What is an Equity Investment?

Definition: Equity investment is a financial transaction where certain number of shares of a given company or fund are bought, entitling the owner to be compensated ratably according to his ownership percentage. In other words, it is an operation where an individual or company invest money into a private or public company to become a shareholder.

What Does Equity Investment Mean?

The most basic equity investment operation is the purchase of a common share. Common shares are pieces of a given business, also known as stocks. These stocks entitle the owner to a certain portion of the profits and assets and they can be bought either privately or publicly, depending on how the company is currently structured.

On the other hand, there are other types of equity investments like preferred shares, stock options and convertible bonds, which are different than common shares since they limit the way the owner participates in the company’s profits or they require certain event to take place before they can be converted into an equity instrument. Also, there are financial companies that offer equity investment securities that serve as a pool of many equity investments.

This is the case of equity mutual funds and ETFs, normally managed by professionals. For investors to engage in this kind of investments they must purchase the mutual fund or ETF shares and that entitles them to certain portion of the overall pool of equity investments.

Example

Jack is a 63 years old retired engineer who’s currently working freelance as an angel investor. His job is to pour funds into promising newly created businesses (startups). Jack has been recently interested in a business proposal he received from Marcus, an entrepreneur who’s working in a way to reduce the amount of paper sheets used by companies through an instant paper recycling machine.

In order to get things moving, Marcus needs $50,000 for research and development expenses. He is promising Jack to have a working prototype if he commits to invest the money. Jack asked Marcus a 35% of his company for the $50,000. That means 35 out of each 100 shares issued by Marcus’ business. This equity investment will be the cornerstone of this awesome project since it will get Marcus the funds he needs to fully develop the product.