Primary Market is a part of the capital market which is also known as the new issue market.
When a company needs funds to expand its business, it can go for it either via a business loan or raise funds from the capital market. And the primary market is one such place where a Company or Government sells its securities or bonds to raise funds or capital from the investors.
This whole process of becoming a public company by selling securities for the first time in the primary market to raise capital is known as Initial Public Offering.
To get a detailed understanding of Initial Public Offering, read this article.
Now that you have a fair understanding of the primary market, let’s look at the 3 bodies that are directly involved in this transaction:
- Company or Issuer
- Investor
- Underwriter
The whole transaction looks like this – a company raises funds through an IPO by selling a part of its shares to a motley bunch of investors. The cost for the total securities which they sold out is calculated by underwriters.
Content:
- Functions of Primary Market/New Issue Market
- Primary Market Instruments
- Primary Market Example
- Advantages of Primary Market
- Disadvantages of Primary Market
- Quick Summary
Functions of Primary Market/New Issue Market
Now that you have understood the meaning of the primary market, let’s now dig further to find out the role of the primary market.
It plays its role in providing both private and public issues.
Public Issues – When the issue is provided to more than 200 investors and is advertised to the public at mass.
Private Issues – When the issue is provided to less than 200 investors, and they are not allowed to be advertised.
This market is the place where new and fresh stock or bonds are sold to the public for the first time. Apart from stocks and bonds, companies can also issue Bills, Notes, etc.
But, this process happens with a few stringent rules.
To safeguard the interests of the major as well as minor investors, these rules and the market are regulated by the Security Exchange Board of India (SEBI). It comes under the jurisdiction of the Government of India.
Before we explore the instruments related to the market, let’s have a brief understanding of the procedure of the primary market.
It is simply a three-step process. These are:
Step-1: New Issue Offer
Step-2: Underwriting Bodies
Step-3: Distribution of New Issues
Let’s understand these steps further.
Step-1: New Issue Offer
The underwriters work on issuing the securities of a company that doesn’t trade on any exchanges.
They work on various parameters to assess the company’s viability. The report looks at the business demographics and all other qualitative factors.
Besides, they also analyze and understand different financial parameters like:
- Promoter’s Shareholding
- Balance Sheet
- Liquidity Ratio
- Profit and Loss Statement
- Debt-to-Equity Ratio
- The company’s compliance with all laws
Once these processes are done, they will be looking for investors for the proposed issue.
Step-2: Underwriting Bodies
Generally, they are Investment Banks or Merchant Bankers.
These investment banks play a huge role in the primary market. They are responsible for guaranteeing a certain portion of fundraising for the issue. For which, they earn some commission on their service.
Later, they sell those securities to investors who apply for IPO in the primary market. Merchant Bankers or underwriters of the issue are the primary indicators by which investors judge the quality of an IPO.
A merchant banker who has given good returns in the past can expect the managed issue to fill easily.
Recently, when Burger King’s IPO was released, it was completely subscribed in 2 hours. The Underwriting Bodies of this IPO were:
- Kotak Mahindra Capital Company Limited
- CLSA India Private Limited
- Edelweiss Financial Services Limited
- JM Financial Limited
Step-3: Distribution of New Issues:
The distribution function of new issues can happen in the primary market. These distributions are made by the merchant bankers using a Draft Red Herring Prospectus (DHRP).
The proposed issue is heavily advertised, and investor roadshows are conducted.
After understanding the role and the procedure of the market, let’s now dig further into the related instruments of the market.
You might be wondering, what happens next? Well, once the financial instruments are offered to the public, they are traded among investors and traders in the Secondary Market. Read this article to have a clear on what is Secondary Market.
Primary Market Instruments
The companies can participate in the primary markets in 5 ways that are generally known as the types of primary market issues.
These are:
- Public Issue
- Private Placement
- Preferential Issue
- Qualified Institutional Placement
- Rights and Bonus
Public Issue:
The public issue is routed via an IPO (Initial Public Offering).
This is considered the most common method of primary market issues. It targets a larger public group of investors to raise funds for a company from the capital market.
The private companies that can provide this type of issue can become a publicly managed company. The main motto of a private company to apply for the public issue is to:
- Expand its business
- Invest in Infrastructure
- Reduce its debt
- Future liquidity
Private Placement:
When a company decides to raise funds from a small group of investors, it is called a private placement. The securities can be either stocks or bonds.
A private placement offering is easier than a public issue. The investors in these issues can be financial institutions or an individual.
Preferred Issue:
This is the quickest method to raise funds for the companies. By this model, both listed and unlisted companies are eligible to issue their securities to a selective group of investors.
Qualified Institutional Placement:
Qualified Institutional placement is purchased by QIB (Qualified Institutional Buyers). They are entitled to complete or partial securities of an issuing company.
During the public issues, these QIBs can avail of a slot (partition in total issues) by submitting the pre-file issue to SEBI.
QIBs are generally known as anchor Investors. They can be:
- Foreign Institutional Investors (FII)
- Mutual Funds
- Foreign Venture Capital Groups
- Financial Institutions (Private/Public)
- Insurance Companies
- Scheduled Commercial Banks
- Pension Funds by Government
Rights and Bonus Issues:
The 5th type of primary market issue is Rights and Bonuses. This method is to encourage existing investors to purchase more shares.
In Right Issues, the existing investors will be provided an option to buy more shares at a discounted price at a particular timeframe.
On the other hand, a Bonus is a kind of endowment to the existing shareholders.
To know more about Bonus Issues and how it is done, read our blog on Bonus Share.
Now that you have understood the related instruments, now let’s try to look at the related example.
Primary Market Example
During the lockdown phase, in May 2020, you might have heard about the Rights Issue of Reliance Industries Limited (RIL).
It was India’s largest-ever rights issue for Rs.53,124 Cr. Subscribed by 1.6 times, the issue was launched for a mammoth 42.26 Crore Shares at a Face Value of Rs.10.
Almost 14 Merchant Bankers were rolled out as the underwriter bodies.
After the Rights Issue, RIL Share price peaked up to Rs. 2314 from Rs.1008 in just 4 months.
Advantages of Primary Market
- Any private company can become a public company by issuing its securities in the primary market.
- This is the only platform for raising funds by a company without interest.
- The primary market provides the liquidity of securities by IPO. There are no brokerage fees, stamp duty, and any transaction charges.
- The securities bought on fresh issues can be sold in the secondary market. Thus, it bears a low risk of investment.
Disadvantages of Primary Market
- It is hard for retail investors to get an allotment when an IPO is oversubscribed.
- There is no historical data on the share price movement.
- Even the financial and fundamental valuation parameters are limited to 3-4 years.
- Not all the issues listed in the primary market get listing gains. Many securities listed in 2018 are still trading lower than the IPO price.
To get a clear understanding of how primary market is different from secondary market, read our blog on Primary Market vs Secondary Market.
Quick Summary
- A primary market is a place where investors can purchase securities directly from the issuer.
- Any company can sell its securities to raise funds. This can be used for business expansion or infrastructure development.
- There is a process involved in the issue of funds in exchange for securities. This whole process includes New Issue Offer, Underwriting Institutions, and Distribution of new issues.
- There are 5 different types of primary market issues viz. Public Issue, Private Placement, Preferential Issue, Qualified Institutional Placement, and Rights & Bonuses
- Generally, this market has more advantages and fewer disadvantages. The risk involved here is very less as it involves zero volatility.
- Aliceblue has a robust framework and platform that helps investors in buying securities in the primary market
We hope that you are clear about the topic. But there is more to learn and explore when it comes to the stock market, and hence we bring you the important topics and areas that you should know:
