Equity position definition
/What is Equity Position?
Equity position refers to an investment made by a third party (the investor) in a business in exchange for stock. Such a position may be taken by an investor for a variety of reasons, including the ones noted below. An equity position represents less than a 100% share of the stock of the business issuing the shares.
Expectation of a Return
The investor may believe that it can earn a generous return by buying shares in the business. This belief may be based on an analysis that finds the purchase price of the shares to be unusually low, in which case the investor believes that the price will increase over time. Alternatively, the investee may have a history of paying out generous dividends, which the investor might be counting on as part (or all) of its expected return.
Conversion of Convertible Debt
The third party may have concluded that the convertible debt it holds in a business represents a worse return than the return to be gained if the debt is converted into stock.
Alternative Form of Payment
The third party is a creditor of the business, and elects to accept stock in settlement of the debt. This situation usually arises when the business is in such poor financial condition that there is no other reasonable alternative. If so, the third party is making the best of a poor situation, and is hoping to mitigate its loss.
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Example of an Equity Position
Curmudgeons International decides to purchase a minority position in the common stock of Killjoy & Sons. By making this investment, Curmudgeons now has an equity position in Killjoy, and is one of its shareholders.
As a shareholder, Curmudgeons is entitled to a portion of any dividends that Killjoy’s board of directors may declare. Curmudgeons will also obtain its rightful share of any residual assets if Killjoy were to terminate its operations. Curmudgeons also stands to gain from any run-up in the value of Killjoy stock, which might happen if there is increased demand for its shares on the stock market. Finally, the articles of incorporation of Killjoy mandate that, as a shareholder, Curmudgeons can now vote on a number of key issues at the annual shareholders’ meeting, such as whether to sell the company and who should be on its board of directors.
The chief downside of being a Killjoy shareholder is that Curmudgeons may see the value of its investment drop if Killjoy reports poor earnings to the investment community. Or, if Killjoy were to shut down, Curmudgeons might find that the value of its entire investment has disappeared.
Advantages of an Equity Position
Part of the intent of the third party in buying the position may be to gain some measure of control over the business, in which case the percentage of ownership represented by the position may be of some importance. Also, it is useful to look at the terms associated with the sale of stock (which are likely to have been negotiated specifically with the third party). The terms may include:
Board seat. A sufficiently large equity position may entitle the third party to a seat on the board of directors.
Voting rights. The third party may obtain special voting rights, such as being able to approve or disapprove of any proposed sale of the business.
Registration rights. The business may be required to have the shares registered with the Securities and Exchange Commission within a certain period of time, or else additional shares must be issued to the third party.
Warrants. The business must issue a certain number of warrants to the third party along with the shares.