When a company starts its business, it issues shares in proportion to the initial capital brought in by the promoters (i.e. those who start the business as a company). As the business of the company grows, the promoters often require more capital to meet the company’s growth objectives like capacity expansion, new product development, increase in marketing budgets etc. They have 2 ways of raising this capital:
❖ Getting a loan from a bank (Debt Capital); or,
❖ Raising Equity capital – selling equity shares of the company (Equity Capital)
Both means of financing have their pros and cons. Debt capital would burden the company and require it to make regular interest payments on the borrowed sum. On the other hand, raising equity capital would increase the number of owners in the business thereby reducing the stake of each owner. However, the advantage in the latter case is that the promoters by selling a portion of the company’s ownership (i.e. equity) in return for capital will be able to avoid interest obligations which they would have incurred on debt financing.
When you buy a share, you become part owner of the company. For example, if a company issued 1000 shares and you bought 10 of them, you own 1 % of the Company. This gives you the right to share in the future growth and profits of the company, as also the right to receive the company’s reports and accounts and a right to vote on corporate affairs. The more shares you own, the bigger your stake.
Need for raising equity capital
It is easy to find new investors to come in as owners so long as the business is small and requires little capital. But imagine a company which requires Rs. 1,000 Cr for expansion. In such a case one often needs to talk to many prospective stakeholders at the same time because you don’t often find individuals or any one group willing to invest that much amount of cash. This is done by making an ‘Offer For Shares’ of the company in the form of an Initial Public Offering or IPO. The company advertises its need for raising equity capital and how the capital is proposed to be utilized and invites investors to become stakeholders in the company in return for this capital. The process is regulated by the Securities and Exchange Board of India (“SEBI”) and the stock exchanges where the shares of the company get listed after their sale to those who apply in the IPO.
Avenues of raising equity capital in India
For businesses and companies looking to raise capital via diluting equity (i.e. selling a certain percentage of stake in the business) there exist numerous ways in which this can be achieved, including:
- Preferential allotment of shares to a select group of investors – this method is mostly used by private equity firms looking to invest in growing businesses.
- Bringing out a public issue of shares – SEBI has laid down conditions for raising capital via the IPO route in the ICDR Regulations. These days even for smaller companies, this option is being increasingly utilized with exclusive exchanges like the BSE SME catering to this segment. Small cap companies (i.e. companies with post issue equity capital between Rs. 1 Cr – Rs. 25 Cr), can take this route subject to meeting certain conditions.
These days young businesses are leveraging on the internet and the social media to raise small amounts of money from a large group of people in return for financial stake or financial rewards in the business, commonly referred to as Crowdfunding.