Equity vs Debt Video Lecture | Stocks, Bonds, Equity and Valuation : Complete Knowledge - Entrepreneurship

Everything we've talked about
so far with this startup
company selling socks and all
of 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 you
could go to your friends and
family to raise money.
And then the company could go
public and raise money from
the public markets.
But there's actually
two ways that a
company can raise capital.
So this is why this playlist is
called capital markets, or
it's part of it, the name
of raise capital.
Capital is just essentially--
I mean the easy way to think
about it is 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.
And so that's all of
those VC examples.
The equity investor-- so when
you sell equity, you're
essentially selling-- you're
kind of making that person
who's buying the stock-- you
know, an equity is the same
thing as stock-- you're making
the person who's buying a
stock kind of a partner
in the company.
So if the company-- let's say
there's two situations-- 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 shareholders
end up with nothing.
They end up with nil.
But if the company has a lot
of upside, the stock gets a
lot of upside.
Because they're partners
in it.
If this was a company, that
start-up that we talked about,
if it turns into Amazon.com and
becomes a billion-dollar
company, everyone is going
to do really well.
Everyone's going to share
in that upside.
But there's another way to raise
money, and actually this
is probably something that's
more familiar at
the household level.
I mean at the household level
you never raise equity.
You never say, you know what--
well you can, but you're not
going to say hey, I need to buy
a house, why don't I go to
my rich friend and offer to sell
10% 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 on
a personal level you raise
money through debt.
And that's interesting.
So what's good about debt is
it's-- so let's think about it
from the point of view of
the person who's lending
the money to you.
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, could I borrow $1 and
I'll give you $1.25 in a year?
And he says, OK, you're
good for it.
But I'm essentially promising
I'm going to give the money
back at 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
$1 and then you get a 20%
cut of my business.
If my business does awesome,
you get 20% of all of the
profits of my business.
If my business does horrible,
well you took a risk, you get
nothing and I get nothing.
Debt says regardless of how my
business does, if it does
awesome all you're going
to get is the interest.
That's kind of the upside.
So the upside's limited,
right?
If I borrow money at 9%
interest, all that person's
going to get is 9%.
Even if my company becomes the
next Google or Microsoft or
whatever else, that person's
just going to
get 9% on their money.
While this person might have
gotten a hundred times their
money because they made a bet.
On the other hand, this downside
is much lower.
So limited downside.
Because they're going to get
their money back at a
certain-- you know, there's a
certain payment schedule.
And they're going to get their
money back before the
stockholders-- so let's say
in a situation where the
company's going into
difficulty-- and we'll do a
whole playlist on bankruptcy--
the people who lend money to
the company will see their money
before the stockholders
see anything.
So how does all of this come
out from the balance sheet?
So let's say we have
a public company.
If you wonder what a CFO at a
company does, this is really
the main decision that they're
always making.
Do we raise money-- well, 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.
Current assets means something
different, and we'll talk
about that in the future.
But let's say, so that's
its assets.
You know it might have
some cash here.
We'll go into more detail.
We'll actually look at real
company balance sheets and
decipher what all of the terms
on the balance sheet mean.
But that's its assets for now.
And let's say right now all of
its money it's raised so far
has been equity.
And let's say it's a publicly
listed company.
It doesn't have to be.
Let's say 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's
public-- remember, every time
when a company was private and
it took an investor, when it
took equity investors, they
had to sit and have a
negotiation saying what is
this worth?
What are these assets worth?
But what's cool is, is when
you have a publicly traded
company, these shares are traded
on an exchange, right?
These shares are on, let's
say it's on the
New York Stock Exchange.
So every day you could
go to Yahoo!
Finance or wherever and you
can look at a chart.
Let me draw a chart.
You can draw a chart.
And we've all seen stock
charts, I think.
So let's say that this is this
could have been its IPO date
or it could just be the start
that we're looking at, and
let's say the stock IPO went up,
and then the whole market
went down a little bit.
But the stock-- maybe
it's there, right?
But on any given, 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, I don't know, 100 shares
get traded at any second, or
let's say only 100 shares get
traded in the day, is that
an indicative 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 float
and all of that.
But let's say at this split
second the company shares
traded at $15 a share.
This is $15, right, at
this second in time.
This is like right now.
Traded at $15 a share, and you
could look it up on your
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 the
share at $15.
There was a willing buyer and
a willing seller at exactly
$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 $15 per share times 10
million shares-- not
necessarily a dollar sign.
So the market is assigning
a, 15 times 10 is 100.
$150 million market cap.
Market capitalization
for the company.
And you could look on the kind
of, I think it's the key
statistics tab on Yahoo!
Finance, and you'll see market
capitalization for a company.
And it's just the number
of shares times the
price of the shares.
This is essentially what
the market's value
of the equity is.
The market is saying that
this piece right here
is worth $150 million.
And since this piece is the same
size as the assets, we
have nothing else on the
right-hand side, the market's
essentially saying that the
assets 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 an extra
calculation to figure out what
the asset value or-- and I'll
throw out a new term here, the
enterprise value
of the firm is.
The enterprise value's
essentially the asset value
minus excess cash.
The cash the company really
doesn't need to operate.
And we'll go into more
detail of that.
But we'll just view it as
the assets for now.
So if I'm the CFO of this
company, and let's say we need
to raise another, I don't
know, $15 million.
I have two options.
I could say OK, 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 the 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'd go to the board, we would
essentially create another
million shares, and then sell
them into the market, and
hopefully people will 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 buy it at $14
per share, and we
would raise $14 million.
And that would be a follow-on
offering.
So we can always use the public
markets as a way to
raise more money.
We didn't have to go to all
this-- I mean, for the most
part we didn't have to do this
huge valuation exercise and
negotiations and do all of this,
hire banks and all that.
Although the banks will
still collect fees.
We actually would have to
hire banks to do this.
So that's one option.
Or the other option is we're an
established company, we're
generating cash, we could
make interest
payments if we want to.
We could go to a bank.
And actually there's a lot of
different ways to do this.
But we could 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 $1 million
follow-on offering,
that gave us $14 million.
And let's say we want another
$2 million, but this time
instead of selling shares--
so right now how many
shares do we have?
We sold 1 million, we
had 10 million, we
have 11 million shares.
Let's say, you know what, let's
say as a CFO I feel like
our shares are going to
move up a lot more.
So we don't like selling
them at this low price.
And let's say interest
rates are really low.
Instead we're 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,
$3 million of debt, and
we would get $3 million
of cash.
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 had
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 it's essentially, it could
just literally be a bank loan.
They might have just gone to
Bank of America and said hey,
we're a big company and we're
good for the money, why don't
you lend us $3 million.
And maybe it would be $3 million
at a low interest
rate, at maybe 6% 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 oh, you have
essentially a good company
credit score.
So we'll give it to you at
a low interest rate.
So what happens in the future
is, these assets are going to
generate, hopefully,
some cash.
And before these guys see it--
let me do to it in the--
before these equity holders--
this is the equity holders
right now-- before the equity
holders see anything, these
guys have to get paid their
interest. And I'll show you
all of that on 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 just keep writing over
the same drawing-- your assets
are now larger than
your equity.
I think now, and 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, your equity plus
your liabilities.
Your liabilities now
are $3 million.
Plus liabilities.
So if you wanted to know what
your assets are worth, because
your assets are equal
to your equity.
So what's your market value
of your equity?
Well, we figured that
out already.
We have 11 million shares now.
And let's say the stock plummets
to $10 a share for
some strange reason or for
a not-strange reason.
So what's the market cap? $10 a
share, 11 million shares, we
have a $110 million
market cap.
We're doing a market value.
And we'll talk more about the
difference between market and
book value.
But this is the market
value of your equity.
And then what is your
liabilities?
Well we owe $3 million,
so plus 3 million.
So we could say that for the
most part the market value of
our assets, the market thinks
that this 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 that for
the most part is the enterprise
value of the company.
What is the company's
assets worth?
And we'll talk-- 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 can value what the
company's worth.
A lot of people when they do
a market capitalization
calculation they say
oh, that's what
the company's worth.
Well no, that's what the
equity is worth.
Market cap is what the
equity's worth.
If you want to know what the
company's worth, you have to
take the market cap and
then add the debt.
Another way-- well, I won't get
too complicated because I
just realized I've run
out of time again.
See you in the next video.