Stock exchange for beginners

The lowdown on equity financing through the stock market

Entrepreneurs, small and medium enterprises (SMEs) and large companies can either raise funds through debt or equity, the latter consisting of the entrepreneur foregoing some ownership of the company and the investor assuming the risk of the business going bankrupt. Unlike a loan, the entrepreneur doesn’t repay the investor with interest. More secure and more heavily regulated, equity financing encourages a savings culture and a more diversified, and therefore less risky, portfolio. It includes funds from personal savings, friends and families, corporate partners, angel investors as well as from venture capitals. Moreover, entrepreneurs view their company as successful if it is able to obtain equity financing by listing on a stock exchange.

A centralized system

A stock exchange, often identified as an extension of equity crowdfunding, acts as a centralized system boosting communication between all stakeholders interested in equity financing. Through this platform, information on bids, prices and transactions becomes public knowledge. Unlike an over-the-counter market (OTC), the same prices are available to everyone. It is typical for an apprentice to wonder who sets the stock prices. The answer is the market. The reason behind stock prices’ fluctuation is just a simple matter of economics involving supply and demand. Thus, a certain share is sold at the maximum price any investor is willing to pay for and at the minimum price any shareholder is willing to sell for. Moreover, the value of a company, which is its market capitalization, is merely the stock price multiplied by its outstanding shares. This means that a company’s value shrinks as the demand for its shares decreases. Possible means for predicting a stock’s price consist of either using past and present stock values or looking at companies’ earnings. However, although many theories exist, it is a mystery how investors change attitude towards a certain stock.

Reducing risk

Stock exchanges are beneficial to all stakeholders in the economy. Despite some downsides faced by public companies such as market fluctuations, transparency needs, demands on the management team, costs incurred, responsibilities to shareholders, investor relations as well as market pressure on short-term accomplishments, it is the most effective strategy for those interested in raising large amounts of money, but also in gaining visibility and credibility, in improving their corporate profile, in enhancing corporate discipline, in encouraging employee motivation and in facilitating access to bank loans. Moreover, the risk involved in capital markets can be reduced by recognizing investments as long-term, thereby avoiding the risk of market volatility. In countries where stock exchanges exist, investors and venture capitalists, are more willing to invest in startups and SMEs. Since exiting businesses is their way of getting returns on investment and enhancing their professional profile, investors look for exit strategies from the moment they chose to invest. In theory, their exit options are either to sell back their shares to the entrepreneur, to sell the startup to a bigger company through an acquisition process, or to let the company grow enough in order to go public. A roadblock at one exit will hamper investors’ returns, thus preventing economic growth.

It is understandable how a stock exchange is vital for a free-market economy. However, for it to be successful, the “laissez-faire” approach should be avoided. Instead, it is essential that rules and regulations are in place. Moreover, capital markets are only beneficial to economic growth if their development does not come at the expense of the banking system. As such, the trick to a successful exchange is in the hands of the legislators and regulators.