A huge guy with a elite blue suit walks out of his rolls royce and hand over a brief case full of cash. Here Santa, here is your Money, go fund the Banta Co. Cheers!
If only Businesses used to work that way!
Welcome back Riters, today we will discuss how Businesses raise money and whats in it for you as a consumer. So lets dive in.
Every Business comes with a cost. Business need money to generate money, and there are four major ways a Business can raise capital –
- Early Stage Investors or Seed Money – This is usually when a Business is just starting up, and the founders may put in their money or may reach out to venture capital for investment.
- Profit as a source of financial capital – If firms are earning, they may chose to reinvest some of their profit back.
- Borrowing – Firms may choose to borrow money from Banks, that they can then invest back into the Business. This can also be referred to as debt financing. While debt is easy, it puts a additional burden to pay off interests.
- Stocks– This is a way by which a company can issue shares, and in turn get the public money to invest back into the Business. This can be referred to as equity financing. While this may sound attractive but going public may often means a lot of additional work that goes into financial reporting, where in you need to announce your earnings to the public and file them. If not done correctly it can also result in a company downfall, and eventual demise.
Oftentimes a company will use a mix of both debt and equity to finance their Business. And the best mix of debt & equity referred to as an optimal capital structure of firm helps maximize a company’s market value and minimize its cost. Often debt/equity ratio is something that a potential investor looks at.
Lets further discuss how do the company raise capital via stocks.
IPO – Initial Public Offering is the way by which a privately held company goes public and get listed on Stock Exchange. Think of Exchange as a place where Stocks (a piece of company) are sold & bought, so that you public get to be the owners! Owners, not in a real sense though you don’t get to take or make any decision as such, but you do get to keep a part of profit or loss.
Now, as a consumer, you just don’t need to sell the shares/stocks to encash the profit, Some Companies also offer a regular payment a part of their earnings as ‘dividends’. And remember the golden rule of Investment – Invest only in things you understand & do your own due diligence.
Now, if your Car runs out of fuel, you go to a petrol pump nearby and pour in some gas! Same way if a Company feels it needs more fuel aka more money to run, it may go back to you the public and ask for it, via FPO.
FPO – referred to as Further Public Offer or a Follow-on Public Offer is a process by which a already listed company issues new shares to the existing shareholders or the new investors.
FPO is used by companies to diversify their equity base with a aim to inflow subsequent public investment. FPO is comparatively less riskier, more predictable, and has a profit lower than IPO
The issue of shares IPO, FPO, private equity or debt instrument is regulated by SEBI (Securities and Exchange Board of India) in India.
There are two types of FPO:
- Dilutive FPO – when the new offer of shares actually increases the outstanding shares of company. Such FPO is undertaken to fund the expansion activities or pay off some debts like the current Yes Bank FPO.
- Non-Dilutive FPO– This one provides no additional shares or diversify the equity. This is when company’s founders, the board of directors, or other large shareholders sell their privately held shares on the open market.
Tata Steel Ltd, Engineers India Ltd, Power Grid Corporation of India, Power Finance Corporation Ltd, and NTPC Ltd are some of the successful FPOs in the past. The success of any IPO or FPO, depends on various factors like pedigree of the company, its promoters, earning capacity, potential and the Sentiment among the Market.
Each type of funding has its pros and cons, not knowing how to invest the money you earned or raised whether for a consumer or a business can make a whole difference between expansion or fall, growth or decline.
Thank you for reading, look out this space for more!