Primary Market/New Issue Market Meaning

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.

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.

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.

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

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)

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.

 Pricing of IPO

SEBI has no role in the pricing of shares. It is the issuer company that consults with the
investment bank while fixing the issue price based on the market's prevailing rates. A
company considers the following factor for determining the issue price:

1. Employee Pension Scheme;

Further, a company can issue shares either through Fixed Price Issue or by Book-Built Issue. In a
fixed price method, a share is issued at a fixed price. Whereas in a Book-Built method, the shares
will have a price bracket within which an investor can bid.

Disadvantages of a new stock issue:

1. Owners can buy back stocks to replenish their share percentage later after the financial
objective that the company intended for is achieved.
2. The major disadvantage is the owners reduce their share percentage to issue new stock in
the market. The diluted shares may cause lower earnings per share.
3. The owner may be at high risk of losing control over the business.
4. The issue of new shares gives rise to additional costs in the form of flotation costs which
is usually higher than the cost of acquiring debt.