Conflict of Interest in Investment Banking
February 12, 2025
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The initial public offer model works well for big companies. However, as far as smaller start-ups are concerned, IPOs are not a viable or efficient means of raising capital. This is because there is a huge transaction, as well as legal fees that are associated with IPOs. Hence, as long a company is not raising upwards of $100 million, these costs become too high on a percentage basis, and there is no point using the IPO route. Similarly, banks may also find the current cash flows of smaller businesses insufficient and hence may not want to extend loans to them.
In the past, such small businesses were totally dependent upon angel investors and venture capital funds. Since these funds were few in number, start-up companies did not have enough bargaining power to get a fair valuation. There was a dire need for an IPO like mechanism wherein smaller companies can also sell their shares to individual investors without having to rely on a few parties to pick up all the shares. This is where equity Crowdfunding has come into the picture.
In this article, we will understand how equity Crowdfunding works and how it impacts the investment banking business.
In the case of equity Crowdfunding, the platforms generally create a website. This website acts as a platform where all the information related to investment is listed. Investors can go through different opportunities that might be available at the time and can choose where to invest their money.
Investment bankers have realized that right now, the equity crowdsourcing industry is a small fringe. However, it can be the way in which corporations raise money in the future. Hence, they have started investing in the equity crowdsourcing model. Most of the platforms on which companies list their investments are owned by investment banks. Needless to say that investment banks charge a fee for listing as well as when funds are actually raised. Also, the information present on the portal needs to be verified. Only then can the investors perform thorough due diligence. This is also where the investment bankers come in. They charge a fee to validate the financials of the company and provide their stamp of approval.
When companies use equity crowdsourcing, they do not issue shares in the traditional sense of the word. This is because, in most parts of the world, transferring shares would involve the services of a registrar. This would make the process more expensive. Also, shares provide equal voting rights. This would make it difficult for start-up owners to run the company.
In the case of equity crowdsourcing, the securities issued are contracts made to mimic the functions of shares. However, since they are not technically shares, they can be transferred without involving a registrar. Also, in most cases, they do not carry any voting rights. In some cases, there are platforms that request the shareholders to provide them approval to become their nominee, i.e., to perform technical shareholder tasks on their behalf.
At the present moment, equity crowdsourcing is used only by a very small fraction of companies. This is because of the following issues.
The bottom line is that the equity crowdsourcing model is still at a nascent stage. At the moment, it does not actually pose a risk to the traditional IPO and investment banking model.
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