The Purpose of the Stock Market
| Q: | Why is there a stock market? |
| A: | The purpose of the stock market is to provide liquidity, thus making it easier for companies to finance themselves through an IPO. |
| Q: | Um..? |
Okay, a little more detail.
Suppose you want to start a company, or enlarge an existing one.
At the beginning you'll have an idea for a product or service that you want to create and sell.
You'll also have startup costs, which might include salaries, equipment, rent, raw materials...
The one really important thing you won't have is money to meet these startup costs.
(This is what people mean when they say that "it takes money to make money" -
it takes money to pay startup costs before you can start making money by selling goods and services.)
One way to raise the money is by borrowing it.
This is called debt financing.
The other way is called equity financing, and it means selling portions of the company, called shares, to investors.
This process is called an initial public offering, or IPO.
Eventually, the people who buy the IPO will sell their shares in the stock market, hopefully at a profit.
From then on, the shares continue to change hands in the stock market, and the issuing company gets no further benefit from these trades.
But the point is that the IPO could never have happened without the stock market,
because the original buyers would never have bought if there wasn't a convenient way for them to sell their shares later.
And so, that's the purpose of the stock market:
to provide liquidity, so that companies can finance themselves through an IPO.
Q.E.D.
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Note that the purpose of the stock market is not to make Wall Street hot shots rich -
believe it nor not!
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