What Is an Equity Agreement?

Before we define an equity agreement, first of all, what is equity? It simply refers to the value that would be given to a company’s shareholders if all of its assets were liquidated and all of its obligations were paid off. It can be used widely for whole businesses or specifically to the market worth of a single item. Assets can be referred to as valuable objects like property, merchandise, trademarks, or patents that might be tangible or intangible. One of the most popular pieces of data used by analysts to analyze a company’s financial health is equity which is listed on the company’s balance sheet.

An equity agreement is a business document that enables entrepreneurs to acquire funds for their start-up by handing up a percentage of their company’s ownership to investors. In summary, these arrangements often entail investors supplying cash in return for stock shares that they will keep and perhaps sell for a profit in the future. They have been utilized by businesses since their inception and have grown in popularity as technological advances have made them easier to set up and implement.

What’s Inside an Equity Agreement?

Here are the common elements that can be found and should be included when drafting an equity agreement:

Recitals. This is typically the first important part that would appear in an equity agreement (or in any kind of agreement). They are also usually known as the “whereas” clauses. By definition, recitals are opening phrases in a written agreement or action that appear at the beginning and are comparable to the preamble. They include a summary of the parties’ intents, such as what the agreement is for, who the intended parties of the agreement are, and so on. The recitals are often not meant to incorporate the parties’ rights or responsibilities, but rather to establish the situation or explain something.Definition of Terms. This is the next important part that appears in the equity agreement. Depending on the number of terms that need to be defined, this section can be written at length and may take up many pages of the document or this may only be written briefly. The importance of this section in an equity agreement (or any kind of legal document) is that it helps the readers understand the simple or complex terms that are scattered throughout the agreement and it also helps them understand the terms in the way the author of the agreement wants it to be understood.Issuance of Shares. In this part of the equity agreement, the business will agree to surrender a particular amount of shares of common stocks to the investor. This part also states in writing that the value of the shares that were given to the investor should be equal to a given closing bid price as stated by regulatory bodies.Closing and Delivery of Shares. The next important part of the equity agreement states the closing date and address of the acquisition of sales (usually done within one business week) and should also state the delivery date of the shares as well as the methods in which the stock certificates are going to be delivered.Authorizations. This section of the equity agreement says that the corporation providing the shares to the investor possesses all of the necessary corporate authority to execute and fulfill the agreement, release the shares and securities, and carry out all of the duties outlined in the agreement document. It also clearly specifies in writing that the agreement entered into by the parties concerned will be legally binding.Validity of Issuance. This section of the equity agreement states that the shares, when released in accordance with the terms of the agreement, will be legitimately issued, fully paid and nonassessable, and free of all taxes, liens, and charges pertaining to their issuance, and will not be issued in infringement of any preemptive right.Notices. This section of the equity agreement says that any notices required or authorized by this agreement must be in writing and are regarded effective upon delivery of the shares to the investor. It further stipulates that all communications must be sent to both parties at the addresses specified in the agreement.Counterparts. This section of the equity agreement states that the agreement may be implemented in two or even more counterparts, each of which shall constitute an original, but all of which shall constitute but one instrument when taken together, and should also become effective when one or more counterparts have been approved by each party hereto and delivered to the other parties.Payment of Fees. This section of the equity agreement also serves as the last important part of the agreement. It says that all parties concerned must cover their own expenditures and legal fees paid on their behalf in connection with this agreement and the operations envisioned by it. If any legal or equitable action is required to execute or interpret the provisions of this agreement, the successful party shall be entitled to appropriate attorney’s fees, expenses, and other disbursements in supplement to any other compensation to which such prevailing party may be eligible.

Examples of Equity Account

By definition, an equity account is a financial interpretation of a business, company, or organization. They are in different variants, some of which are listed and discussed below:

Retained Earnings. Retained earnings are the total amount of income of payouts to shareholders from payment of dividends minus the entire dollar amount of revenue earned to date. Companies may keep a certain amount of money and, rather than sharing it, reinvest it in the company or pay off debts and future commitments. This can improve a company’s long-term prospects, perhaps leading to higher stock ratings and greater rewards to investors.Treasury Stock. Treasury stock, sometimes known as contra-equity accounts, is the money paid to investors for the purchase of their stocks. Companies may employ treasury stock to reduce the overall number of stockholders in the company. Because this sort of account has a negative balance from the standpoint of the firm, it diminishes the organization’s overall quantity of equity.Common Stock. The amount of money investors donated to a business as capital investment to have possession of the firm is recorded as common stock, and it generally indicates a par value of the shares. Because the investor’s par value is occasionally lower, the account balance may be minimal. The value of common stock for the corporation is computed by multiplying the par value by the number of outstanding shares.Owner’s Distribution. An owner’s distribution, as a partnership equity account, is the amount of money an owner receives or withdraws from the firm dependent on how much profit the company creates. Profits can be used for personal use by the owner, or they can be kept in equity accounts to be used as future working capital. These distributions, depending on the amount taken by an owner, might dramatically diminish a company’s equity and assets.

How to Draft an Equity Agreement

An equity agreement outlines what will happen whenever the business structure or ownership changes, what happens when the owner gets incapacitated, and more. It is generally used in exchange for something that the equity holder will provide. With that being said, here are the steps to draft an effective equity agreement:

1. Identifying the Parties Involved in the Agreement

This is generally the first major step to be completed when an equity agreement is being drafted. In this step, the thing that needs to be emphasized is to identify who will be involved in this type of agreement. Typically speaking, the parties involved in an equity agreement are the investor and the business that will be surrendering part of their shares or stocks to the said investor so that they may hold or even sell them when the value of the company that they invested in goes up. Additionally, in this step, the details of the parties such as their operating address and contact details are also included.

2. Writing the Main/Primary Parts

After identifying the parties who will be involved in the equity agreement along with their details such as their operating address and contact information, this step will follow suit. In this step, the main or primary parts of the equity agreement are to be written, which are the definition of terms, the terms for the issuance of shares, the authorizations, and the validity of the shares being issued. The definition of terms will dictate the meaning of the simple and complicated terms that are scattered throughout the agreement, as intended by the author of the agreement. The issuance of shares will state in writing that the business will agree to give a given amount of shares to the investor, the closing and delivery part will state the date and address of the acquisition of shares, and the validity part states in writing that the shares given to the investor are legitimate and free of obligations such as taxes, charges, and so on.

3. Writing the Auxiliary/Boilerplate Clauses

After writing down the main parts of the equity agreement document, this step will then follow. The boilerplate clauses are usually the more common terms that can be found in any contract or agreement, and they are usually located in the end part. Some of the clauses that comprise the equity agreement include the notices, the counterparts, and the distribution of payment/fees. The notices clause states that any notices required or authorized must be in writing and are regarded effective upon delivery of the shares to the investor. The counterparts section of the agreement states, in its simplest form, that the agreement can be done in two or more counterparts. The payment of terms section states all parties concerned must cover their own expenditures and legal fees paid on their behalf in connection with this agreement and the operations envisioned by it.

4. Finalization

After drafting the main and boilerplate clauses of the equity agreement, it’s time to finalize it in this step. It is always recommended to seek legal help when drafting an agreement as there may be terms that are lacking that can only be noticed by someone who is well-versed in these kinds of documents. Additionally, check for grammar and spelling mistakes. One can never know where a single mistake in the agreement can lead. When the verification process has been finished, the parties involved can then enter negotiations and if it goes smoothly, they can affix their signatures and the agreement is set in motion.


How can an equity agreement grow a business?

Employee equity agreements, in particular, entice the personnel you require for success. When knowledgeable workers see the possibilities you have to offer, they will be ready to immediately acquire a stake. Another significant benefit of adopting these agreements is the involvement they engender. When an entrepreneur hires someone in return for a stake in the firm, that person effectively becomes a shareholder. Employees recognize they are working for the success of their own future when they have a stake in the company.

What is private equity?

Private equity is a different investment class that comprises assets that are not publicly traded. Private equity funds and investors either invest directly in private enterprises or engage in buyouts of public companies, culminating in the delisting of public equities. Private equity funding is provided by institutional and individual investors, and the funds can be used to fund innovative technologies, make acquisitions, extend working capital, and boost and stabilize a balance sheet.

What is home equity?

Home equity is basically equivalent to the value of homeownership. The amount of equity a person has in their house shows just how much of the home they own entirely after deducting the mortgage obligation payable. Equity in a property or house is derived through mortgage payments, including a down payment, and growth in property value. This type of equity is frequently an individual’s most valuable source of collateral since the owner may utilize it to get a home equity loan.

This type of agreement states the share of the business that each party owns and is usually a part of a startup business’ founding agreement. Drafting this document can be complicated especially when it comes to splitting equity in a fair amount. In this article, various examples of equity agreements to aid you in drafting this document should you need to do so.