Equity Capital Market (ECM)

The equity capital market (ECM) is where financial institutions help companies raise equity capital and where stocks are traded. It consists of the primary market for private placements, initial public offerings (IPOs) and warrants; and the secondary market, where existing shares are sold, and futures, options and swaps are traded.

The equity capital market (ECM) is broader than the stock market because it covers a wider range of financial instruments and activities. These include the marketing and distribution and allocation of issues, IPOs, private placements, derivatives trading, and book building. The main participants in the ECM are investment banks, broker-dealers, retail investors, venture capitalists, private equity firms, angel investors and securities firms.

Together with the bond market, the ECM channels money provided by savers and depository institutions to investors. As part of the capital markets, the ECM, leads, in theory, to the efficient allocation of resources within a market economy.

The primary equity market, where companies issue new securities, is divided into a private placement market, and a primary public market. In the private placement market, companies raise private equity through unquoted shares that are sold to investors directly. In the primary public market, private companies can go public through IPOs, and listed companies can issue new equity through seasoned issues.

The secondary market, where no new capital is created, is what most people typically think of as the "stock market”. It is where existing shares are bought and sold, and consists of stock exchanges and over-the-counter (OTC) markets, where a network of dealers trade stocks without an exchange acting as an intermediary.

Raising capital through equity markets offers several advantages for companies.

The first one is a lower debt to equity ratio. Companies will not need to access debt markets with expensive interest rates to finance future growth. Equity markets are also relatively more flexible and have a greater variety of financing options for growth as compared to debt markets. In some instances, especially in private placement, equity markets also help entrepreneurs and company founders bring in experience and oversight from senior colleagues. This will help companies expand their business to new markets and products or provide needed counsel.

But there are also problems with raising capital in equity markets. For example, the route to a public offering can be an expensive and time-consuming one. Numerous actors are involved in the process, resulting in a multiplication of costs and time required to bring a company to market.

Added to this is the constant scrutiny. While equity market investors are more tolerant of risk as compared to their debt market counterparts, they are also focused on returns. As such, investors impatient with a company that has consistently produced negative returns may abandon it, leading to a sharp drop in its valuation.