What is Primary Market and Its Types?
All about Primary Market, Its Types, and Functions
A primary market is where a company or government entity creates new securities and sells them to investors directly. An example of such a transaction is an Initial Public Offering (IPO), where a company issues shares to invite public participation for the first time. The new stock is sold to the investors through the IPO in a process known as underwriting. Once they are sold, they can be purchased and sold by traders and investors in the secondary market. Keep reading to know more about primary market and its types:
Types of Primary Market
There are different types of issues that fall under the primary market. These are:
Public Issue – A public issue is conducted through an IPO. The securities for sale are offered to new investors, through which the company raises funds that can then be used for various purposes, such as repayment of debts, business expansion, etc. When the shares of a private company are offered to the public, the company becomes a publicly-traded entity. The Securities and Exchange Board of India (SEBI) regulates and supervises IPOs.
Private Placement – When the newly-created securities are offered to a small group of people in the form of stocks, bonds, or any other securities, it is termed a private placement in the primary market. The investor may be an institution, individual, or both.
Private placements are less complicated than IPOs and are considered best for start-up companies. Capital can be raised through a hedge fund, investment banks, or Ultra-High Net Worth Individuals.
Preferential Issue – In the primary market, this is the easiest way for any company – listed or unlisted, to raise capital for their business. The shares are sold to a selected group of investors. A preferential issue is neither a rights issue nor a public issue. Preference shareholders are offered dividends before ordinary shareholders.
Qualified Institutional Placement – This is a different type of private placement where the listed company issues equity shares, debentures (wholly or partly convertible), or other securities, except warrants. These securities are bought by Qualified Institutional Buyers (QIBs), who are investors with comprehensive knowledge of finance and investment in the capital market. Some examples of QIBs are:
- Foreign venture capital investors
- Mutual funds
- Alternate investment funds
- Foreign institutional investors who are registered with SEBI
- Pension funds
- Scheduled commercial banks
- Public financial institutions
A qualified institutional allotment is much easier than a preferential allotment because it doesn't require undergoing many rules, such as submitting pre-issue filings with SEBI.
Rights Issue – Right issue is also a type of issue in the primary market where the company issues new securities to existing shareholders. A price is predetermined for the shares before issuing them to the shareholders. Rights issue of new securities allows the existing shareholders to purchase them at a discount within a certain time period. Not only does it allow the company to raise funds without incurring any additional costs, but it also gives the shareholders more control over the company.
Bonus Issue – Bonus issue, like its name, is when the existing shareholders are offered fully-paid additional shares of the company without any cost. These shares are issued to the existing shareholders of the company from the securities premium account or free reserves. Unlike other types of the primary market, bonus issue doesn’t require any fresh capital for the obvious reason that the shares are given for free.
Functions of Primary Market
Organization of New Issue – The primary market organizes new issue offerings that have never been traded on any exchange. It requires a comprehensive assessment of the feasibility of a project along with financial arrangement, which includes considering the liquidity ratio, debt-equity ratio, and equity ratio, among others.
Underwriting Services – An underwriter decides the sale price of the new issue of securities. Generally, financial institutions like insurance companies or investment banks offer underwriting services. The underwriter assists and oversees the new issue offering. Thus, underwriting is the process of selling new stock to investors through an IPO to raise capital.
Distributing New Issue – The public is invited to purchase the new issue of shares through a prospectus which contains details of the issue, company, and underwriters.
Example of Primary Market
An example of a primary market transaction is the IPO of Airbnb in December 2021. Fifty million new shares — Class A common stock — were issued by the company. It was a primary market transaction as these securities were created and sold for the first time to investors.
Benefits of Primary Market
- Low-cost capital-raising for companies
- Offers high liquidity as the securities issued in the primary market are instantly eligible for sale in the secondary market
- Provides an opportunity for direct foreign investment
- Treasury bonds can be sold to raise capital
- When compared to secondary markets, the risk of price manipulation is low
- Mobilizes savings
With this financial information, you can now invest in shares accordingly.
Q. What is a Prospectus?
Ans. In the primary market, a prospectus is also referred to as an Offer Document when it is a public issue and a Letter of Offer when it is a rights issue. It contains information on financial details, company, projects, the reason for raising funds, promoters, terms of the issue, etc. It is an invitation for subscription to the offer made by the issuer.