The words Equity Capital Markets (ECM), might immediately make you think of Initial Public Offerings (IPOs) and companies raising billions of dollars in large stock-market debuts. However, there is a lot you need to know about ECMs that you can learn from the SEBI-registered experts. It is a segment of the financial market in which the companies raise funds by issuing and selling shares of their ownership to the investors. These shares are named as equity. In this article, we are going to delve into the things you should know about ECM. Let’s get started.
What Is ECM?
ECM is a subset of the broader financial market, where companies and financial institutions interact to trade financial tools and increase capital for companies. ECMs are indeed riskier than debt markets and, hence, also provide significantly higher returns.
The Equity Capital Market is a platform for the following functions:
- Marketing of issues
- Distribution of issues
- Allocating new issues
- Initial public offerings (IPOs)
- Private placements
- Trading derivatives
- Accelerated book-building
The small cap, mid cap, and large-cap companies can be listed on the Equity Capital Market. And the dominant traders are:
- Investment bankers
- Retail investors
- Venture capitalists
- Angel investors
- Securities firms
What Are the Types of ECM?
The Equity Capital Market is of main two types: One is primary equity market and other is secondary equity market. Let’s understand these:
Primary Equity Market
The primary equity market consists of the companies that are issuing new securities. It comprises two main parts:
- The Private Placement Market: In the private placement market, companies sell shares with no predetermined prices directly to investors to increase their private equity.
- The Primary Public Market: In the primary public market, private companies become public via IPOs. The listed companies can offer new equity via seasoned issues.
Secondary Equity Market
The secondary market is usually described as the stock market. It doesn’t create new capital. Instead, the existing shares are sold and bought here. It usually comprises stock exchanges and over-the-counter (OTC) markets. The dealers trade stock without any intermediary exchange in case of OTC market.
What Instruments Are Traded in ECM?
Equity capital is increased by selling a part of a claim to your company’s assets in return of money. Thus, the equity capital is defined by the value of the current assets of the company and business. Here are the instruments, that are traded on the ECM:
1. Common Shares: Common stock shares depict the ownership capital. The holders of common shares get dividends out of the total profit earned by the company. The common shareholders have a residual claim to the assets and income of the company.
2. Preferred Shares: These shares usually don’t have voting rights. However in case of bankruptcy, they provide higher priority for dividends and assets.
3. American Depository Receipts (ADRs): These allow investors to own shares in foreign companies as they are traded on U.S. exchanges.
4. Exchange-Traded Funds (ETFs): These are a type of investment funds that are traded on stock exchanges. They provide the investors with a wide exposure to stock ranges.
4. Warrants: They are a type of derivative securities that provide the holder the right to buy the stocks or shares of a company at a specific price within a certain timeframe.
5. Convertible Bonds: These bonds are convertible into a certain number of the shares of the company at a specific conversion ratio. They offer a blend of equity and debt features.
6. Futures: A future contract is a forward contract that is entered and executed via clearing houses. The clearing houses act as intermediaries between the seller and the buyer of futures. The clearing houses also guarantee that both the buyer and the seller are adhering to the deal.
7. Options: This contract is one sided as it gives the right but not the obligation to buy or sell the asset on or before the pre-decided date. A premium amount is paid to acquire this right. An option that is bought is a call option and an option that is sold is a put option.
8. Swaps: A swap is a type of transaction under which one cash flow stream is interchanged for another stream between two parties.
What Are the Benefits of Raising Capital in ECM?
Here are some of the benefits of raising capital in the equity capital market:
- It Lowers Credit Risk: The more is the proportion of equity in the capital structure of a company, the lesser will be the amount of debt it needs to raise. Hence, credit risk is decreased.
- It Has Greater Flexibility: If the debt to equity ratio is lower, it allows greater flexibility in the operation of the company. It is due to the fact that the shareholders are at a lower risk than debt holders. Hence the debt holder stands to gain more profit via dividends if the company makes a large profit. Also they face limited losses because of limited liability if the company faces losses.
- Signaling Effect: Issuing equity is a signal that the company is doing well financially.
What Are the Risks of Raising Capital in the ECM?
Here are the risks of raising capital in equity capital market:
- Dividend Payments Are Not Tax-deductible: In equity capital markets, the dividend payments aren’t tax deductible unlike interest on debt.
- The Company is Subject to Large Scrutiny: To make the investment decisions, the investors trust blindly on the financial statements of the company. Hence, the company and its financial statements are subject to strict disclosure norms and scrutiny.
- Increased Dependency on Shareholders: If you are maintaining a low ratio of debt to equity, it means that so many shareholders have a claim to the profit of the company. Hence the company may need to decrease its retained earnings, even if it causes lower profits in the long run. It is necessary to pay dividends to the shareholders in the short run.
The Bottom Line
Equity Capital Market improves the flow of capital from investors to businesses. It supports the growth of our economy by connecting the companies that need capital to the investors who are looking for opportunities for significant returns. However you need to do a detailed research of the financial status and the regulations of the company before you make an investment decision. Also you can get a sufficient understanding of the market at Bank Nifty SEBI registered telegram channel to prevent significant losses.
