often find active equity portfolio management taking place in corporations that have excess shareholder’s equity. For example, if your company is continually turning a profit, but not paying dividends out to shareholders, it means that there is likely idle cash. Rather than reinvesting this money into expansion, companies will often invest this money into other companies or bonds, creating a need for portfolio management.
At the core of equity portfolio management lies the need to build a portfolio model. After building a portfolio model, the manager will be able to calculate returns and evaluations. This will then produce benefits in terms of efficiency and optimization. Equity portfolio management can be sorted into further subsections, namely active and passive equity management. The specifics of each of these subbranches of equity portfolio management can be seen below.
Active and Passive Equity Management
There are two strategies used to create revenue on investment accounts, namely active and passive equity management. These strategies further divide into subsections; active equity management approaches can either be fundamental (discretionary) or quantitative (systemic).
Fundamental active strategies are the ones that emphasize the role of human logic when investing, whilst quantitative active strategies put rules-based models at a priority when arriving at a decision. You can discern fundamental and quantitative approaches using comparisons. If a type of management seems to place more importance on personal judgment and is objective, the strategy is likely to be more fundamental than quantitative.
Passive management is a type of management different from active management that deals with investing strategies and important trades for portfolios. The main difference between active and passive equity management is that active requires a higher level of buying and selling to get past a specified benchmark, whereas the purpose of passive equity management is to create a return that is the same as the chosen index.
Recap
In this article, many aspects of equity management have been discussed. To recap, the fundamental reason why equity management is undertaken is to make sure that a business is using its equity efficiently and ensuring owners have their appropriate stake in the business. You can calculate equities by subtracting the total liabilities from assets.
Equity administrators are the people responsible for keeping track of equity. They complete various tasks with the aid of equity management software–programs that display the current equity status–and take care of legal implications. Shareholder’s equity is a form of equity that refers to a shareholder’s stake in a company and financial planning is the analysis of the monetary requirements of the corporation, ranging from debts to sales and loans.
Hopefully, this article has given you a strong fundamental understanding of equity management and how equity management software can help your company. If you have any question about equity management software, please contact us.
Getting Your Stock Plans IPO Ready
Download Now: