What is an Equity Capital Market?
Equity capital markets is a term used to describe raising funds by issuing new shares of stock. According to our equity capital markets consultants, this process can also be called an Initial Public Offering, or IPO. The equity capital markets are divided into three different tiers: Tier 1 refers to the primary markets wherein new shares are traded and companies go public, Tier 2 pertains to the secondary markets where stocks once held by individual investors trade among themselves, and finally Tier 3 includes private trading venues that provide alternative liquidity through off-exchange transactions.
Fintalent’s equity capital markets consultants observe that the equity capital market tier system has become a valuable tool for institutional investors who only invest in a certain tier or level of investment. For example, a hedge fund that chooses to invest in Tier 3 private stocks is not likely to invest in a Tier 2 public stock since the stock moves too fast in comparison to their investment goal. This system is built around the idea that an investor who only invests for the long-term does not need to be exposed to the volatility associated with trading on an exchange.
Equity capital markets are generally used as a means of providing companies with much needed working capital as well as other purposes such as business combinations, acquisitions, and going public. Equity capital markets are used because of their versatility to provide a number of different types of securities. These include common stock (which gives investors voting rights in addition to owning a piece of the company), preferred stock, convertible notes, and secured loans.
The equity capital market tier system was an idea conceived by equity capital markets professionals as a means to provide investors with a specific vehicle for investing in that particular type or tier of security. At the same time it also allows non-professional individual investors to make informed decisions about where to allocate their funds based on investment preferences.
Equity capital markets also have a role in providing companies with working capital. This is especially important for startup companies as well as companies that have suffered significant damage such as major fires or hurricanes, which are often not able to pay current interest on their debt obligations. These types of companies utilize the equity capital markets to obtain funding to re-open their doors and get back to business
During the earliest days of the world’s trading, long before the equity capital markets existed, shares of stock were used by lenders. For example, a city might give “shares” of its land to a borrower in return for money that was needed to maintain public works (such as roads or bridges). This land could then be leased to others at a certain price, say one tenth of the rental value. If the number of shares in that plot were increased by two, it would not affect the loan agreement or simultaneously mean that the person leasing the plot would pay two tenths of its rental value. Shares, in these early days were not traded independently on exchanges but rather were sold, lent and borrowed within a group of people all involved in an agreement to perform some kind of work or provide some kind of faith. Shares were given as a symbol for future payment and represented a debt obligation until such time as it was repaid. The number of shares represented the amount of work that was to be completed. The concept of equity capital markets is much more modern since it deals with tradeable securities known as stocks, and especially those that trade on an exchange.
The equity capital markets have been around since the beginning of time. The only difference is that they were not traded in an exchange like they are today. These markets consist of:
Primary markets: this is where new issues are first issued, through the form of an Initial Public Offering (IPO). This is also where a company’s stock goes public and can be traded into secondary markets.
Secondary Markets: this is where existing shares are traded. The secondary market consists of all the transactions that investors make with each other on exchanges such as the New York Stock Exchange, or OTCBB (Over-the-counter bulletin board) for contracts that are privately negotiated. Secondary markets vary from country to country and could be used for any of the purposes listed below:
Off-Exchange Transactions: these are transactions that are arranged outside of a regulated exchange’s rules or regulations. Cash market transactions include commercial paper, auto-bills and term bonds. Bond auctions are also considered cash market transactions but do not take place over phone lines because they require thousands to participate in the auction.
Over-the-Counter Market: this is where contracts such as options, futures and swaps (options on options) are traded. Because these contracts are not traded on exchanges, prices are often subject to manipulation or brokers who have access to information that may be unavailable to other investors. This can skew the market price, therefore creating an unfair advantage for brokers that have access to this information.
Exchanges: this is where transactions take place on a regulated exchange where each trade is made in public. The stock exchanges consist of all the different types of equities that are traded on them and they can be listed, or unlisted. There are two types of exchanges:
The OTCBB (Over-the-counter bulletin board) is an electronic quotation service that carries a limited listing of securities that trade over the counter (OTC). OTCBB was once known as the “pink sheets” because it was printed on pink paper, however there are now online quote services. Any company can be listed on the OTCBB, whereas only companies meeting certain requirements can be listed on an exchange. OTCBB is also monitored by the SEC, however it does not have as many regulatory requirements as other exchanges.
