The equity capital market (ECM) refers to the arena where financial institutions help companies raise equity capital and where stocks are traded. ECM encompasses both the primary market for private placements, initial public offerings (IPOs), and warrants; and the secondary market, where existing shares are sold, as well as futures, options, and other listed securities are traded.
Key Takeaways
- Equity Capital Markets (ECMs) refer to a broad network of financial institutions, channels, and markets that together assist companies to raise capital.
- Equity capital is raised by issuing shares in the company, publicly or privately, and is used to fund business expansion.
- Primary equity markets involve raising money from private placement and mainly consist of over-the-counter (OTC) markets.
- Secondary equity markets include stock exchanges and serve as the primary venue for public investment in corporate equity.
- ECM activities encompass IPOs, secondary offerings, and other mechanisms to bring shares to the market.
Understanding Equity Capital Markets (ECMs)
The equity capital market (ECM) is more expansive than merely the stock market because it includes a broader range of financial instruments and activities. These activities encompass the marketing, distribution, and allocation of issues, initial public offerings (IPOs), private placements, derivatives trading, and book building processes. The main participants in the ECM are investment banks, broker-dealers, retail investors, venture capitalists, private equity firms, and angel investors.
Alongside the bond market, the ECM funnels money provided by savers and depository institutions to investors. As a part of the capital markets, the ECM aims to achieve the efficient allocation of resources within a market economy.
Primary Equity Market
The primary equity market is where companies issue new securities. It’s divided into the private placement market and the primary public market. In the private placement market, companies raise private equity through unquoted shares sold directly to investors. In the primary public market, private companies can go public through IPOs, and listed companies can issue new equity through seasoned issues. Private equity firms may utilize both cash and debt in their investments (such as in leveraged buyouts), whereas venture capital firms generally deal only with equity investments.
Secondary Equity Market
The secondary market, often perceived as the “stock market,” is where no new capital is created. Instead, existing shares are bought and sold. This market includes both stock exchanges and over-the-counter (OTC) markets, where a network of dealers trades stocks without an exchange acting as an intermediary.
Advantages and Disadvantages of Raising Capital in Equity Markets
Raising capital through equity markets offers several benefits for companies:
- Lower Debt Ratios: Companies won’t need to rely on high-interest debt to finance their growth.
- Flexibility: Equity markets provide a wider array of financing options compared to debt markets.
- Added Expertise: Especially through private placements, companies can bring in experienced investors who offer valuable oversight and guidance.
However, there are also challenges:
- Cost and Complexity: The process of going public can be expensive and time-consuming due to multiple actors and regulatory requirements.
- Scrutiny: Public companies face constant evaluations and pressures to perform for their investors.
Equity Capital FAQs
What Is Equity Capital and Debt Capital?
Equity funding involves exchanging shares of a company’s ownership for capital, while debt funding relies on borrowing. Equity capital offers operational freedom and lower liability, contrasted with debt capital’s lower cost and tax benefits.
How Is Equity Capital Calculated?
A company’s equity, or shareholders’ equity, is the difference between total assets and total liabilities. The market capitalization, or value of publicly-traded stock, is calculated as the share price times the number of shares outstanding.
What Are the Types of Equity Capital?
Equity can be private, involving unquoted shares via primary markets, or public, involving shares traded on secondary markets. Common stock is the most common form of equity, but there are also preferred stocks and other classifications.
What Is the Difference Between Capital and Equity?
Capital encompasses all resources including cash used for productive purposes. Equity is one form of capital representing ownership stakes in a company.
Related Terms: primary market, secondary market, IPO, private placement, stock exchanges.
References
- Anthony W. Lynch. “Foundations of Finance, Lecture 2”. Page 2. Leonard N. Stern School of Business, New York University.
- Anthony W. Lynch. “Foundations of Finance, Lecture 2”. Pages 5-6. Leonard N. Stern School of Business, New York University.
- PitchBook. “A Guide to Every Step in the IPO Process Explained”.
