In order to finance the operating cost and expansion plants, the companies usually utilize profits earned from business operations. But as a start-up company, you do not have any revenue or profits. So, in order to get funds, you are left with only two options namely Debt financing, and Equity Financing.
What is Debt Financing?
When a company requires cash to finance several requirements such as the expansion of business or set up a new unit, the company makes use of debt financing. Debt financing is to borrow a fixed sum from the lender i.e. Bank or NBFCs with an assurance that you will pay back the principal amount along with interest within a fixed rate and time.
What is Equity Financing?
When a company requires money to finance several requirements such as the expansion of business or set up a new unit, the company makes use of equity financing from the retail investors by selling a percentage of the business or the company to the investors, in exchange for capital. The investors who buy the share of any company have a voting right.
Usually, a company can raise funds via issuing Initial Public Offerings, or via venture capital financing. Venture capital financing is beneficial to raise money from high net worth individuals who are looking for investment across various companies to diversify and minimize the risks associated.
In the case of initial public offering when the company raises funds from retail investors the venture capitalists have an option to sell or reduce their stake by selling equity shares to institutional or retail investors.
What is Equity?
Let us assume, I want to start a business and I have a capital of Rs. 80,000/-. To start my business, the first thing I need is to own land and a factory. The total cost of the land and the factory is Rs. 1,00,000/-. So I decided to borrow Rs. 20,000/- from an individual. I have borrowed the capital of Rs. 20,000/- from an investor and in reply I gave him a share of my company through the ratio-proportion method. This is share or equity. As the investor borrowed me Rs. 20,000/- and I have invested Rs. 80,000/- the ratio is 4:1. As I give him my company’s share he is also an owner of my factory, land, and other assets in the ratio of 4:1.
If after one year our company earned a profit of Rs. 10,000/- then the profit was equally divided among the equity shareholders in the ratio of 4:1. According to the ratio proportion, my profit amount is Rs. 8,000/- and another investor will get Rs. 2,000/-. This amount is called a dividend.
- Read also: Equity – Investopedia
So, Equity or share is a unit of ownership that represents an equal proportion of a company’s capital. It entitles the shareholder to an equal claim on the company’s profits and an equal obligation for the company’s debts and losses.
What is Initial Public Offer or IPO?
Suppose, I ran a company for the previous 10 years. My company Market cap is Rs. 1 Lack. As I decided to grow my company I need to set up a new factory across the country and for that I need a capital of Rs. 1 lack. The initial public offering is the process by which a private company can go public by issuing new shares to the public or the existing shareholders can sell their shares to the public without raising any fresh capital.
By issuing the IPO of my company I sell ownership rights to the investors who give me Rs. 1 Lack. Let us illustrate 4 investors insisted and buy share or equity of Rs. 25,000/- each. So the company’s total market cap is Rs. 2 lack. And the ratio of ownership is Rs. 1,00,000/- : Rs. 25,000 : Rs. 25,000/- : Rs. 25,000/- : Rs. 25,000/- = 4:1:1:1:1.
Suppose, the company after one year our company earned a profit of Rs. 10,000/- then the profit was equally divided among the equity shareholders in the ratio of 4:1:1:1:1. According to the ratio proportion, my profit amount is Rs. 5,000/- and other investors will get Rs. 1,000/- each.
How to open a Demat Account
To buy the share of the different company you need to open a Demat account. Demat account is just an account of your savings account or PPF account. Through a savings account, you can shop or withdraw cash from ATM. Through the Demat account, you buy shares, invest in the Mutual fund.
To open a Demat account you just have to go any registered bank in which your savings account is opened or any other bank like, SBI, HDFC, ICICI Bank, Kotak Mahindra Bank, or RBI Registered Bank.
- While opening a Demat account you have to produce an identity Proof, i.e., PAN Card, Address Proof i.e., Voter IDCard, Aadhaar Card, and an Internet Banking enabled Bank Account.
- After a Demat account is opened, you are wondering about how to invest your money. Let us assume, you have Rs. 1,10,000/- in your savings account. After logging in your trading or Demat account you have to lien the amount of Rs. 1,00,000/- to the Demat account from your savings account through Internet Banking. After that, you can buy any company share from your Demat account.
Benefits of Buying a share or Equity
Minority Ownership
Well, it does sound like an exaggeration, but when you put your money in a reputed company’s stocks, you become a part-owner of the company, irrespective of however smaller your share may be. You can improve your standing in the market by sagaciously putting your money in different companies. Moreover, you can exit whenever you want.
Right to Vote
Minority ownership gives you the right to vote and voice your opinions at the corporate level. If the company is thinking about taking a loan from the market for setting up a new factory or expand the consisting factory, the company should have to consent to the shareholders of the company. If the majority of shareholders agree to that proposal then the company go forward and if the majority of shareholders are opposed that decision then the company can not go forward.
How Capitalante can help you
Are you confused about how to prepare an effective financial plan to achieve financial freedom? If yes, learn how to prepare effective financial planning.
- Read also: Why People Lose Money in the Stock Market
- Read also: How to buy stocks in India for Beginners
If you have any questions regarding how to invest in the stock market for beginners in India feel free to comment so that we can have a discussion. If you found this post helpful don’t forget to share with your loved ones.