Equity Investment: What's Required And Why?

Equity investment is a fundraising activity started by a company. Instead of taking out a business loan, a company collects money from the general public, who can then buy a partial share of the company as an equity investment. Equity is defined as a stock, share, or any other security representing a person’s ownership interest in a company. When one owns a company’s share, they are a part owner of the said company. The two popular options for investing in equities are “equity shares” and “equity mutual funds”. Equity shares represent a portion of a company’s value that investors or shareholders own. Equity mutual funds, on the other hand, are investment instruments that pool money from several investors and then invest in a company’s bonds, stocks, securities, etc.

Equity investment as a fundraising activity

Equity investment is a fundraising activity where money is raised by selling shares of ownership in a company on the stock market. This type of investment is often sought out by investors as it provides an opportunity to share in the profits and growth of a company.

Equity investment can be done through equity funds, which are managed by fund managers who aim to generate returns for investors by investing in a diverse portfolio of stocks. Equity funds are also known as stock funds due to their focus on stocks. They offer benefits such as diversification, professional management, and the potential for superior returns. However, they also come with the risks associated with stock market volatility and losses.

There are two main types of equity funds: actively managed funds and passive funds. Actively managed funds have portfolio managers who actively research, analyse, and select stocks to outperform a benchmark index. On the other hand, passive funds, such as index funds, aim to replicate the performance of a specific market index.

Equity investment can also be done by purchasing shares of stock in a company directly on the stock market. This can be done through a demat account with a broker firm or with the guidance of a financial advisor.

The main benefit of equity investment is the potential to increase the value of the principal amount invested through capital gains and dividends. Additionally, equity investment can strengthen a portfolio's asset allocation by adding diversification. However, there are risks associated with equity investment, including market risk, credit risk, foreign currency risk, liquidity risk, and political risk.

Overall, equity investment as a fundraising activity provides companies with the capital needed to start up or expand their operations, and it offers investors the opportunity to own a part of a company and share in its profits and growth.

Benefits of equity investment

Equity investment involves purchasing shares or ownership stakes in a company, making the investor a partial owner and shareholder. There are several benefits to equity investment, including:

Potential for Capital Appreciation

The primary advantage of equity investment is the potential for capital appreciation. As companies grow and become more profitable, the value of their shares can increase. This appreciation can lead to significant wealth accumulation over time.

Dividend Income

Many established companies distribute profits as dividends to shareholders. By investing in dividend-paying stocks, investors can receive regular income streams, which can be particularly beneficial for those seeking regular cash flow.

Ownership and Voting Rights

Equity investors become partial owners of the company, entitling them to certain rights and privileges. This includes voting on key company decisions, such as electing board members or approving mergers and acquisitions. Having a say in company affairs allows investors to participate in shaping the company's future and governance.

Diversification

Equity investments offer the opportunity to diversify an investment portfolio. By investing in stocks across different sectors, industries, and regions, investors can spread out risk and reduce exposure to any single company or sector. Diversification can help mitigate the impact of market fluctuations and potentially enhance overall portfolio performance.

Inflation Hedge

Equities can act as an effective hedge against inflation. As the prices of goods and services rise, the interest earned on savings deposits may not keep up. By investing in equities, individuals can protect the purchasing power of their wealth and stay ahead of inflation.

Access to Networks and Expertise

Equity investors not only provide financial capital but also offer knowledge, expertise, and valuable networks. Angel investors, for example, can provide advice and mentorship to early-stage businesses, while nominated advisors can guide more mature businesses through the IPO process.

Equity shares

• Share Capital: When a company limited by shares is established, it distributes ordinary shares to its owners or shareholders. Shareholders pay for the share capital of each share at a nominal or face-value amount.
• Share Premium: The difference between the amount paid for the shares and their nominal value.
• Retained Earnings: Accumulated earnings and losses in different periods or quarters, including historically distributed dividends.
• Diversification: Equity allows investors to diversify their portfolios according to asset classes such as stocks, bonds, and real estate.
• Liquidity: Liquidity refers to how instantaneously stocks can be bought and sold without impacting the actual stock price.
• Tax benefits: Investors are often exempt from paying long-term capital gains (up to a certain amount) from selling their equity shares.
• Returns on equity: Equity investors benefit from focusing on investment for at least five to ten years to yield higher returns.
• Dividend income: Equity investors receive dividends from the company's net profits.
• Bonus shares: Companies issue bonus shares to gather more equity funding while rewarding existing shareholders with free additional shares.
• Ownership of equity shares: Companies distribute shares to their owners or shareholders against their purchase of shares.
• Equity loans: Equity investors can keep the shares they hold in their demat account as collateral to obtain various loans.
• Risk management: Equity investments in stocks or mutual funds allow investors to control the risks associated with an investment.

Equity mutual funds

Some common types of equity mutual funds include domestic equity funds, international equity funds, sector equity funds, and environmental, social, and governance (ESG) funds. Domestic equity funds invest in stocks of companies based in the investor's home country, while international equity funds focus on companies outside of the investor's home country. Sector equity funds invest in companies pursuing similar types of businesses or offering similar products and services. ESG funds, on the other hand, incorporate specific criteria into their investment strategies, allowing investors to align their investments with their values.

Risks associated with equity investment

Equity investments are a risky business, and there are several types of risk to be aware of. Firstly, market risk: the possibility that economic downturns, geopolitical events, or changes in investor sentiment can cause share prices to decline. During turbulent times, equity fund prices can fluctuate significantly, and investors may experience short-term losses.

There is also liquidity risk, where a company is unable to meet its short-term debt obligations. This can make it difficult for investors to redeem their investments without incurring losses.

Credit risk is another factor, where a company is unable to pay its debts. This can lead to bankruptcy and investors may not get their money back.

Foreign currency risk is also a concern, as shifts in international currency values can affect a company's performance and, subsequently, the value of investor equity.

Political risk can affect equity investments, too, with a company's returns potentially suffering due to political changes or instability in a country.

Economic concentration risk is another type of risk, where a company is too heavily concentrated in a single entity, sector, or country. If the value of that concentration factor drops, the company will suffer disproportionately.

Inflation risk is also a possibility, where a company's value drops due to rising inflation, diluting its worth.

It is important to note that these risks are inherent in equity investments, and while they can be mitigated through careful research and diversification, they cannot be completely avoided.

Frequently asked questions