Editor's Note:- It's a guide for Startups and Investors that offers a clear breakdown of the key financial instruments like stocks, debt, and hybrids. It's a must-read for entrepreneurs and investors looking to navigate capital raising.
Securities of a company is a tradable financial instrument with a monetary value that expresses the ownership in the company in the form of bonds or debt, that can be traded for money.
However, private investors use securities to diversify their portfolios and participate in a company's successes and failures by trading them in the market. So, in this article, we will understand security investments and types of security.
Among multiple types of security investments, it's very important to choose the right security depending on the requirements of the company. We have written on different types of security investments so you can choose for your organization.
Equity securities, or stocks, represent ownership in a company, giving investors rights to assets, and profits, and voting on key decisions like electing the board. However, if the company isn't profitable, equity holders won't receive dividends, and in the event of a sale, they are paid last after other stakeholders.
It’s a win-win for investors and founders in the company’s success.
1. Common Shares:- Common shares represent ownership in a corporation and a claim on profits. It is typically issued to founders and early employees. Owning common stock grants voting rights on company policies and board elections. While common stock tends to appreciate over time, dividend income is not guaranteed.
2. Preferred Shares:- Preferred stock is typically issued to angel investors and venture capitalists to raise funds. These shareholders receive dividends before common shareholders and have priority in payouts if the company goes bankrupt. Additionally, preferred shares may include a callability feature, allowing the company to repurchase them after a certain time.
3. ESOPs:- An Employee Stock Option Plan (ESOP) is a financial instrument that is designed to attract, reward, and retain talented employees by offering them ownership in the company through stock options. In this, if the company wants to allot shares of the company to the employees then the existing shareholders have to dilute their shares. In this, the company needs to take a grant from the shareholders.
It’s a type of security that is mainly used by companies and startups to raise funds in the form of loans without diluting the shares of the company but in return, the company has to pay interest on the loan amount and till the maturity date the company has to pay the full amount.
1. Convertible Debentures:- Convertible Debentures are long-term debt instruments that are issued by the company and can be converted into the company’s common stocks after a certain period or under certain conditions. They offer the combined advantage of both debt and equity shares where the investors can get the interest on their loan amount and also, the option to convert them into shares.
2. Non-Convertible Securities(NCDs):- Non-Convertible Securities are fixed-income instruments that are issued by companies and startups to raise capital. Unlike convertible debentures, this cannot be converted into equity. Non-convertible debenture investors receive fixed interest for their loan amount. NCDs can be either secured, backed by company assets, or unsecured, which carry more risk but can offer higher returns.
This type of security derives its value from underlying assets like commodities, stocks, or indexes. Common types include options, futures, swaps, and forwards. Investors use these instruments to enable market participants to hedge against risks and optimize investment strategies.
This type of security is a tradable financial product that generates returns based on a company’s performance or a fixed rate of return. The two primary types of securities are equity (stocks), which represent partial ownership in a company, and debt (bonds), where investors lend money to a company in exchange for interest and scheduled payments.
Hybrid securities combine elements of both, allowing companies to raise capital without the full obligations of a bond or the risks of a stock offering.
1. Convertible Bonds: This bond comes with the option of being converted into different types of financial instruments at a future date. Majorly the bonds are converted into shares of stock in the issuing company. This makes a convertible bond a hybrid security but the value of the bond depends on the asset underlying the bond’s conversion option.
2. Convertible Preferred Shares: Like all preferred shares, convertible preferred shares have a guaranteed schedule of dividend payments. These shares come with the option to convert them into either equity shares or cash payments. During the asset’s maturity date, the shareholder receives a guaranteed payment whether in the form of cash or common stock. The value of preferred shares is tied to the company’s stock price , making them both an equity and bond-like instrument.
Category | Equity Securities | Debt. Securities | Derivative Securities | Hybrid Securities |
Risk | High risk | Low risk | Variable risk | Intermediate |
Return | Dividend return not guaranteed | Fixed interest payment | Offers leveraged returns based on asset movements | Fixed income with potential capital appreciation |
Ownership | Gives ownership | No Ownership | Does not have ownership over the underlying assets. | May have after the maturity date |
Maturity | No maturity | Fixed maturity | Specific contract duration | Have maturity date |
Taxed | Dividends and capital gains are taxed at different rates | Interest payments are often tax-deductible for the issuer | Tax treatment can be complex due to the timing of gains and losses | Tax treatment is complex due to debt and equity features |
It is very necessary to understand various financial instruments to build a business effectively. Each type of security has its advantages and disadvantages and by understanding this, startups can tailor their strategies for raising capital from the public. When it comes to investors it is important for them to know in what securities they should invest their hard-earned money. These securities play a key role in enabling companies to raise capital from the public.
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