Investing is the practice of purchasing an asset to earn money over time, either through income generated by the asset, by selling the asset at a higher price in the future or both. All kinds of assets can be used as investments, such as homes, land, shares of stock or even collectibles and antiques. An equity stake is an ownership interest that a person has in a certain asset.
Read More: Types of Equity Instruments
What Is an Equity Stake?
In investing and finance, equity is the value of ownership that a person has in a certain asset. For example, if you own a home, the value of the home that exceeds any debts associated with the home, such as home mortgages or lines of credit, is your home equity. Similarly, if you own shares of stock in a company, you literally own a small part of the company, and the total value of those shares is equity.
The term "stake" or "equity stake" simply means that you have some amount of ownership or equity in a certain asset. For instance, if you own a few shares of stock in a company, you have an equity stake in the company. The value of those shares is the size of your equity stake.
Read More: How to Make an Equity Partnership
Benefits and Drawbacks
Having an equity stake can be beneficial since the total value of your equity can increase over time if the value of the asset increases. For example, if you own shares of stock in a company and the share price doubles over time, your equity will also double. On the other hand, if an asset becomes less valuable over time, you will lose equity.
If you buy part of a small business, you can ask for a share of the profits, ownership of part of the company, or a combination of both. Asking for a combination of both gets you regular cash payments (if the business profitable) and a piece of the sale price of the company if the owner decides to sell it.
When taking an equity stake in a small business, make sure you know what type of partnership you are entering into. Some partnerships give you more say in how the business is run, but open you up to more legal liability.
Potential of Equity Stakes
The larger your equity stake in a certain enterprise, the more likely you are to be able to influence the enterprise. For example, if a single shareholder owns more than half of the shares of stock issued by a company, he is said to be the majority shareholder. A majority shareholder is able to control the operations and may have the power to appoint members to the board of directors, which makes important decisions about the company.
Read More: How to Calculate Capital Gains Taxes
Taxes on Capital Gains
If you buy shares of stock and sell them later on for a profit, the profit is called a capital gain and is subject to federal capital gains taxes. Gains realized when selling stocks you hold for less than a year are subject to a short-term capital gains tax rate. Talk to your financial advisor about tax strategies that might include reinvesting stock gains or gifting stocks to children.
Gregory Hamel has been a writer since September 2008 and has also authored three novels. He has a Bachelor of Arts in economics from St. Olaf College. Hamel maintains a blog focused on massive open online courses and computer programming.