Stock Markets for Cashing Out
Stock Markets for Cashing Out
Stock markets no longer serve the MAIN purpose they were created for. Investors and entrepreneurs need to deal with this new reality.
The purpose of stock markets was to provide capital to entrepreneurs with limited capital but fundamentally sound business ideas. However, in recent times, we have not seen an IPO where companies are seeking capital for expansion or driving new business. Today, entrepreneurs go to Venture capitalists for capital, whereas the risk-taking investors who want to invest in new business ventures (searching for better returns) turn to SPACs. There are many reasons.
The Albatross of Compliance
The cost of legal compliance and dealing with the legal fallout of failures are drastically high. For new ventures, they cannot deal with it. The high costs are the result of peculiar behaviour amongst the regulators.
The regulators are trying to accommodate in the equity markets a class of investors who are risk averse. These investors would have traditionally invested in very safe bonds and other debt investments. However, they cannot get the expected returns from bond and debt instruments because of this unique policy of low interest rates that keeps the cost of debt low.
Very, VERY low cost of debt
Since the Greenspan era of the 1990s and, more specifically, after the 2008 financial crisis, the cost of debt for good borrowers has declined. Today, it is quite easy to access debt capital at about a 7% interest rate or lower for BBB-rated (good) borrowers. For risky borrowers (CCC-rated High Yield), the interest rates are 7% or lower.
Getting a loan or debt has never been easy. There is a lot of it around (too much, if you ask me). It is raining money! Or rather, banks are raining money. But, the money only rains on the rich.
When easy loans are accessible to the rich, we get institutional early investors that finance new ventures.
To get access to early investments, the promoter/entrepreneur has to give away some of his/her shares to the early investors. We have created an ecosystem that takes new ventures from the seed stage to the first round, second round and finally to IPO. At each stage, you see a bit of dilution in entreneurs’ skin in the game.
The IPO is the exit for these institutional early investors. An IPO brings in traditional risk-takers i.e. the equity market investors. This group is now dominated by hedge funds and pension funds. They seek lower returns than the early investors but with lower risk than early-stage enterprises. The returns are still higher than the returns on debt investments.
In Sum
If you are a new entrepreneur and need to access capital, it is best to do so from early-stage investors. The negotiating power of early-stage investors is higher, and therefore, the entrepreneur may end up parting with more ownership than comfortable. However, markets have a means of correcting themselves.
There is a lot of competition among early-stage investors. You need to know how to get the best deal for your venture.
Further, many early-stage investors provide valuable hand-holding, allowing the entrepreneur to focus on his/her venture. Going with such ventures reduces risks and opens more opportunities and value in the business.
So remember, the stock market is for cashing out - it is an exit strategy. We need to accept it and build it into our plans.
Notes
There are, broadly, two types of capital - equity and debt. Equity is fractional ownership, and the cost of equity is very high because the risk associated with ownership is high. Debt is lending against collateral assets or lending to “reputed borrowers” i.e. those who always pay on time.
Most entrepreneurs do not need outside capital. I say this responsibly: most ventures can be self-financed to the stage of proof-of-concept/prototype/wireframing, etc. So, most new businesses do not need outside seed capital or even stage I investments.
Quite a few entrepreneurs can get access to more stable capital within their families. The low-cost and easily available debt allows families to fund high-risk ventures for diversification.