Unlike your local grocery store, the primary market does not have a physical location. Instead, it refers to a transaction in which an issuer sells securities directly to an investor. The primary market exists to assist issuers—typically businesses or governments—in raising cash.
Securities are generated in the primary market and traded in the secondary market by investors. Companies first sell new stocks and bonds to the general public on the Primary market, as in an initial public offering (IPO) (IPO).
A primary market Initial Public Offering is used when a firm wishes to go public for the first time (IPO). As securities are frequently issued for the first time, a primary market is also known as the NIM (New issue market). The primary market differs from the secondary market, which allows investors to trade securities with one another.
To define it precisely:- “The primary market is a segment of the capital market in which corporations, organizations, governments, and other entities raise cash by issuing debt and equity-based securities.”
It can also refer to a sector of the capital market in which firms, governments, and other entities raise cash by selling debt and equity-based instruments.
A classic example of this sort of transaction is an initial public offering (IPO), in which a firm offers shares for the first time.
Corporations, institutions, investment banks and public accounting firms are the four principal market participants.
Corporations lend debt or shares to institutions in exchange for capital investment, whereas institutions invest in businesses wanting to expand and grow. Investing banks connect organizations and enterprises based on their risk tolerance and investment preferences.
A market like this is regulated by the Securities and Exchange Board of India (SEBI). The entity issuing securities may aim to, among other things, expand its activities, fund other corporate initiatives, or increase its physical presence.
Taking Example of Zomato–A Food Delivery App in India and Its IPO Case.
Last year, the food delivery startup Zomato made a remarkable debut on the stock exchanges, with its stock trading at a price that was more than 50 percent higher than its final offer price of 76. Its gains have now been extended, and it is now trading above 120. Retail investors, who have a lesser risk tolerance, subscribed to Zomato’s Initial Public Offering (IPO) 7.45 times.
The promoter, Info Edge India, offered a 375 crore offer for sale as part of Zomato’s primary market offering, which included a 9,000 crore new issue and a 9,000 crore offer for sale.
Due to their extreme caution, retail investors are known to prefer modest returns over even a smidgeon of volatility. During Zomato’s IPO, they did, however, prosper in the primary market.
Companies considering IPOs later last year should have a bright future, with so many private investors rushing to primary markets.
After Coal India’s share sale (Rs 15,199.44 crore) in October 2010, Zomato’s IPO was the second-largest. The meal delivery platform showed bravery by being the first Indian start-up to go public, clearing the path for others to follow.
Let’s discuss how this Primary Market works—Its functioning and approach mechanism!
Firms, governments, and public sector organisations can generate funds by selling new shares in an initial public offering, and companies can raise cash by issuing primary market bonds (IPO).
Typically, this is accomplished with the aid of an investment bank or a securities dealer financing syndicate. In the majority of primary market transactions, an investment bank underwrites the securities sale and acts as a middleman. Underwriters help with the sale by identifying buyers for the securities.
Types of a Primary Market
Some of the different types of Primary Markets are as follows:
Initial Public Offering (IPO):
One of the most popular forms of primary market offerings is an initial public offering (IPO) as it is most likely to be popular amongst youngters. The process through which a private business becomes publicly traded by selling stock on a stock market is known as an initial public offering (IPO).
Although each investor has the opportunity to participate in an IPO, these assets are not always readily available. Customers of the underwriting banks are usually the only people who may purchase IPO shares.
Institutional investors, such as mutual funds and pension funds, as well as a few high-net-worth individuals, are frequently the first to invest.
Private businesses engage with investment banks to introduce their shares to the public market, which necessitates extensive due diligence, marketing, and regulatory compliance.
A rights issue is a major capital market transaction. In this sort of transaction, a corporation that has already issued public shares distributes additional shares to its current owners. When a company wishes to obtain capital, it typically gives up rights.
These are some scenarios in which a corporation may need to pay off debt, buy equipment, or acquire another company. If no other feasible fundraising sources exist, a company may utilize a rights issue to raise money. This sort of transaction benefits both the corporation and the buyer since it provides more funds.
A private placement is a type of public offering in which an issuing business offers securities to investors. A “private placement,” as the name implies, is a private alternative to issuing or selling publicly traded securities as a way of obtaining funds.
When a company, or issuer, offers and sells debt or equity securities to a limited number of investors, this is known as a private placement. In contrast, a private placement is not the same as an initial public offering (IPO). Instead, it is exclusively offered to a select group of experienced investors.
Functions of a Primary Market
The major objective of the Primary Market is to encourage capital growth by allowing individuals to invest their savings. It makes it easier for businesses to issue new shares in order to directly generate funds from clients for business development or to pay financial commitments. It enables the government to solicit public funding to assist public-sector initiatives.
In contrast to the secondary market, which exchanges listed shares between buyers and sellers, the primary market exists for firms and the government to issue new securities directly to investors.
The fundamental functions of the primary market are described below:
Securities that have never been traded on another exchange are sold for the first time on this market. As a result, it’s also known as the New Issue Market. Organizing fresh issues entails, among other things, a thorough evaluation of project feasibility. Considerations of promoters’ equity, liquidity ratio, debt-equity ratio, and foreign exchange demand are included in the financial arrangements for the purpose.
When launching a new issue, underwriting is crucial yet a lot of steps go in this. An underwriter’s principal job in a primary market is to purchase unsold shares if the firm is unable to sell the requisite number of shares to the public. Underwriting commissions may be paid to a financial institution acting as an underwriter.
In a primary market, a fresh issue is also disseminated. This method of distribution starts with the publication of a fresh prospectus. It asks the general public to buy a new issue and provides detailed information on the firm, the issue, and the underwriters.
Advantages and Disadvantages of a Primary Market
Investing in the primary market offers its own set of benefits, including the following:
- The company was able to raise financing successfully.
- Primary market investing is safer since there is less price manipulation.
- There are no brokerage or transaction costs, nor are there any taxes such as service tax, stamp duty, or STT to pay.
- There is no need to time the market because all investors get the same price for their shares.
It has certain negative qualities in addition to its positive responses:
- Due to oversubscription, shares are distributed proportionally; small investors are unlikely to receive any.
- Money is held in escrow, and after a few days, shares are distributed. Shares in the secondary market are credited within three business days.
Types of Issuance in the Primary Market
When an issue / offer of shares or convertible securities is made to new investors in order for them to join the issuer’s shareholder family, this is known as a public issue (the entity making the issue is referred to as the “Issuer”). An initial public offering (IPO) and a subsequent public offering (FPO) are two forms of public offerings (FPO).
A private limited company can become a publicly traded corporation through an initial public offering, for example (IPO). Capital can also be used to improve a company’s current infrastructure and pay off debts, among other things. It also improves a company’s liquidity and is one of the most common ways of transferring securities to the general public.
A private placement occurs when an issuer distributes shares or convertible instruments to a small group of people (no more than 49). It’s not a rights offering or a public offering. When a corporation offers securities to a small number of investors, this is referred to as a private placement.
Stocks, bonds, and other types of securities can be used as principal securities. A private placement may be participated in by institutional or individual investors.
It is one of the most effective ways for companies to generate revenue for their operations. In this situation, both listed and unregistered corporations can issue securities to a specific group of investors.
In addition to the requirements specified in the Companies Act, the issuer must follow certain provisions, such as price, disclosures in the notice, lock-in, and so on.
It is critical to remember that personal preferences are not matters of public or human rights concern. Preference shareholders receive dividends before ordinary investors in this sort of offering.
Qualified Institutional Placement (QIP):
When a listed issuer issues equity shares or non-convertible debt instruments with warrants and convertible securities other than warrants to Qualified Institutional Buyers only, this is referred to as a QIP under the requirements of Chapter VIII of the SEBI (ICDR) Regulations, 2009.
It is a form of fundraising approach used by publicly traded firms to raise funds by selling primary securities to qualified institutional buyers (QIBs). It was formed by SEBI, the capital market regulator, to make it easier for enterprises to raise cash in the domestic market.
Rights and Bonus Issues:
This is a one-of-a-kind issuance in the primary market. In this situation, the company offers securities to current investors by allowing them to purchase additional securities at a fixed price (in the case of a rights issue) or obtain a larger share allotment (in the case of a bonus issue).
A bonus issue occurs when an issuer issues shares to current shareholders without remuneration based on the number of shares they already possess as of a record date. On a record date, the shares are issued in a precise proportion to the amount of securities held in the Company’s free reserve or share premium account.
In a rights issue, investors have the opportunity to buy stock at a discounted price for a short time. A bonus issue, on the other hand, is when a company’s shares are given to its current shareholders.
As a result, we’re certain that now you’ve heard of the word and have a greater understanding of what a Primary Market is and how it operates. You may have never heard of a primary market offering as an individual investor but that’s okay. Knowledge comes to everyone somewhere for the first time only.
These transactions are typically restricted to select stockholders, as previously noted. In many IPOs, securities are only available to institutional investors and customers of the underwriting investment banks.
In the case of private placements, only accredited investors are allowed to invest. If you do have the opportunity to engage in a primary market offering, you should be aware of the risks and make sure you participate in one, in the future as you get to learn from the risks too.