Equity in business: A founder's perspective

Author:
The Carta Team

|
Read time:
16 minutes
Published date:
15 December 2025

Learn the fundamentals of company equity, including the different types you will issue and how to manage ownership as you build your business.

What is equity in business?

In the simplest terms, equity in business is ownership. In a private company, equity represents the total ownership divided among the people who have a stake in it, including founders, employees, and investors. This ownership gives them a claim on the company's future profits and assets, and it's important for all holders to understand the resulting taxes on equity, including capital gains.

You may see equity called “shareholders’ equity” (public companies) or “owners’ equity” (private companies). In each case the definition is the same: Equity is the portion of ownership shareholders have in a company.

You can think of business equity using a basic accounting formula: Assets - Liabilities = Equity. If a company were to sell all of its assets and pay off all of its debts, the value that remains is the equity. This is the core meaning of equity and represents the net worth of the business.

While a textbook definition of equity comes from the accounting formula of total assets minus total liabilities, this doesn't capture the full picture for a startup. The true value of a company’s equity isn't just what’s on the balance sheet today, but what the company could be worth in the future.

This future potential is what makes equity so compelling: It represents a stake in the upside you and your team are working to create. Understanding how equity works, the principles of equity management, and how to use this powerful asset are some of the most important skills a business owner can develop.

For a founder, equity is the most powerful tool you have to build your company, serving as the currency you use to raise money, attract a great team, and align everyone around a shared vision. It's how you reward the people who take a risk on your vision before there's any revenue or profit to show for it.

For employees, the ability to own equity can be an incentive to join a company, stay at the company for longer, and feel more invested in the company’s success. Many businesses, including most startups, include equity as part of their overall compensation to employees.

What are the types of equity?

The two main types of equity issued by private companies are shares of common stock and preferred stock. Both types offer different benefits to shareholders. In general, shares of common stock are issued to founders and employees, while shares of preferred stock are issued to investors.

Common shares

Common shares represent a direct ownership stake and are granted with certain rights, such as voting rights, which allows holders to have a say in company decisions. This type of equity is the foundation of your company's ownership structure.

Founders can amend their Articles of Incorporation to create more shares. This usually occurs as a company grows, often in conjunction with raising money from investors. With more shares available, companies can award equity in the form of stock grants or stock options to more employees. These forms of equity compensation offer an incentive for employees to join the company.

The major disadvantage of common shares versus preferred shares is that they receive a lower preference if there is a liquidity event—common shareholders generally only receive a payout after preferred shareholders have received at least their initial investment back.

Preferred shares

Preferred shares is a type of equity issued primarily to investors when they invest in a company’s funding round, known as equity financing. Preferred shares come with specific rights that common stock doesn't have, such as a liquidation preference. A liquidation preference gives investors their money back first in an exit scenario, like an acquisition, before common stockholders receive anything.

Employee equity

Companies can issue several different types of equity to employees depending on the company’s compensation philosophy, fundraising stage, or option pool. Issuing equity to employees can create a possibility of profit if the company’s share price grows over time. Like all investments, however, gains are never guaranteed, and shares can become worthless if the company fails.

Stock options

A stock option allows an employee to buy a set number of company shares at a fixed price (known as the strike price, or exercise price). You’re never required to exercise a stock option.

The two types of employee stock options in the United States are incentive stock options (ISOs) and non-qualified stock options (NSOs). Both enable equity ownership and are offered to service providers depending on different factors.

• Incentive stock options (ISOs) could qualify for favorable tax treatment if you meet certain requirements.
• Non-qualified stock options (NSOs) do not qualify for favorable tax treatment for the employee.

Other types of equity awards

Other types of equity awards like restricted stock awards (RSAs) and restricted stock units (RSUs) are two examples of equity alternatives to stock options. Companies usually switch to RSUs as they grow larger to reduce share dilution and to make the awards attractive and affordable to employees.

• Restricted stock units (RSUs) are a promise to give you shares of a company’s stock on a future date—as soon as you meet certain conditions.
• Restricted stock awards (RSAs) are equity awards that are acquired upon grant, and are usually subject to vesting conditions.

Convertible instruments

Convertible instruments are tools used in early-stage fundraising. The conversion of these instruments, typically happens during a priced funding round where preferred stock is issued.

Types of equity in an LLC

LLCs may set up an LLC equity compensation plan to detail how the company shares ownership with employees and consultants.

Types of interests

• Profits interests units (PIUs) or incentive unit plans offer employees future profits from the company, either from a sale or from yearly distributions.
• Membership interests are another form of equity for LLCs. Membership interests owners have the same financial privileges as other members do and may also have voting rights.
• Phantom equity or synthetic equity awards recipients the right to future value, typically in the form of a cash payment when the company reaches a milestone.
• Options to acquire LLC interests is a type of a contract LLCs use that functions similarly to a stock option grant agreement does for corporations.

Vesting

Employees must work for a certain period of time or meet specific milestones to earn their equity awards. This is called vesting.

Some equity plans can allow early exercising, which lets you exercise options before they are vested.

How does equity turn into cash?

The process of converting that paper ownership into actual cash happens during liquidity events. A liquidity event is the moment when the years of hard work can finally pay off and equity becomes a tangible asset.

Merger and acquisition (M&A)

When one company purchases another, shareholders of the acquired company may receive a cash payout or new shares from the buyer.

Initial public offering (IPO)

An initial public offering (IPO) is when a private company offers its stock on the public market for the first time.

Secondary market transactions

The secondary market for private stock allows stockholders of private companies to liquidate their equity before an exit event.

How to calculate your equity’s value

Knowing how much shares are worth is essential to understanding the value of your equity. In the public markets, the share price of all companies listed on stock market exchanges is publicly available in real time, and is based on supply and demand. Private companies that offer equity calculate share prices using a 409A valuation.

Why does equity matter for your startup?

Before your company generates significant revenue, equity is what you use to bring on co-founders, grant advisory shares, hire your first key employees, and secure the initial capital needed to get your idea off the ground. It allows you to build a compensation plan that rewards key people for the risk they are taking by joining your unproven venture.

Frequently asked questions about equity

What does owning a percentage of equity in a company mean?

Owning a percentage of equity means you own that portion of the company's total value. The monetary worth of your stake will change as the company's valuation grows or shrinks over time.

What is the difference between equity and stock?

Equity is the broad concept of ownership in a company. Stock is the specific security that represents a unit of that ownership.

How much equity should I give to early employees?

There's no single right answer when deciding how much equity to give early employees, as the ideal amount depends on the role, the employee’s experience, and your company's stage. However, benchmark data can provide a concrete starting point for making competitive offers.

What does a 10% equity stake mean?

An equity stake of this size means you own that percentage of the company’s total outstanding shares on a fully-diluted basis.

How is equity paid out?

Equity is paid out when a shareholder sells their shares for cash during a liquidity event, such as an acquisition, IPO, or a secondary transaction like a tender offer.

What is dilution and should I worry about it?

Dilution is the decrease in your ownership percentage when new shares are issued to investors or employees, but it's a necessary part of growing a company and making the overall pie much larger.