Shareholder funds are an alternate term for owner’s or shareholder’s equity. It represents the funds invested in the company through stock purchases or other private investments. Companies report this figure on the balance sheet, with shareholder funds playing an important role in the accounting equation. The accounting equation is assets equal liabilities plus owner’s equity. Companies can sell two types of stock that represent shareholder’s equity: preferred and common. Preferred shareholders receive dividends while common shareholders having voting rights.
Publicly held companies are the primary users of shareholder funds. These organizations sell stock to raise equity capital for business growth opportunities. Companies will often avoid issuing preferred shares so they do not have to pay dividends. Dividends represent immediate cash repayment of individual investments, often requiring companies to pay quarterly or annually to investors. Failing to pay dividends will result in current investors leaving the company, which results in lower shareholder funds, and future investors seeing the company as undesirable, as it does not live up to its promises.
Shareholder funds are a type of external capital. Companies will use this equity to pay large expenditures without using operational capital. Operational capital comes from normal business operations and is most often used for daily business expenses. Companies will also retain a portion of operational capital to improve short-term liquidity. Investors will review a company’s balance sheet to determine how much equity the company uses to pay for assets needed to run its operations. This creates leverage, meaning the company must repay investors their money for these assets. A common formula to measure this leverage is the shareholder equity ratio.
The shareholder equity ratio is total shareholder equity divided by total assets. For example, a company with shareholder funds (equity) of $500,000 US Dollars (USD) and assets of $750,000 USD has a shareholder equity ratio of 67 percent. If the company must liquidate assets in the event of bankruptcy, the shareholders will receive 67 percent of the company’s cash received from its capital. This will pay off investors their shareholder’s equity, ending their relationship with the company.
Similar to debt financing, companies can over-leverage their company through equity financing. Not only does this mean the shareholder’s equity ration increases, but it also results in diluting the shares of current investors. Diluting shares will result in a lower value for all currently outstanding shares. Unless the company increases the financial of all returns through increased equity investment, shareholders will simply lose this value of their investment.