What Is the Equity Capital Market (ECM)?
The equity capital market (ECM) refers to the arena where financial institutions help companies raise equity capital and where stocks are traded. It consists of 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 (ECM) refers 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 the expansion of the business.
- Primary equity markets refer to raising money from private placement and mainly involves OTC markets.
- Secondary equity markets involve stock exchanges and are the primary venue for public investment in corporate equity.
- ECM activities include bringing shares to IPO and secondary offerings.
Understanding Equity Capital Markets (ECMs)
The equity capital market (ECM) is broader than just the stock market because it covers a wider range of financial instruments and activities. These include the marketing and distribution and allocation of issues, initial public offerings (IPOs), private placements, derivatives trading, and book building. The main participants in the ECM are investment banks, broker-dealers, retail investors, venture capitalists, private equity firms, and angel investors.
Together with the bond market, the ECM channels money provided by savers and depository institutions to investors. As part of the capital markets, the ECM, leads, in theory, to the efficient allocation of resources within a market economy.
Primary Equity Market
The primary equity market, where companies issue new securities, is divided into a private placement market, and a primary public market. In the private placement market, companies raise private equity through unquoted shares that are sold to investors directly. 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 use both cash and debt in their investment (such as in a leveraged buyout), whereas venture capital firms typically deal only with equity investments.
Secondary Equity Market
The secondary market, where no new capital is created, is what most people typically think of as the "stock market”. It is where existing shares are bought and sold, and consists of stock exchanges and over-the-counter (OTC) markets, where a network of dealers trade stocks without an exchange acting as an intermediary.
Advantages and Disadvantages of Raising Capital in Equity Markets
Raising capital through equity markets offers several advantages for companies.
The first one is a lower debt to equity ratio. Companies will not need to access debt markets with expensive interest rates to finance future growth. Equity markets are also relatively more flexible and have a greater variety of financing options for growth as compared to debt markets. In some instances, especially in private placement, equity markets also help entrepreneurs and company founders bring in experience and oversight from senior colleagues. This will help companies expand their business to new markets and products or provide needed counsel.
But there are also problems with raising capital in equity markets. For example, the route to a public offering can be an expensive and time-consuming one. Numerous actors are involved in the process, resulting in a multiplication of costs and time required to bring a company to market.
Added to this is the constant scrutiny. While equity market investors are more tolerant of risk as compared to their debt market counterparts, they are also focused on returns. As such, investors impatient with a company that has consistently produced negative returns may abandon it, leading to a sharp drop in its valuation.
Equity Capital FAQs
What Is Equity Capital and Debt Capital?
Companies seek to raise capital in order to finance their operations and grow. Equity funding involves exchanging shares of a company's residual ownership in return for capital. Debt funding instead relies on borrowing, where lenders are repaid principal and interest without receiving any ownership claim. In general, equity capital is more expensive and has fewer tax benefits than debt capital, but also comes with a great deal of operational freedom and less liability in the case that business fails.
How Is Equity Capital Calculated?
The equity of a company, orshareholders' equity, is the net difference between a company'stotal assetsand itstotal liabilities.When a company has publicly-traded stock, the value of its market capitalization can be calculated as the share price times the number of shares outstanding.
What Are the Types of Equity Capital?
Equity can be categorized along several dimensions. Private equity differs from publicly-traded shares, where the former is placed via primary markets and the latter on secondary markets. Common stock is the most ubiquitous form of equity, but companies may also issue different share classes including allocations to preferred stock.
What Is the Difference Between Capital and Equity?
Capital is any resource, including cash, that a company possesses and uses for productive purposes. Equity is but one form of capital.
