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Entrepreneurs conceive a business idea. They gather manpower, materials and money to start an enterprise. After initial teething troubles, a corporate is established. Then comes his higher ambition to grow larger nationally and internationally. This is tougher challenge and magnitude of organizational demands huge capital and manpower skills. Such a growth path is most desirable and purpose of the entrepreneur’s initial dreams.

A large professionally managed organisation of today was once proprietary dream of an entrepreneur. However, if the corporate had not raised right resource (Equity & Debt) at the right time, giant corporations would have died premature had never taken off. Single most important decision attributable to creation of formidable enterprise for the success of an initially profitable venture, is its Initial Public Offering (IPO).The initial resource and ability to raise further resource is coffered upon form IPO.

EQUITY is available to even a fresher with a bright business proposition that can be monetised, while DEBT can be availed only when one has collateral securities and certainty of cash flow to pay interest and repay the principle.

Raising equity from capital market has multi-magnitude advantages as narrated here after:

1. CORPORATE VALUATION:

Corporate create profits from business activities. Annual Cash flow is the powerful weapon to build future assets that are cash machines. Cash flow can be discounted (advanced) either by raising DEBT or by issuing EQUITY.

DEBT is a conservative means of finance both from lenders’ (safety & assured return) and borrowers’ (limited intrusion in management & fixed expenses) perspective. However there are limited existing assets that can be pledged to create future assets. Hence debt offers limited funding options.

Major difference between DEBT & EQUITY is the valuation. Debt takes into account past and current cash flow, at best immediate future cash flows. While EQUITY, that is listed, factors in more for the future cash flows based on the entrepreneur’s’ vision and delivery capabilities by way of Price Earning Ratio.

EQUITY is a lethal means of finance from the perspective of investors (Risky & unpredictable return) and issuers (Unlimited intrusion in management). However in reality financial investor offer full freedom to the management without any commitment of assured returns.

EQUITY is an unlimited means of finance for a growing enterprise and virtual currency for an established enterprise expanding organically and inorganically. When the corporate wishes to expand beyond his normal cash flow, equity is the best means of finance. When it comes to equity, it’s the valuation that matters the most. A listed equity is valued more appropriately then an unlisted equity.

This means equity is used as legal tender currency.

LISTED EQUITY is traded on the stock exchanges where in various participants trade the stock and assign PRICE to the corporate – it’s business, cash flow (present & future) and quality of management. One sees variations in the stock market valuations of similar cash flow companies in same business based on quality of management.

Stock market also values efficiency of capital employed and return of capital employed (Fixed & Current Assets) by rating higher valuation to companies with more operating margin and higher return on capital employed.

Thus listing helps generate an independent valuation of the company by the market.

In nutshell, stock market is a voting machine in the short term and valuation machine in the long term for the business activities of the corporate. Listing is a constant evaluation platform that is absent for unlisted equity.

2. EQUITY CURRENCY:

This means equity is used as legal tender currency.

INVESTORS’ use listed equity as a currency –

  • Families invest in good company equity their savings for dividend income and capital appreciation. They buy when general market is ignoring value creation done by the corporate and sell when market gives unrealistic value to the business and profit from this anomaly in stock market behavior let by human emotions like GREED, FEAR, HOPE, EGO & PRIDE.
  • Investor pledges the listed equity with banks and raises fund to meet his current requirement when he choices to hold the equity for long term.
  • Investors with modest resource who cannot start industry on their own, buys few shares and join the partnership. When they sell at stock market, new investors buy and join the partnership. In the process the old investors get exit and net investor gets entry without disturbing company’s invested capital.
  • Investor fulfills his needs of life by selling them when the occasions arise. Equity is a perfect hedge instrument against INFLATION as old economic assets starts getting values at current replacement cost by way of higher stock price. DEBT cannot give this inflation hedge, infect it is victim of rising inflation.
  • Equity is divisible. If an investor has equity holding of Rs.10 Crs and he needs only Rs.1 Cr to meet marriage expense of his son, he can sell equity worth Rs.1 Cr and continue to hold equity of Rs. 9 Crs. Such a divisibility is unimaginable if he is holding a Real Estate worth Rs.10 Crs. First of all, he can’t sell it immediately, second he will have to sell full property worth Rs.10 Cr. Also he has to pay Long Term Capital Gain Tax on sale of Real Estate.
  • While there's no Long Term Capital Gain Tax on Sale of Equity. Listing brings in liquidity and ready marketability of securities on a continuous basis adding prestige and importance to listed companies.

CORPORATES’ use listed equity as a currency -

  • When the corporate is planning to raise capital for growth, to fund new projects/undertake expansions/diversifications and for acquisitions an initial listing increases a company's ability to raise further capital through various routes like Convertible Warrants, Preferential issue (PIPE), Rights issue, Qualified Institutional Placements, ADRs/GDRs/FCCBs & Overseas Listing.
  • When a business partner – supplier or buyer – for strategic reason wants stake in the company, it’s most easy in terms of price and regulatory approvals.
  • In case corporate wants to take over unlisted company, listed equity can be offered to the target company shareholders. Otherwise additional equity is issued and funds can be paid to the target company shareholders. Such a facility ensure seamless takeover without disturbing existing cash flow.
  • Promoter inter se family settlements are easiest when the equity is listed. The section of the family choosing to quit the business can offer to continuing family members their share or sell their share in market through judicious placement planning.
  • PERHAPS LISTING OFFERS THE BIGGEST ADVANTAGE TO PROMOTER WHO WISHES TO SELL AT AN APPROPRIATE TIME – when he sees business cycle slowing or has reached personal limitation and has accomplished his career goal.
  • Corporate dreaming to take over or set up businesses on foreign soil can easily do so when its equity shares are listed on domestic stock exchanges for few years. They can seek listing on the foreign bourses, raise capital to take over or set up businesses and continue to avail advantages of overseas listing.
  • Listed equity can act as collateral to raise debt for Banks & Financial Institution.

BRAND EQUITY:

This is the most prominent advantage and offers an edge over remaining unlisted. Listed companies are frequently given coverage by domestic & overseas TV Channels, newspapers, magazines, rating agencies, consulting firms and government agencies. Employee attraction by way of Sweat Equity/ESOP is eminent advantage to deliver better performance and stay with the company for longer time.

The listing agreement signed with the exchange provides for timely disclosure of information by the company. Thus providing more transparency, better corporate practices, and building investor confidence.

These continuous disclosures create a Capital Market Brand that separates resource raising ability of listed companies against those of unlisted companies.

DMC Firewall is developed by Dean Marshall Consultancy Ltd