At their simplest, you can think of capital markets as where various entities such as institutions, governments, and investors trade long-term financial instruments. This broad term captures public equity markets (including stock and bond markets), debt markets and private markets. Capital markets are a critical part of the economy that enable the flow of capital between investors and businesses that need funding to operate and grow.
Which markets are included within the capital markets?The capital markets include stock markets (such as the London Stock Exchange), derivative markets (including options, futures and swaps), foreign exchange, bond markets, debt securities markets and private markets (including alternative assets such as venture capital, private equity, real assets etc.).
What is the difference between the capital markets and money markets?Despite their similarity in names, capital markets and money markets are distinctly separate from one another. Generally intended for long-term investments of at least one year or more, the capital markets are a way for businesses to secure money from investors in return for partial ownership in their company.
Money markets are where short-term (less than one year) lending and borrowing occur and some institutional-grade debt-based financial instruments (such as commercial paper and treasury bills) are traded. For instance, banks will lend large amounts of money to other banks, institutions, or governments within the money markets. Retail investors can also participate in money markets through money market mutual funds or exchange-traded funds. Together, the capital markets and money markets make up what are broadly known as the financial markets.
What are funds?Funds are investment vehicles that investors can use to manage and spend large amounts of pooled capital. Typically, funds will have specific mandates and investment criteria that must be met for potential investments. Funds are used in public market investing as well as private market investing, though different types of funds are preferred for different investment purposes.
What is the difference between closed-end and open-end funds?Open-end funds can be accessed more regularly, allowing for the addition of new capital or redemptions from shareholders (such as mutual funds or exchange traded funds), while closed-end funds are more rigid, featuring longer lock-up times and restrictions on when money can be added or returned to investors (typically preferred in the private markets).
What does it mean to open or close a fund in the private markets?When a VC or PE firm opens a fund, it’s in the process of raising a large pool of capital, which it will then use to invest in promising private companies. VC and PE firms raise this money from limited partners.
When a VC or PE firm closes a fund, it has completed the fundraising process and is focused on actively investing in private companies.
What is the difference between the public and private markets?Most people are more familiar with public markets than private markets for obvious reasons, but activity in the private markets plays an important role in helping companies receive funding. To understand this lesser known, traditionally opaque space, it’s important to understand how it differs from the public markets.
The public markets
In the public markets, companies sell shares to institutional and retail investors who can then buy, sell or trade these shares on a stock exchange. When someone invests in the stock market, they own a portion of the public company they’ve invested in. Often larger and more mature, public companies are heavily regulated by government organizations. To ensure they remain accountable to shareholders, these companies are also required to disclose information about their performance, which makes it easy to see their financials, revenue and more.
The private markets
In the private markets, on the other hand, fast-growing companies that are not publicly traded give professional investors equity in exchange for the funding and mentoring they need to continue growing. These investors include venture capital firms, which invest in young companies (startups), and private equity firms, which invest in more established companies.
With the exception of extremely wealthy individuals, the general public cannot invest in this space. Because private companies do not answer to public shareholders, they are less heavily regulated. They do not have to disclose earnings reports or submit financial statements for auditing, which makes it hard for outsiders to find reliable, accurate information about them.
What are valuations?A valuation determines a company’s current dollar value based on a variety of factors, including capital and ownership structure.
In the public markets, a company’s market capitalization (or market cap) is often casually considered to be their valuation, though investors may each have their own valuation for a specific company based on their own models or analysis.
In the private markets, valuations will frequently be based on most recent funding rounds. Often, each round of investor funding increases a company’s valuation, which is why private market valuations are regularly referred to as pre- or post-money (“money,” in this case, refers to a round of funding). If a private company goes public or is acquired, its valuation is used to help calculate the share price or purchase price.
What do high valuations represent?Valuations are an indicator of investors’ risk appetite for the VC strategy as well as the quality of the startups that are in the market raising capital. For this reason, they affect many areas throughout the venture cycle, from negotiations on investments to investor fund performance.
To see some of the highest valuations in European VC, see the following blog articles:
- PitchBook’s list of companies in the UK with the highest venture valuations
- PitchBook’s list of companies in France with the highest venture valuations
- PitchBook’s list of companies in Germany with the highest venture valuations
How does the exchange of private market capital work?
What is a capitalization table (or cap table)?
As startups receive funding, their capital structure evolves. Cap tables are important because they show who invested in each round at what share price. They also outline liquidation preferences. This helps investors understand how valuable their equity is as well as how diluted shares may be.
What are series terms (or deal terms) in private markets?
With each new round of funding, new series terms are negotiated. These terms define how a deal is structured, outlining liquidation preferences, dividend rights, anti-dilution provisions, voting rights and more.
What is the difference between primary and secondary markets?
The primary market is where securities such as stocks and bonds are initially created. In public stock markets this would often happen through an IPO.
The secondary market is where existing securities are traded, often on popular exchanges such as the London Stock Exchange (LSE). Private markets and public markets both have primary and secondary markets.
In the context of the private markets, secondary markets involve transactions between individual shareholders (like general partners or employees) who sell or buy shares in a private company instead of from the company itself. For public markets, most trading takes place via secondary markets, including exchanges like the Frankfurt Stock Exchange, Euronext and New York Stock Exchange (NYSE).
What are some advantages of secondary markets in VC and PE?
Secondary markets serve as a way to provide investors with liquidity in the relatively more limited and opaque environment of private company shares. These transactions give investors the opportunity to realize value and return capital without a full exit.
Who is involved in VC and PE secondary markets?
GPs and founders commonly participate in secondary markets as they often have equity in private companies. Otherwise, employees of privately held companies who receive equity compensation can also be involved.
Want to learn more about valuations in the private markets? Download our 2020 Annual European VC Valuations Report.