A company issues equity securities to the general public to raise capital in the financial market for any major reason like business expansion, merger of the company or business product development. By purchasing the equity, the investor or the public is entitled be called a partial owner and gets voting rights in the company. Equity securities are the stock of shares held by the investors as reported in the company’s balance sheet. Equity securities are issued to the public as an alternative to the bonds which would be considered as a form of debt in the markets. The first public issue of equity securities of any company is called initial public offer (IPO). Investors too have a role in the company’s stock prices rising or falling.
Usually a company does not issue their entire available shares at one time. Some are reserved for a future date as there could be a possibility of the company requiring capital again for some new purpose. This second offer is called secondary or follows on offering. A big disadvantage to issuing equity securities is the downside risk. When a company decides to adds up new shares to existing shares to have more trading, then the existing shareholder’s equity ownership is reduced percentage wise. For example, a equities securities holder has 15 percent of a company’s shares, but the company decides on more public issue there increasing the trading, it would mean the shareholder’s percentage against the total shares has reduced. So when the profits are being calculated he tends to lose.
In case a company does not want to issue equity, the debt security is the other primary option. The debt securities are bonds issued by an entity which could be a corporation or a governmental office to the public. Once they purchase the bonds the investors becomes the creditor to the government. But the catch here is that in spite of buying the debts securities, the buyer does not become an owner. He continues to pay the ongoing interest payment to the creditors and other shareholders.
Other than the IPO, there is the private equity which caters to the equity securities of the unlisted companies in the stock exchange. Private equity is through investment of capital into the existing companies or by the taking over the company. The main investors here are the institutions. The various types of private equity are:
- Leveraged buyouts: Private equity firms buy businesses through the funding by a huge debt. The buying firm than uses the assets of the firm they bought as collateral
- Venture Capital: Any business starting newly cannot guarantee that it would be able to raise capital by public issue. Banks too hesitate for new ventures and so these new companies turn to private equity funding.
- Growth Capital: Companies which are already established but still want to expand turn to private equity funding. This is also a debt in between equity and secured debt. These are also called mezzanine capital and are high risk to investors providing it.
- Distressed investment: Some companies become financially distressed and are unable to function. At these times the private equity take advantage and and they go in for what is called “distress investment”.
There is a secondary market too to make investments.
- Rights Issue: A Company offers certain number of shares to their share holders when they are in need of new capital. It is a right given to existing shareholders in proportion with their existing holdings. The offer could be at a discount or a premium. In case a shareholder does not want his rights issue he can sell the shares to another share holder.
- Foreign Currency Convertible Bond: The FCCB is a bond combined of debt and equity. The bond holder has to make coupon and principle payments though they have the option to convert to equity where there is no coupon payment.
- Fully convertible debentures: It is a debt security which is convertible into equity shares. There is a conversion ratio which is decided by the issuer. Once the debentures are converted, the investors get the same status a share holder.
- Warrants: This is a security by which the holder is granted warrant by the company to buy number of shares at a particular price before a expiry date.