Equity and Valuation: Understand the relationship between equity and the value of the company
Introduction: In corporate finance, two fundamental concepts for investors to evaluate businesses are equity and valuation . Equity refers to a company's net asset Valuation, corresponds to the total economic value of a company—that is, an estimate of how much the entire business is worth on the market, considering its future earnings potential. Although related, equity and valuation are not the same thing. In this educational article, we will clearly explain what equity is, how to calculate it, how it differs from valuation, and how factors such as brand and other intangible assets company 's perceived value . We also provide practical examples (such as high-valuation and low-equity startups investors analyze equity versus valuation when deciding their investments.
What is equity and how is calculated?
Equity is basically the corporate participation or equity of a company. It is the portion of the value of the business that belongs to the owners (shareholders), after all obligations and debts were subtracted from the assets. A simple way to understand: Think of equity as your own slice in business, your “piece of cake” after paying debts . In the balance sheet , this translates into the formula:
- Equity = total assets - total liabilities.
In other words, if the company sold all assets and paid all debts today, what was left would be the equity, representing the accounting value that actually belongs to the partners. Therefore, equity is also known as equity. This metric reflects the current financial health of the business - a positive and growing shareholders' equity usually indicates that the company has accumulated resources and wealth over time, while a negative equity means that liabilities surpass assets (a worrying situation).
To calculate the equity of a company, the balance sheet data is used. Added to the value of all assets (circulating and non-circulating) and subtract all liabilities (circulating and long term). The result is equity. For example, imagine that a company has total assets of $ 100 million and passive of $ 70 million ; Its equity (equity) would be $ 30 million . This simple account depends on the quality of accounting information, but gives an immediate view of the accounting value of the business. In short, the higher the equity, the greater the base value of the company , as there are the more their own resources supporting the operations. However, as we will see later, equity alone does not tell the whole story about the value of a company.
Difference between Equity and Valuation
Although related, equity and valuation are different concepts. Equity is a present accounting value , a kind of financial photography of the company at a given moment - it shows what the company is worth today in terms of accumulated heritage. Valuation is a market value estimate , usually designed for the future - it is like a film that considers the company's growth potential, its future profitability and other external factors.
While equity represents the current property (equity) of shareholders, valuation is the process of determining how much the business is worth a whole . It's like giving the whole cake a price and not just current ingredients , considering future recipes, expected growth, risks and opportunities. Valuation is obtained through financial methodologies (discounted cash flow, market multiples, comparable, etc.) and incorporates multiple factors beyond the balance . In short, equity focuses on the present and past (data already performed), while valuation focuses on the future and value generation potential.
This difference means that a company can have a very different equity value from its valuation. For example, it is possible for a company to have negative equity (more debts than active today), but still have a positive valuation if it has great future growth potential . This is often the case with startups in early stages: even operating in red or with modest equity, they can achieve high valuations based on growth expectations, innovative technology or other differentials. Valuation is a projection and vision exercise , not just accounting, while equity is an accounted for what has been built so far.
Another way to understand the relationship is: valuation directly influences the value of each shareholder's equity . If a company's valuation rises, each partner's equity becomes more valuable in the market. However, a high valuation does not instantly change accounting net equity —it reflects a market valuation. Therefore, equity should not be confused with market valuation , as the latter considers multiple factors and future projections that go beyond what is recorded in the accounting books.
Equity and the perceived value of the company
Equity impacts a company's perceived value , but it is not the only determinant of valuation. In established companies and those in traditional sectors, there is usually a closer relationship between equity and market value. Investors often look at indicators such as Price/Book Value (P/BV) to assess whether a stock is expensive or cheap relative to what the company actually owns. For example, the P/BV ratio compares market value (share price times number of shares) with book equity; if a stock trades below its book value (P/BV less than 1), it may indicate that the market values the company at less than its net assets would be worth, suggesting a potential discount or possibly problems not reflected in the balance sheet. On the other hand, companies with a P/BV much higher than 1 are valued by the market well above their equity, which generally means that their intangible assets or future profit prospects are highly valued by investors .
In short, robust equity tends to increase a company's valuation floor , as it indicates financial strength. Banks, for example, need strong equity to gain market confidence. A company with low equity may see its market value penalized —a classic case of companies in crisis, whose share price falls and ends up being worth less than its equity, due to a lack of confidence in its profitability. Investors carefully analyze the quality of equity : not only the value itself, but also its composition (equity vs. debt), the trend (rising or falling equity over the years), and the profitability generated on that equity (indicators such as ROE – Return on Equity ). A high ROE suggests that the company can generate significant profit relative to its equity, which usually increases valuation. A low or negative ROE, on the other hand, indicates inefficiency or problems, potentially reducing perceived value.
However, it is possible for the market to assign a high valuation to companies whose accounting equity is low . This happens especially when other factors come into play - and that's where intangible assets and growth expectation come in. Next, we explore as elements such as brand , technology, and other intangibles can make Valuation much over the accounting value.
The role of brand and intangible assets in valuation
One of the reasons a company's valuation can significantly exceed its equity is the value of its intangible assets . Intangible assets are non-physical resources—for example, brands , patents , software , intellectual capital , customer bases , and technology . These items are often not fully accounted for on the balance sheet (unless acquired from third parties), but they have enormous economic value. In the modern economy, intangible assets have become the primary drivers of corporate value creation . For example, it is estimated that in 2020, intangible assets represented approximately 90% of the market value of companies in the S&P 500 index (the 500 largest publicly traded companies in the US), while in 1975, this percentage was only 17%. This illustrates how intangible factors today weigh much more heavily on valuation than physical, tangible assets.
A strong brand , for example, adds value by allowing the company to charge premium prices and achieve greater customer loyalty . This means better profit margins and more predictable revenue, elements that increase the present value of future cash flows and, therefore, raise valuation. As Felipe Jorge, partner at the Valuation Brasil consultancy, pointed out, "a strong brand allows for premium prices and greater loyalty (...). All of these factors increase the company's ability to generate cash in the future—and that's what really matters in a valuation ." Besides the brand, other intangible advantages include intellectual property (patents, exclusive technology), which creates barriers to entry against competitors, and customer relationships (e.g., recurring users in a subscription model), which ensure a steady revenue stream. In short, intangibles increase expectations of future profits—and valuation is nothing more than pricing in these future expectations .
Accounting, if these assets are not registered (or underestimated) in the balance, the accounting equity is below the “real value” of the business. Therefore, when evaluating companies, investors look beyond net equity: they consider future performance indicators. Valuation methods such as discounted cash flow (FCD) serves precisely to capture the value of intangible assets within the financial projection. This method brings at present value all the cash flows that the company can generate in the future, more faithfully showing the impact of advantages such as brand, technology and customer base on cash generation.
In innovative or technology companies, it is common for valuation to be much higher than equity precisely because of these intangibles. Think of technology giants or platform startups: Much of the value comes from things as a global brand, millions of users, accumulated data and intellectual property - factors that do not appear fully in the PL , but which investors “precet” by determining the market value. A valuable brand and strong active actives make investors to pay much more than the accounting amount of tangible assets , because they expect extraordinary future gains from these competitive differentials.
Practical Examples: High Valuation Startups Low Equity
To illustrate, let's look at market examples - especially startups - where valuation reaches high figures while equity is still reduced. Growth startups often operate with damage in the early years , consuming capital to gain market, which keeps its equity low or even negative. Still, they can reach billionaire valuations due to the expectation of future dominance in the market and the value of their intangible assets (innovative technology, emerging brand, user base).
Nubank is an example of a Brazilian startup that achieved a billion-dollar valuation despite operating at a loss in its early years. In 2019, Nubank—Brazil's leading card fintech and digital bank— had never made a profit since its founding , accumulating losses of around R$380 million in its first five years. Even so, large investment funds invested heavily in the company (over US$700 million so far) and, in the last investment round before the IPO, valued Nubank at almost US$3.9 billion (approximately R$15 billion) . In other words, despite the modest net worth, the valuation was already dozens of times that amount. Why? Investors weren't looking at current profits (nonexistent at the time) , but at other metrics and prospects: explosive customer growth, disruption in the traditional banking sector, and a brand beloved by young people. The big bet was that Nubank would lead a transformation in the Brazilian financial market and eventually become very profitable. Indeed, years later, in 2021/2022, Nubank went public with a valuation that exceeded R$250 billion, surpassing the market value of traditional banks, despite still having incipient profitability. This case highlights how investors price the future potential and intangible qualities of the business (brand, technology, customer loyalty) far above current equity.
Nubank is not an isolated case. Several unicorns (startups valued at over $ 1 billion) followed this way. the “startups with valuations disproportionate to its cash generation was caught , true loss machines operating with very high market value. This disconnection tends to sound a warning: eventually, to support high valuations, the company will need to deliver compatible results. Otherwise, there may be drastic corrections in value. International examples such as Uber and Wework were famous for reaching stratospheric valuations despite successive losses - later facing questions and adjustments when investors began to demand clear paths for profitability.
On the other hand, there are companies whose valuation is less or close to equity - for example, mature companies from traditional or difficult sectors, where the market believes the business is worth a little more than its liquid assets. In these cases, few valuable intangibles or low growth perspective cause the price to be pulled down and may even be below equity (p/VP <1). This can signal opportunity (cheap actions in relation to accounting value) or simply reflect that the assets in the balance is overpowered and the company cannot generate proper return on them.
As investors analyze equity vs. Valuation when investing
investor 's point of view , understanding the relationship between Equity and Valuation is crucial to making good investment decisions. In business ratings (whether to buy stocks on the scholarship, or to invest in a startup), the investor wants to know how much it is paying for what the company really has (equity) and how much expects to earn with what the company can come to Valuation (Valuation) .
In the case of investments in startups or closed capital companies , investors look at which equity will obtain from the invested capital and whether the proposed valuation makes sense in the face of fundamentals. For example, if a startup calls for an investment that prices on $ 100 million valuation, but has a much lower equity (say $ 5 million) and little revenue, the investor will question where this value comes from - will usually be anchored in growth projections. Experienced investors carefully evaluate these projections and compare with current indicators to avoid paying too expensive for a slice of a company that may not deliver the expected growth. They also consider dilution : a higher valuation means that, by the same money invested, the investor has a smaller slice of equity; Therefore, it is in the entrepreneur's interest to negotiate a high valuation, while the investor wants a realistic valuation to give him significant participation for the risk he is assuming. Balance in these negotiations comes exactly from the critical analysis of equity vs. Valuation.
In investments in companies listed , Equity vs. Analysis. Valuation appears in indicators such as the already mentioned for VP (price/equity value) and other multiples. Value Investors investors , for example, seek companies whose quotation is attractive to their accounting value - an indication of possible undervaluation . On the other hand, growing companies often negotiate with multiples above the equity value, and investors agree to pay this prize if they believe in the growth of future profits. In both cases, the key is to understand the difference between the present value (equity/equity) and the future value (valuation) . As a valuation guide points out, "knowing the real value of a company (valuation) and what represents your equity allows you to identify the best opportunities and avoid financial traps . In other words, by mastering these concepts, the investor can decide with more basis if it is worth injecting capital into a business and when terms.
Also, understanding equity and valuation gives negotiation power . In a company sales or investment capture, knowing how to correctly calculate the equity and to support a valuation prevents the owner from accepting an offer below what the business is worth or, in the opposite case, covers an unrealistic price that fans investors. For investors, this clarity helps to negotiate stakes and fair prices , aligning return expectations. Startups that have a well -founded and transparent valuation are easier to attract capital, as they convey confidence that the numbers make sense (data indicates that light valuation startups capture investment 40% faster).
Finally, it is noteworthy that Equity and Valuation complement each other in the analysis. Equity shows where the company is today , and Valuation points out where it can arrive tomorrow . Smart investors look at both: check if the company has a solid base (assets, own resources, low leverage) and also if there are prospects for growth and strong intangibles that justify paying above this base value. This 360º Vision helps identify promising businesses as well as avoid investment pitfalls - for example, companies with high valuation “sold” on Hype, but without heritage substance or real cash capacity. As a synthesis, Equity is the anchor of the company's current financial reality, and Valuation is the balloon of future expectations - the investor's work is to check if the balloon is not too full to the point of disconnecting from the anchor. Balancing these aspects, the chances of making safer and more profitable investment decisions increases.
the Balance between Equity and Valuation
Equity and Valuation are two sides of the same coin when it comes to evaluating companies, but each brings a different perspective. Equity reveals the intrinsic value built so far - equity, what partners actually have today . Valuation reflects the price that the market attributes to the business , looking forward - what investors believe that the company will be worth , given its potential, brand, intangible assets and market context. For investors , understanding both concepts is essential: allows you to value companies more completely, identify hidden opportunities (and risks) and negotiate better agreements. For entrepreneurs , it means to better structure investment rounds, avoiding excessively diluting your participation and knowing how to justify the value of your business with data and projections.
In short, equity is foundation, valuation is the perspective . Knowing how to balance the analysis between what the company has and what it can generate is the key to smart decisions. As we have seen, a strong brand and other intangibles can leverage valuation far beyond net equity, and examples of startups show that the market often pays for the future more than for the present. However, in the long run, it will be the convergence of these two elements - growing assets and expectations - that will determine the success of an investment. So whether you are an investor or entrepreneur, keep your feet on the ground with the equity numbers, but without taking your eyes off the horizon designed by Valuation. This will give you a complete strategic vision of the company's value in all its dimensions.
