What it means
It helps to separate two things that both get called the equity market. The primary market is where new shares are created and money flows into the company, and the secondary market is where existing shares change hands between investors with no cash reaching the business at all.
ECM is mainly about the primary market. When a company needs capital for expansion, an acquisition or repairing a stretched balance sheet, and does not want to add interest and repayment obligations, selling shares is the alternative to borrowing.
A typical deal runs through bookbuilding. The bank markets the offering to institutional investors, collects indications of how many shares each would take at which prices, builds a demand curve from those orders and then sets a price with the company, usually a little below where the book clears so the shares trade up on debut.
The cost of equity capital shows up as fees. The underwriting spread, typically a few per cent of gross proceeds on a large deal and more on a small one, plus legal, accounting, listing and printing costs, all come out before the company sees the money.
The trade-off against debt is dilution and control. New shares divide future profits among more owners and reduce the founders' percentage, which is why the timing of an equity raise matters so much: issuing when the share price is depressed means giving away far more of the company for the same money.
In practice
Real-world examples.
Example
A software company that has raised four private rounds decides to go public to fund international expansion and to give its early backers a way out. Its ECM advisers recommend a deal that is roughly 70% new shares and 30% existing, so the company gets meaningful new capital while investors get partial liquidity.
Example
A retailer breaches a banking covenant after a poor trading year and needs to cut debt quickly. Rather than an IPO it runs a deeply discounted rights issue, offering existing shareholders three new shares for every five they hold at a price 40% below the market, which raises the money without needing to find new investors.
Example
A mining company wants $80,000,000 to accelerate a development project and completes an accelerated bookbuild overnight, placing new shares with institutions at a 7% discount to the previous close. The whole process takes under twenty-four hours, which is the main attraction for a company already listed and well known to investors.
Formula
Calculation
Gross proceeds = shares offered x offer price
Underwriting fee = gross proceeds x underwriting spread
Net proceeds = gross proceeds - underwriting fee - other transaction costs
Kestrel Analytics lists on a public exchange, offering 10,000,000 shares at $24 each. Of those, 7,000,000 are new shares issued by the company (primary) and 3,000,000 are existing shares sold by early investors (secondary). The underwriting spread is 6% and other costs, covering legal, accounting, listing and marketing work, come to $3,600,000.
Gross proceeds = 10,000,000 x $24 = $240,000,000
Underwriting fee = $240,000,000 x 6% = $14,400,000
Net proceeds across all sellers = $240,000,000 - $14,400,000 - $3,600,000 = $222,000,000
Splitting the gross between the two groups:
Company's share = 7,000,000 x $24 = $168,000,000
Selling shareholders' share = 3,000,000 x $24 = $72,000,000
The company had 33,000,000 shares before the offering and issues 7,000,000 new ones, giving 40,000,000 shares in issue afterwards.
Market capitalisation at the offer price = 40,000,000 x $24 = $960,000,000
Existing holders' combined stake = 33,000,000 / 40,000,000 = 82.5%, so they have been diluted by 17.5%
Free float = 10,000,000 / 40,000,000 = 25% of the company now trades publiclyCase study
Seen in the real world.
The following case is illustrative and the company is fictional. Brightwater Systems, an invented industrial sensor manufacturer, ran a dual-track process in which it prepared for an IPO while simultaneously negotiating a trade sale, a common way to keep pricing pressure on both routes. Its bankers indicated a valuation range of $700,000,000 to $850,000,000 for the listing.
Market conditions weakened during the marketing period and the book was not covered at the top of the range, so the offer was priced at $19 rather than the indicated $23. Selling 8,000,000 shares raised $152,000,000 gross instead of the $184,000,000 the company had planned around, a shortfall of $32,000,000 against a capital expenditure programme already committed.
The board chose to proceed anyway, list at the lower price, and return for a follow-on offering fifteen months later once two large contracts had been announced and the shares traded at $27. The follow-on raised the remaining money with far less dilution than a larger IPO at $19 would have caused, which is the practical argument for treating an equity raise as a sequence of decisions rather than a single event.
Watch out
Common mistakes.
- Assuming all the money raised in an IPO goes to the company, when a secondary component simply transfers cash to existing shareholders who are selling.
- Judging a deal's success by first-day price movement alone, since a large jump often means the company priced too cheaply and left capital on the table.
- Ignoring the total cost of issuance and comparing only the headline underwriting spread, when legal, accounting and listing costs can add several million dollars on a mid-sized deal.
Questions
People also ask.
What is the difference between equity capital markets and debt capital markets?
ECM raises money by selling ownership, which has no repayment obligation but dilutes existing owners, while DCM raises money by selling debt, which must be repaid with interest but leaves ownership intact.
Why would a company issue shares at a discount in a rights issue?
Because the discount encourages existing shareholders to take up their entitlement, and since they are buying proportionally, the discount does not transfer value away from them.
Does a company need to be listed to use the equity capital market?
No, private placements to institutional or strategic investors are also equity capital raising, though listed companies have far more routes available.
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