Equity for promotion of businesses

Small and medium enterprises in India donot scale up due to several factors, lack of Finance, regulatory hurdles, physical constraint of the management.
Equity can play a major role in scaling up thebusiness. Few business entities know the value of their equity. A running profitable business can command very high valuation, which means very low dilution of equity to raise the resources. Scaling up will also help the management to hire better manpower, which will improve the physical capability of entity to handle larger business. Apart from it will ensure the perpetuity to business, if second generation is unwilling to join the business. The original promoters may gradually dilute the holdings in favour of willing to continue or enjoy the dividends, if the company is well managed by professionals, as is the case with ITC, LT, Infosys etc.
Scaling up of small and medium enterprises into large ones will trigger more competition, forcing them to be more efficient.

Equity investments-need of the hour

The questions are being asked that how equity investment in general will help the new entrepreneurs. In our country, there is very low penetration of equity concept with both investors and entrepreneurs. There are large numbers of successful small business entities in India having a turnover of more than INR 50 crores, especially in eastern parts of India, which are fully controlled by the promoters. Even the large corporates and PSUs have very high stake of the promoters leading to low efficiency and accountability to the public shareholders. If one can see the performance of corporates in Stock Markets, the companies having low stake of promoters and MNCs reward much more to public shareholders than the family controlled ones.

If more money flows in stock markets and more people start investing in equities, it will slowly become easy for the larger number of entities from market. This will help many small and medium enterprises to scale up and deepen the market. Already, we are observing that small-caps and mid- caps are performing better than large-caps in long term. There are funds specifically designed for investment in small-caps, mid-caps. Most of the small-caps are picked up by fund managers early and they make big gains, when these scripts become popular with general investors. Though returns are good in these funds, but there is greater volatility due to liquidity issue.

If the existing big corporates will start seeing the threat of them being overtaken, they too will start to dilute their holdings to scale up offering more opportunities to common equity investors.

If there are more investors in the market willing to take risks and investment in small-cap and mid-cap funds rise, the days of funds specifically designed to act as angel investment will see the day.

For this to happen, general public need to understand equity. 

This is applicable for both entrepreneurs and investors.

Equity as philonthropy

In a country, where equity is sold as wealth creation and quick money making tool in general, can we assume equity as philanthropy?  Some of us have heard of Angel Investors. The word “Angel” itself signals the concept of philanthropy.   

Let us see, how it happens? A young student, an employee or your friend can have idea, which can be converted to business provided he has enough capital to start with. The idea may succeed or fail and anybody putting his money is ready to burn his capital. Investors in these start-ups are nothing but Angel to the person having an idea but unable to convert it into business. So, anybody putting money in untested territory is none other than Angel Investor. He may be your employer, your friend or relative. If the idea succeeds, the business can draw more investors by way of equity or debt.

Then, why Equity?

It can be learnt with experience that not all ideas succeed or all fail. If the angel investor puts his money as equity, he has fair chance of making big gain, if business succeeds. Private Equity Investors follow the concept by putting the money for large number of such ventures.

The people having fair knowledge of Joint Stock Company know that the equity capital is a sunk capital, which cannot be withdrawn from business except exceptional cases. Only the persons holding this equity change without any outflow or inflow in business. Thus, the business operators or directors have no obligation to return the principal or the return on this capital. He can pursue his idea freely, which is very important with experiments in developing a new business, process or product. Thus the person putting the business ends up with no further liability to pay, if it fails.

Same is not true with debt. The interest liability starts from day-one. There may be moratorium for payments of principal or interest for a period of time, but the interest accumulates and debt liability increases. In the case of delay in getting the idea click or it fail, the person putting the business ends with liability that he has to become crook or suicide.

The absence of equity culture in India discourages new entrepreneurs. This also helps crooked entrepreneurs to prepare inflated projects to get bank finance. This has resulted in depositors’ money at stake. The experience of banks proof that even lender has to bear the risk of failing businesses.

For investors, the difference in equity and debt is towards risk sharing. If business is not doing well, the lenders do not get interest in time, the employees not getting salary in time. But you do not share the super growth of business, which you gain in equity. 

If more money moves towards equity, there will be less money available for debt and the promoters will be forced to move towards equity than debt. The lower control over the company through lower equity holdings will force the managements to perform and ultimately improve the business efficiency. Detailed shareholding pattern of well-run companies like L&T, ITC, ICICI Bank, HDFC Bank, Infosys will prove that good performance is enough for managements to continue in their seats and they do not need the cushion of high shareholding to retain control.

Thus, Indians should start investing in equities not only for wealth creation, but in national interest. If 125 crore population start keeping Rs. 100  per month apart for equity, the new entrepreneurs will come up in hordes and create jobs in unbelievable numbers.

Let equity investment be treated as philanthropy for nation building. Returns are only collateral. Let us start today.