Equity Vs. Stock Options — James Griffin Cole (2024)

The term “equity” refers to shares of stock, or it often may refer to stock options. Stock options allow you to buy a specific number of shares at a certain price point after a particular amount of time. Stock options don’t represent ownership unless your right to buy them has vested.

In comparison, equity investment means ownership in a business. You buy equity after your stocks trade at a particular value. You do this with the hope the price will continue to rise, increasing the value of your position.

A share of stock represents a small percentage of ownership in a business. Most publicly traded companies are corporations, which issue a specific number of shares of common stocks. Every common stock share represents equal equity or ownership percentage.

So, if you buy shares, you take part in both losses and profits of that corporation. Also, you get to vote at annual meetings. Yet, you aren’t personally responsible for anything wrong with the corporation. That’s what happens when you have an equity position.

Click this link to learn about other entrepreneurial topics, like CAO vs. COO or pre-seed vs. seed. And if you want to learn more about how to get an entrepreneur mentor, click here.

What Are Stocks?

Stocks are a tradable form of equity. When you buy stock, you’re purchasing equity in a business from the person selling it. When you trade stocks, you’re selling that equity to another person.

Different people have different beliefs about different companies' present and future values. Stocks enable them to trade with others based on those different goals and opinions.

What Are Stock Options?

Stock options give an investor the right, not the obligation, to buy or sell stocks at an agreed-upon date and price. There are two types of stock options: calls and puts. Puts are bets that stocks will fall, and calls are bets they will rise.

What Is Equity?

Equity refers to ownership positions in a company. For example, if you have 40% equity in a company, that means you own 40% of that business, and you’ll get 40% of its profits.

Perhaps you’ve also heard about “home equity” and that you need to pay a 30% down payment on a mortgage to buy a house. Here, the bank tells you that you must purchase 30% equity in the home before they allow you to borrow money to buy the other 70% of that equity. Even then, the bank owns that 70% because you owe them money.

The more stocks you purchase in the stock market, the more equity you have in the company. With time, you’ll increase your equity by paying off the loan principal, getting 100% ownership of the house.

Equity Vs. Stock Options

Equity is daunting. Not all equities have tradable stocks, but all tradable stocks involve equity. At a high level, owning equity in private companies is a bet on the companies’ future success. They are referred to as ‘options’ because stock options don’t mean ownership in a company, but instead, they give you the option to buy a certain number of shares.

At a basic level, equity is ownership in a company. Shares are issued in a series and labeled as preferred or common.

Typically, employees get common stock. Common stock differs from preferred stock because it has no preferences, such as added-on perks accompanying shares.

Employees receive equity from the “option pool,” a specified amount of equity that employees can share. Unfortunately, there are no standard rules on how small or large an option pool can be.

While there are many ways to get equities as startup employees, the most common is via stock options. Stock options guarantee employees the opportunity to buy a set amount of stocks at a specific price, no matter the increase in value. The price at which you buy shares is called the “strike price.” When you purchase the shares at that price, you’re exercising your options.

Furthermore, when a company awards you equity, it might be taxable. The type of equity you get and what you pay for it influences the amount of tax you’ll pay. For instance, stock options awarded to an employee with a strike price equal to the fair market value aren’t taxable. However, an award of the actual stock is taxable if the employee doesn’t buy it from the company.

Final Thoughts

Equity is just another word to represent partial ownership of a company and refers to residual rights after subtracting all the debts associated with that company.

Thus, equity typically represents the shareholders’ stake in the business as identified on the business’s balance sheet. In comparison, stock options give you the right, but not the obligation, to buy or purchase stocks at a specific price or date.

Equity Vs. Stock Options — James Griffin Cole (2024)


Is equity better than stock options? ›

Stock options don't represent ownership unless your right to buy them has vested. In comparison, equity investment means ownership in a business. You buy equity after your stocks trade at a particular value. You do this with the hope the price will continue to rise, increasing the value of your position.

Which is best equity or option? ›

Options can be a better choice when you want to limit risk to a certain amount. Options can allow you to earn a stock-like return while investing less money, so they can be a way to limit your risk within certain bounds. Options can be a useful strategy when you're an advanced investor.

What is the difference between equity and stock? ›

The total value of a company's equity gives the book value of the company and the total value of a company's stocks gives the company's total market value. Stocks attract supply and demand hence their prices fluctuate daily but the price of equity does not fluctuate.

What is the difference between equity incentive plan and stock option plan? ›

ESOPs are designed for prolonged, sustained growth by a business, and for a business that intends to operate for 10, 20, or more years into the future. An Equity Incentive Plan, in contrast, is geared more toward a change of control and exit from the business by service provider employees in 3-5 years (or less).

What are the disadvantages of stock options? ›

However, there are some downsides:
  • Options being worthless if the stock value of the company doesn't grow.
  • The possible dilution of other shareholders' equity when option-holders exercise their stock options.
  • Complex tax implications for ISOs, especially the concept of AMT.
Jul 5, 2023

Are stock options really worth it? ›

Stock options give employees a share in the potential upside of the company's success. They are high-risk, high-reward compensation. You don't know how much they will be worth when they're first issued. But if the company does well, employees with large option grants stand to gain significantly.

Why buy options instead of stocks? ›

The biggest benefit of trading options versus stocks is that it requires considerably less money or buying power to purchase calls and puts than it does to buy or short-sell a stock directly.

Why option trading is risky than equity? ›

Options contracts are considered risky due to their complex nature, but investors who know how options work can reduce their risk. Various risk levels expose investors to loss of premiums, gains, and market value loss.

Why don't more people trade options? ›

Not Understanding Risks and Rewards

Instead, they hold on to options with minimal returns just because they are less risky to trade. Eventually, such people wouldn't achieve much financially because reward is often closely tied to risks.

What is the best strategy for investing? ›

Top investment strategies for beginners
  • Buy and hold. A buy-and-hold strategy is a classic that's proven itself over and over. ...
  • Buy index funds. This strategy is all about finding an attractive stock index and then buying an index fund based on it. ...
  • Index and a few. ...
  • Income investing. ...
  • Dollar-cost averaging.
Apr 17, 2024

What is equity in simple words? ›

The term “equity” refers to fairness and justice and is distinguished from equality: Whereas equality means providing the same to all, equity means recognizing that we do not all start from the same place and must acknowledge and make adjustments to imbalances.

What is equity in simple terms? ›

Equity can be defined as the amount of money the owner of an asset would be paid after selling it and any debts associated with the asset were paid off. For example, if you own a home that's worth $200,000 and you have a mortgage of $50,000, the equity in the home would be worth $150,000.

What are the pros and cons of stock options? ›

Stock options are also a way to encourage employees to stay and not be tempted to leave and work for a competitor. However, critics of stock options warn that they can encourage executives to follow strategies that might benefit the stock price in the short term but could be detrimental to the company in the long term.

What are the benefits of equity options? ›

Advantages of Options
  • They can provide increased cost-efficiency.
  • They can be less risky than equities.
  • They can, at times, deliver higher percentage returns.
  • They can offer investors strategic alternatives.
Dec 19, 2023

How do equity stock options work? ›

A stock option is the right to buy a specific number of shares of company stock at a pre-set price, known as the “exercise” or “strike price.” You take actual ownership of granted options over a fixed period of time called the “vesting period.” When options vest, it means you've “earned” them, though you still need to ...

Which is better equity or futures or options? ›

What is better for returns, stocks or futures and options? The answer rests with you, the individual investor. Stocks may be a good bet when you want experience in the markets. Although investing in the share market today requires work and analysis, investing in futures and options requires even more of this.

Should you accept equity as compensation? ›

With equity compensation, there is never a guarantee that your equity stake will actually pay off. As opposed to equity (or in combination with equity compensation), being paid a salary can be beneficial if you know exactly what you're getting.

Is equity better than bonus? ›

Employees receiving equity compensation will find a range of benefits as their shares could ultimately yield more value over time than a regular paycheck or monetary bonus.

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