Learn about Equity vs. Debt Video

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Learn about Equity vs. Debt

Everything we've talked about so far with this startup companies selling socks and all that, has been raising money from an equity. We raised private money, when the company was private. It went to VCs and it went to angel investors. And maybe it go to your friends and family to raise money. And then the company could go public and raise money from the public market. There is actually two ways where the company can raise capital. So this is why this playlist is called capital markets. It’s part of the name, Raise Capital. Capital, the easy way to think about it is that you're raising cash that you want to invest in some way to grow your business or to sustain your business or start your business. So everything we talked about so far was equity. And that’s essentially selling shares in your company to raise money. Right. And so that’s all of VC examples. And the equity investors also, when you sell equity, you're essentially making that person whose buying the stock. An equity is the same thing as a stock. You're making the person who’s buying the stock kind of a partner in the company. Let's say there's two situation, if the company goes bankrupt. And I’ll talk a lot more about what bankruptcy even means. But if the company goes bankrupt, all the share holders end up with nothing. They end up with nil. But if the company has a lot of upsides, the stock gets a lot of upside. Right. Because their partners in it. If this was a company that start up that we talked about, if it turns to Amazon.com and becomes a billion dollar company, everyone is going to do really well. Everyone is going to share in that upside. But there's another way to raise money and, actually this is probably something that’s more familiar to kind of a house hold level. I mean, at the household level, you never raise equity. You never say, you know what? You can, but you're not going to say, hey, I want to buy a house. Why won't I go to my rich friend and offer to sell him 10 percent of the stake in my house to him and he’ll be kind of a partner in my house. That could happen, but for the most part it doesn’t. Usually, when you do something in a personal level, you raise money through debt. And debts interesting. So what's good about debt, so let's think about it from the point of view of the person who’s lending the money to you. Right. Debt is just borrowing money. I think all of us know what borrowing money is. I go to my rich friend and I say, hey, can I borrow a dollar and I’ll give you a dollar 25 in a year? And he says, okay, you know you're good for it. But I'm essentially promising I'm going to give the money back in some future date. If I sell equity, I'm not promising anything. I'm like, hey, I got a great business why don’t you give a dollar and then you get a 20 percent cut of my business. If my business does awesome, you get 20 percent of all of the profits of my business. If my business does horrible, well you took a risk, you got nothing and I got nothing. Debt says, you know what, regardless of how business does. If it does awesome, all you're going to get is the interest. So all you get is interest. That’s kind of the upsides. So the upside is limited. If I borrowed money at 90 percent interest, all that person’s going to get is 9 percent. Even if my company becomes the next Google or Microsoft or whatever else. That person just going to get 9 percent on their money. Well this person might have gotten 100 times their money because they made a bet. On the other hand, the downside is much lower. So limited downside. Because they’re going to get their money back, there's a certain payment schedule. And they're going to get their money back before the stock holder. Let's say the situation with the company’s going to difficulty. And we’ll do a whole playlist on bankruptcy. The people who lend money to the company will see their money before the stockholder see anything. So how does that all of these come out from the balance sheet? So let's say we have a public company. And this is really, if you're wondering what a CFO of a company does, this is really the main decision that they're always making. Do we raise or how do we raise money if we need it? And do we raise money from the equity markets or from the debt markets? So let's come up with a company again. Let’s say that that’s its current assets. Not current, I don’t want to say current assets. It’s the assets that it currently has. Because current assets means something different and we’ll talk about that in the future. So let's say, so that’s its assets. It might have some cash here. Some cash and we’ll go in a more detail. We’ll actually look at real company balance sheets and decide for what all of the terms of the balance sheet mean. But that’s its assets for now. And let's say right now it’s, all of its money is raise so far has had been equity. And let's say it’s a public enlisted company and it doesn’t have to be. That’s all of its equity, and let's say it has, I don’t know, 10 million shares. And the other interesting thing about when a company is public, remember every time, when a company was private and it took in equity investors. They have to sit and have a negotiations saying what is this worth? What is this asset worth? But what's cool is, is when you have a publicly traded company, these shares are traded on exchange. Right. These shares are on the New York stock exchange. So every day, you can go to Yahoo Finance or whatever. And you can look at the chart. Let me draw a chart. You could draw a chart. So we've all seen stock charts, I think. So let's say that this is, this could have been IPO date or just be the start were looking at. Let's say the stock and the IPO went up and then the whole market went down a little bit. Maybe its there, right. But really, almost any given second, there's a price that somebody traded that stock at. And it might not be the best price, but it is a price. And we’ll talk about why that happens. Because you might have 10 million shares and if only 100 shares get traded at any second or let's say only 100 shares get traded in the day, is that an indicative of price? Because that’s not a huge percentage of all of the shares. But anyway, we’ll talk more about what volume means relative to the total flow and all of that. But let's say at this split second, the company shares traded at $15 a share. This is $15 at this second in time. This is like right now. Traded at $15 a share. And you can look it up on Bloomberg terminal or whatever else. So essentially the market is providing us a value for this company. The market is saying, wow, the market is willing to trade this share for $15. There was a willing buyer and a willing seller exactly at $15 a share. So that means that the market at that moment is valuing this company at $15 per share times 10 million shares. So the market is assigning a, 15 times 10, is $150 million market cap. Market capitalization for the company. And you can look on the kind of, I think it’s the key statistic tab on Yahoo Finance, you’ll see market capitalization for company. And it’s just the number of shares times the price of the shares. And this is essentially what that markets value of the equity. So market is saying that this piece right here is worth $150 million. And since this piece is the size as the assets, we have nothing else on the right hand side, the market essentially is saying that the asset right now are worth $150 million. And these aren't always going to be equal. We’ll see probably in a few videos, when you start raising debt, you have to do a little bit and extra calculation to figure out what the asset value. I'm going to throw you a new term here, the enterprise value of the firm is. And the enterprise value is essentially the asset value minus kind of excess cash. Cash the company really doesn’t need to operate. And we’ll go in a more detail on that. Let’s just view it as the asset for now. So if I'm the CFO of this company, and let's say we need to raise another $15 million. I have two options. Right. I could say, okay, the company is trading at $15 per share, I need to raise $15 million, so I could issue another million shares. It wouldn’t be an initial public offering, because I'm already public. It would be a follow on offering. Or sometimes it’s called a secondary offering. Although the word secondary has kind of two connotations. But it would be a follow on offering. Where I would issue, I would go to the board. We would essentially create another million shares and then sell them into the markets and hopefully people would buy it at $15 a share or probably a little bit less. Because we’re kind of flooding the market with a ton of shares. Maybe they would buy it at $14 per share and we would raise $14 million. And that would be a follow on offering. We could always use the public market as a way to raise more money. And we didn’t have to go to all of these, I mean for the most part, we didn’t have to do huge evaluation exercise and negotiation and do all of this. Hire banks, although the banks will still collect fees, we actually have to hire banks to do this. But anyway. So that’s one option. The other option is, you know, were an established company. Were generating cash. We could make interest payments if we want to. We could go to a bank, and actually there's a lots of different ways to do this. But we can essentially borrow money. And let's just say we do that. Instead of doing this. Let’s say we do both. So let's say we did a million dollar follow on offering, that gave us $14 million. Let's say we want another $2 million, but this time, instead of selling shares. So right now how many shares do we have? Sold a million, we had 10 million, we have 11 million shares. Let's say, you know what, let's say our CFO feels our shares are going to move up a lot more. So we don’t like selling them at this low price, instead. Now let's say interest rates are really low, instead were going to borrow money. That’s essentially raising debt. So let's say we borrow another $3 million because we need it. So actually this would be debt. And we would get $3 million of cash. And so now our assets are all of this stuff on the left hand side. And what are our liabilities now? Now we didn’t have liabilities before, because everything we have were equities. But now we do, now we owe somebody $3 million. Right here. And I’ll talk more about all the different ways to kind of borrow money. But essentially, it could just be a bank loan. It might just gone to Bank of America, say, hey were big company and were good for the money. Why don’t you lend us $3 million? Maybe it would be $3 million at low interest rate at maybe 6 percent per year. And Bank of America feels good because you have a high, we’ll talk more about credit ratings and all of that. But they say, you know, you have essentially good company credits for. So we’ll give it to you low interest rate. And so, what happens in the future is these assets are going to generate, hopefully some cash. And before these equity holders see anything, these guys have to get paid their interest. I’ll show you all of that in a line by line basis in an income statement. Everything we've done so far has been a balance sheet. But something interesting is happening now. Now all of a sudden your assets, which is that side, I know I keep writing over the same drawing. Your assets are now larger than your equity. Right. And I think now, this is just kind of a review of the balance sheet video. You see that the assets are equal to your equity, which is this right here, plus your liabilities. Your liabilities now are $3 million. So if you wanted to know what your assets are worth. Your assets are equal to your equity. So what's your market value of your equity? The market value of your equity. Well, we figure that out already. We have 11 million shares now and let's say, I don’t know, let's say the stock plummets to $10 in a share. For some strange reason or not strange reason. So what's the market cap? $10 per share, 11 million shares. We have 110 million market cap. Were doing a market value. And we’ll talk more about the different market and book value. But this is a market value of your equity. And then, what is your liabilities? Well, we owe $3 million. Right. So plus 3 million. So we could say that the for the most part, the market value of our assets, the market things that these entire left hand side is going to be worth the value of our equity, The market cap of the company. Plus the amount of debt, which is equal to $113 million. So the value of these assets are $113 million and debt for the most part is the enterprise value of the company. What is the company’s assets worth? And there's a little bit of a tweak we’ll do in the future on enterprise value. But that’s essentially how you kind of value what the company is worth. A lot of people, when do a market capitalization calculation. They say, oh that’s the company’s worth. Well, no, that’s what the equity is worth. Market capital is what the equity is worth. If you want to know what the company is worth, you have to take the market cap and then add the debt. Right. I won't go too complicated because I just realize I'm running out of time again. See in the next video.

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Everything we've talked about so far with this startup companies selling socks and all that, has been raising money from an equity. We raised private money, when the company was private. It went to VCs and it went to angel investors. And maybe it go to your friends and family to raise money. And then the company could go public and raise money from the public market. There is actually two ways where the company can raise capital. So this is why this playlist is called capital markets. It’s part of the name, Raise Capital.
Capital, the easy way to think about it is that you're raising cash that you want to invest in some way to grow your business or to sustain your business or start your business. So everything we talked about so far was equity. And that’s essentially selling shares in your company to raise money. Right. And so that’s all of VC examples. And the equity investors also, when you sell equity, you're essentially making that person whose buying the stock. An equity is the same thing as a stock. You're making the person who’s buying the stock kind of a partner in the company. Let's say there's two situation, if the company goes bankrupt. And I’ll talk a lot more about what bankruptcy even means. But if the company goes bankrupt, all the share holders end up with nothing. They end up with nil. But if the company has a lot of upsides, the stock gets a lot of upside. Right. Because their partners in it. If this was a company that start up that we talked about, if it turns to Amazon.com and becomes a billion dollar company, everyone is going to do really well. Everyone is going to share in that upside.
But there's another way to raise money and, actually this is probably something that’s more familiar to kind of a house hold level. I mean, at the household level, you never raise equity. You never say, you know what? You can, but you're not going to say, hey, I want to buy a house. Why won't I go to my rich friend and offer to sell him 10 percent of the stake in my house to him and he’ll be kind of a partner in my house. That could happen, but for the most part it doesn’t.
Usually, when you do something in a personal level, you raise money through debt. And debts interesting. So what's good about debt, so let's think about it from the point of view of the person who’s lending the money to you. Right. Debt is just borrowing money. I think all of us know what borrowing money is. I go to my rich friend and I say, hey, can I borrow a dollar and I’ll give you a dollar 25 in a year? And he says, okay, you know you're good for it. But I'm essentially promising I'm going to give the money back in some future date.
If I sell equity, I'm not promising anything. I'm like, hey, I got a great business why don’t you give a dollar and then you get a 20 percent cut of my business. If my business does awesome, you get 20 percent of all of the profits of my business. If my business does horrible, well you took a risk, you got nothing and I got nothing. Debt says, you know what, regardless of how business does. If it does awesome, all you're going to get is the interest. So all you get is interest. That’s kind of the upsides. So the upside is limited. If I borrowed money at 90 percent interest, all that person’s going to get is 9 percent. Even if my company becomes the next Google or Microsoft or whatever else. That person just going to get 9 percent on their money. Well this person might have gotten 100 times their money because they made a bet. On the other hand, the downside is much lower. So limited downside. Because they’re going to get their money back, there's a certain payment schedule. And they're going to get their money back before the stock holder.
Let's say the situation with the company’s going to difficulty. And we’ll do a whole playlist on bankruptcy. The people who lend money to the company will see their money before the stockholder see anything.
So how does that all of these come out from the balance sheet? So let's say we have a public company. And this is really, if you're wondering what a CFO of a company does, this is really the main decision that they're always making. Do we raise or how do we raise money if we need it? And do we raise money from the equity markets or from the debt markets?
So let's come up with a company again. Let’s say that that’s its current assets. Not current, I don’t want to say current assets. It’s the assets that it currently has. Because current assets means something different and we’ll talk about that in the future.
So let's say, so that’s its assets. It might have some cash here. Some cash and we’ll go in a more detail. We’ll actually look at real company balance sheets and decide for what all of the terms of the balance sheet mean. But that’s its assets for now. And let's say right now it’s, all of its money is raise so far has had been equity. And let's say it’s a public enlisted company and it doesn’t have to be. That’s all of its equity, and let's say it has, I don’t know, 10 million shares. And the other interesting thing about when a company is public, remember every time, when a company was private and it took in equity investors. They have to sit and have a negotiations saying what is this worth? What is this asset worth? But what's cool is, is when you have a publicly traded company, these shares are traded on exchange. Right. These shares are on the New York stock exchange.
So every day, you can go to Yahoo Finance or whatever. And you can look at the chart. Let me draw a chart. You could draw a chart. So we've all seen stock charts, I think. So let's say that this is, this could have been IPO date or just be the start were looking at. Let's say the stock and the IPO went up and then the whole market went down a little bit. Maybe its there, right.
But really, almost any given second, there's a price that somebody traded that stock at. And it might not be the best price, but it is a price. And we’ll talk about why that happens. Because you might have 10 million shares and if only 100 shares get traded at any second or let's say only 100 shares get traded in the day, is that an indicative of price? Because that’s not a huge percentage of all of the shares. But anyway, we’ll talk more about what volume means relative to the total flow and all of that.
But let's say at this split second, the company shares traded at $15 a share. This is $15 at this second in time. This is like right now. Traded at $15 a share. And you can look it up on Bloomberg terminal or whatever else.
So essentially the market is providing us a value for this company. The market is saying, wow, the market is willing to trade this share for $15. There was a willing buyer and a willing seller exactly at $15 a share. So that means that the market at that moment is valuing this company at $15 per share times 10 million shares. So the market is assigning a, 15 times 10, is $150 million market cap. Market capitalization for the company.
And you can look on the kind of, I think it’s the key statistic tab on Yahoo Finance, you’ll see market capitalization for company. And it’s just the number of shares times the price of the shares. And this is essentially what that markets value of the equity. So market is saying that this piece right here is worth $150 million. And since this piece is the size as the assets, we have nothing else on the right hand side, the market essentially is saying that the asset right now are worth $150 million.
And these aren't always going to be equal. We’ll see probably in a few videos, when you start raising debt, you have to do a little bit and extra calculation to figure out what the asset value. I'm going to throw you a new term here, the enterprise value of the firm is. And the enterprise value is essentially the asset value minus kind of excess cash. Cash the company really doesn’t need to operate. And we’ll go in a more detail on that. Let’s just view it as the asset for now.
So if I'm the CFO of this company, and let's say we need to raise another $15 million. I have two options. Right. I could say, okay, the company is trading at $15 per share, I need to raise $15 million, so I could issue another million shares. It wouldn’t be an initial public offering, because I'm already public. It would be a follow on offering. Or sometimes it’s called a secondary offering. Although the word secondary has kind of two connotations. But it would be a follow on offering. Where I would issue, I would go to the board. We would essentially create another million shares and then sell them into the markets and hopefully people would buy it at $15 a share or probably a little bit less. Because we’re kind of flooding the market with a ton of shares. Maybe they would buy it at $14 per share and we would raise $14 million. And that would be a follow on offering. We could always use the public market as a way to raise more money. And we didn’t have to go to all of these, I mean for the most part, we didn’t have to do huge evaluation exercise and negotiation and do all of this. Hire banks, although the banks will still collect fees, we actually have to hire banks to do this.
But anyway. So that’s one option. The other option is, you know, were an established company. Were generating cash. We could make interest payments if we want to. We could go to a bank, and actually there's a lots of different ways to do this. But we can essentially borrow money.
And let's just say we do that. Instead of doing this. Let’s say we do both. So let's say we did a million dollar follow on offering, that gave us $14 million. Let's say we want another $2 million, but this time, instead of selling shares. So right now how many shares do we have? Sold a million, we had 10 million, we have 11 million shares. Let's say, you know what, let's say our CFO feels our shares are going to move up a lot more. So we don’t like selling them at this low price, instead. Now let's say interest rates are really low, instead were going to borrow money. That’s essentially raising debt. So let's say we borrow another $3 million because we need it. So actually this would be debt. And we would get $3 million of cash.
And so now our assets are all of this stuff on the left hand side. And what are our liabilities now? Now we didn’t have liabilities before, because everything we have were equities. But now we do, now we owe somebody $3 million. Right here. And I’ll talk more about all the different ways to kind of borrow money. But essentially, it could just be a bank loan. It might just gone to Bank of America, say, hey were big company and were good for the money. Why don’t you lend us $3 million? Maybe it would be $3 million at low interest rate at maybe 6 percent per year. And Bank of America feels good because you have a high, we’ll talk more about credit ratings and all of that. But they say, you know, you have essentially good company credits for. So we’ll give it to you low interest rate.
And so, what happens in the future is these assets are going to generate, hopefully some cash. And before these equity holders see anything, these guys have to get paid their interest. I’ll show you all of that in a line by line basis in an income statement. Everything we've done so far has been a balance sheet.
But something interesting is happening now. Now all of a sudden your assets, which is that side, I know I keep writing over the same drawing. Your assets are now larger than your equity. Right. And I think now, this is just kind of a review of the balance sheet video. You see that the assets are equal to your equity, which is this right here, plus your liabilities. Your liabilities now are $3 million. So if you wanted to know what your assets are worth. Your assets are equal to your equity. So what's your market value of your equity? The market value of your equity. Well, we figure that out already. We have 11 million shares now and let's say, I don’t know, let's say the stock plummets to $10 in a share. For some strange reason or not strange reason. So what's the market cap? $10 per share, 11 million shares. We have 110 million market cap. Were doing a market value. And we’ll talk more about the different market and book value. But this is a market value of your equity. And then, what is your liabilities? Well, we owe $3 million. Right. So plus 3 million.
So we could say that the for the most part, the market value of our assets, the market things that these entire left hand side is going to be worth the value of our equity, The market cap of the company. Plus the amount of debt, which is equal to $113 million.
So the value of these assets are $113 million and debt for the most part is the enterprise value of the company. What is the company’s assets worth? And there's a little bit of a tweak we’ll do in the future on enterprise value. But that’s essentially how you kind of value what the company is worth. A lot of people, when do a market capitalization calculation. They say, oh that’s the company’s worth. Well, no, that’s what the equity is worth. Market capital is what the equity is worth. If you want to know what the company is worth, you have to take the market cap and then add the debt. Right. I won't go too complicated because I just realize I'm running out of time again.
See in the next video.

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