Return on Common Equity (ROCE)
Return on Equity Analysis
Equity Interest Definition
Equity interest, defined as the amount of equity a single person holds in a business, is a common concept to the small business world. For example, if an angel investor receives 25% ownership of a company, the investor has a 25% equity interest in that business. Equity interest accounting is simple: equity is worth nothing until it results in cash flows, either through disbursement of dividends or the sale of assets. At this point standard capital gains tax applies.
Equity Interest Explanation
Equity interest is the level of interest an owner has in the success of a company. It is also a basic business concept. The equity interest rate could be seen as the level of motivation a single owner has towards the outcome of the project. For example, a founder with 90% ownership will work harder for a successful outcome than a founder with 1% ownership. Due to the fact that owners have a difficult time leading a business to growth, their ownership in the business is an obvious factor of motivation while working.
To mitigate the risk of business a financial derivative known as an equity interest rate swap has been created. This is an agreement where future success of a business, measured in cash flows, is agreed to be shared between two businesses. If one business sees success, it pays a portion of this success to the other. In the event that the other business sees success, the other business would then pay the first company a portion of their cash flows. An equity interest rate correlation between the cash flows of the two businesses assures that none sees failure outright.
Equity Interest Example
Frank is an angel investor. He has worked hard to build and sell his first company. Since he has already achieved that, he now turns his focus on investing in other budding entrepreneurs. Frank loves to see businesses grow with the owners.
Frank is invested in multiple businesses. One, a green products manufacturer, has received $1,000,000 from Frank. For this he received 40% ownership. Another, a Web 2.0 company, has received $1,500,000 from Frank. In this business, Frank owns 25%. Yet another, a simple e-commerce store, has received only $750,000 from Frank. Frank owns 15% of this business.
The total value of Frank’s equity interest is $3,250,000. Phrased in terms of a percentage, Frank’s equity interest in all of the businesses is a combined 80%. Though Frank does not own a majority percentage of these businesses he has 80% ownership as a total of 3 businesses.
Frank knows that he, in the event of a disagreement, will not be able to argue control of any business that he does not have approximately 30% of ownership for. This is due to the fact that courts tend to rule in the favor of the majority owner. Unless they appear to have been neglecting the business, that is the case. Frank can accept this for 2 reasons. He trusts the majority shareholders and sees this as just a risk of doing business. If Frank could not accept this, he would be wise to only invest in a business with the end result of 30% or more of total shares of stock.