Original Equity

Definition

Original Equity is the amount of cash initially invested by the underlying owner or owners in a business or venture. This initial investment forms the foundational capital structure of the business and plays a crucial role in determining the owner’s percentage of ownership in the company. This term is specifically distinguished from sweat equity, which is the value added to a company through the effort and work of its founders and employees without cash investment, and capital calls, which are additional capital infusions requested from investors post the initial investment.

Examples

Startup Company: If an entrepreneur starts a tech startup and invests $100,000 of their personal savings into the business, that $100,000 constitutes the original equity.
Real Estate Investment: If a real estate investor purchases a rental property and contributes $50,000 as a down payment from their funds, the $50,000 is considered the original equity in the property.
Partnership: In a business partnership where two partners each contribute $75,000 to start a retail business, the total original equity would be $150,000 shared equally between the partners.

Frequently Asked Questions

Q1: How is original equity different from sweat equity?

A1: Original equity refers to the cash or capital initially invested in a business, while sweat equity is the value of the work and effort invested by the founders or contributors without monetary compensation.

Q2: Can original equity change over time?

A2: The original equity amount is fixed at the initial investment. However, the overall equity in the company can change through additional investments, profits, losses, or issuance of new shares.

Q3: What documentation is usually involved in recording original equity?

A3: Original equity is typically recorded in the company’s financial statements, in incorporation documents, and detailed within equity agreements or partnership agreements.

Q4: How does original equity impact ownership percentage?

A4: The amount of original equity directly influences the percentage of ownership each investor holds relative to the total value of the investment.

Q5: What happens to original equity in case of company liquidation?

A5: In liquidation, claims on the company’s assets are settled in the order of creditors, preferred stockholders, and finally, common stockholders (those with original equity) get the remaining assets.

Sweat Equity: The value created in a company through the efforts and hard work of its founders and employees, rather than cash investment.
Capital Calls: Requests made by a firm to its investors to provide additional capital for the purpose of funding business operations or new projects after the initial investment.
Ownership Stake: The portion of a company owned by an individual or entity, typically represented by equity shares.
Initial Public Offering (IPO): The process by which a private company offers its shares to the public for the first time.
Seed Funding: Early-stage funding provided to startups by investors to initiate business operations.

Online References

Suggested Books for Further Studies

“Equity Asset Valuation” by Jerald E. Pinto, Elaine Henry, Thomas R. Robinson, John D. Stowe.
“Valuation: Measuring and Managing the Value of Companies” by McKinsey & Company Inc., Tim Koller, Marc Goedhart, David Wessels.
“Private Equity: History, Governance, and Operations” by Harry Cendrowski, James P. Martin, Louis W. Petro, Adam A. Wadecki.

Fundamentals of Original Equity: Business Finance Basics Quiz

### What is original equity? - [x] The amount of cash initially invested by the underlying owner in a business. - [ ] The total profit after the first fiscal year. - [ ] The fair market value of a business. - [ ] The value of non-cash contributions made by employees. > **Explanation:** Original equity is specifically the amount of cash initially invested by the underlying owner in a business. ### How is original equity primarily distinguished from sweat equity? - [x] Original equity is cash invested, while sweat equity is the value of effort and work. - [ ] Original equity is always larger than sweat equity. - [ ] Sweat equity requires monetary compensation. - [ ] They are the same in value but differ in name. > **Explanation:** Original equity refers to the cash invested, whereas sweat equity represents the value of non-cash contributions through effort and work. ### What is an example of original equity in a startup? - [x] $150,000 invested by the founders to kickstart the operations. - [ ] The revenue generated in the first month. - [ ] The office furniture donated by a friend. - [ ] The unpaid overtime work done by the founders. > **Explanation:** Original equity in the example is $150,000 invested by the founders as initial capital. ### Can additional investments after the initial investment alter the original equity amount? - [ ] Yes, it can alter the original equity amount. - [x] No, original equity is fixed at the initial investment. - [ ] It only changes with every new fiscal year. - [ ] It doubles with every capital call. > **Explanation:** The amount of original equity is fixed at the initial investment. Subsequent investments do not change the original equity amount. ### In what document is original equity typically recorded? - [ ] Annual revenue report - [x] Incorporation documents and financial statements - [ ] Marketing plan - [ ] Employee handbook > **Explanation:** Original equity is recorded in financial statements, incorporation documents, and equity agreements. ### What is the impact of original equity on ownership percentage? - [x] It determines the ownership percentage relative to the total investment. - [ ] It does not impact ownership percentage. - [ ] It is irrelevant to ownership stakes. - [ ] It only affects voting rights. > **Explanation:** The amount of original equity determines the percentage of ownership each investor holds in the company relative to the total capital invested. ### What happens to the original equity in case of company liquidation? - [ ] It is returned first before settling any debts. - [ ] It is completely lost if there are no remaining assets. - [x] It is settled after creditors and preferred stockholders. - [ ] It remains intact regardless of liquidation. > **Explanation:** In liquidation, the original equity claim is settled after creditors and preferred stockholders receive their share. ### Which term refers to early-stage funding provided to startups? - [ ] Original equity - [ ] Sweat equity - [x] Seed funding - [ ] Capital calls > **Explanation:** Seed funding refers to the early-stage funding provided to startups to initiate operations. ### What does original equity not include? - [ ] Cash invested by the owner - [x] The value of work and effort without cash investment - [ ] Initial capital structuring of a business - [ ] Owner’s percentage of ownership > **Explanation:** Original equity does not include the value of work and effort without cash investment—that is identified as sweat equity. ### Which major aspect differentiates capital calls from original equity? - [x] Capital calls are additional requests for capital after initial investments. - [ ] Capital calls are larger amounts than original equity. - [ ] They occur at the same time and are interchangeable terms. - [ ] Only public companies can make capital calls. > **Explanation:** Capital calls are requests for additional capital from investors after the initial investment, as opposed to the original equity established at the start.

Thank you for diving into the concept of original equity. We hope this comprehensive explanation and quiz further your understanding of foundational business finance terms. Keep exploring!