MIS ep. 2 || Why companies need investors?

Hello everyone. In the last blog, we discussed the purpose of this blog series and how it can help you understand the Equity investment better. If you have not read that blog, I will highly recommend you to read it before reading this blog as it will help you to know what's there for you in the series. You will find that blog here: A millennial friendly guide to Equity Investments.

In this blog we are going to learn about:

1. How a new business starts.
2. Who are promoters in a business.
3. The concept of face value.
4. What are shares of a company.
   
5. Why companies need to raise capital (or money).
6. Different ways for a company to raise capital and expand its business.
   

How a business starts:

Let's understand the share market through the story of a boy named Raghu who lives in a small town and has opened a new lemonade stall. For this business he has invested 2,00,000 rupees. He names his business 'Lemonadewala'. Since Raghu has started this business, he is called the promoter of this business. A promoter, in simple terms, is someone who initially invests money to start the business.

Image by ErikaWittlieb from Pixabay 

What is Face value?

Raghu has invested 2,00,000 rupees to start the business and with a view to expand his business in future he decides that he will create 1,00,000 parts of ownership (or shares) of the business, each costing 2 rupees. To put it in more simple terms, share is nothing but some percent of ownership in the company. This percent depends on the number of shares that the company has. For example in the case of Lemonadewale, it has 1,00,000 shares. Therefore a person who owns 1 share, owns 1/100000 or 0.00001% of the business. 

Initially, the value of one share of this company is 2 rupees and this is called the Face Value of the company. So the face value of Lemonadewala is 2 rupees. Face value is decided by the promoter and it does not change unless there is a split in the price which we will cover in a future blog. All of these one Lakh shares or parts of the company ownership is currently owned by Raghu, the promoter. Now the question comes, how can Raghu use these shares for expanding the business. We will answer this next.

Steps of business expansion:

The next step for Raghu to expand his business is to open another 'Lemonadewala' branch and add the private tag to his company to become 'Lemonadewala pvt. Ltd'. He also invests another 2,00,000 rupees for this in the form of _____ reserve. This reserve is kept separately and can be used in future for expanding the the business even further. Let's keep these reserves aside for now and focus on expanding the business.

Now in order to expand his business, Raghu looks for an Angle Investor who can invest money in Raghu's business. An Angel Investor is someone with a very high net-worth, who backs the business financially by buying some of its shares. Now is the Angel Investor will be able to buy the share at 2 Rupees per share? The answer is no. Since Raghu has taken so much of efforts in growing the business uptil now he will sell the shares at a higher price to the Angel Investor. Let's say he sets the price of one share to 100 rupees.