What is a Primary Market: Definition (2022)

what is a primary market?

The primary market also known as new issue market is the market where equity or debt capital is raised by the issuers by offering securities to the investors. Thus primary market is a place where securities are created and are made available to the public for the first time.

The issuance of securities in the primary market expands the reach of an issuer and makes long term capital available to him from a large number of investors and hence primary market plays an important role in facilitating capital growth by enabling individuals to convert savings into investments.

Here, I am covering details about issuance of equity capital in primary market, as my aim is to make readers aware of the ways in which they can invest in shares of companies via primary market. Another factor is, overall micro structure of the corporate bond market in India is such, that even today it is confined to institutional investors with retail investors accounting for only 3% of the outstanding issuances.

In primary market, companies may offer shares at their face value or at a premium or discount to their face value. Let us first try to understand these terms.

Face Value of a Share:

Face value, also known as par value or the nominal value is the value of a company listed in its books and share certificates. The face value is decided by the company when it offers shares at the time of issuance.

For an equity share, the face value is usually a very small amount (Rs. 1, 5, 10 or 100) and does not have much bearing on the market value of those shares.

Issuance of Shares at a Premium:

When a security is sold above its face value, it is said to be issued at a Premium.

Issuance of Shares at a Discount:

When a security is sold below its face value, it is said to be issued at a Discount.

But today most of the companies issue shares to public at a premium to their face value.

Types of Issues:

Most companies are usually started privately by the promoters. However, the promoter’s capital and the borrowings from banks and/or financial institutions may not be sufficient for setting up or running the business over a longer term.

Sooner or later, companies issue shares to venture capital and/or private equity investors to raise the required capital to grow their business further.

At some stage ahead in future, for need of more capital or to provide exit opportunity to early investors, companies invite the public to contribute towards the equity and issue shares to individual investors. The way to invite share capital from the public is through a ‘Public Issue’.

Different types of issues include –

1. Initial Public Offer (IPO):

Initial Public Offer is when an unlisted company makes either a fresh issue of securities or an offer for sale of its existing securities or both for the first time to the public.

After issuing shares to public, these shares are listed on stock exchanges so that public can easily buy or sell them.

2. Follow-on Public Offer (FPO):

Follow-on Public Offer is when an already listed company makes either a fresh issue of securities to the public or an offer for sale to the public, through an offer document.

Company may issue fresh shares when it wants an additional capital to grow its business or it wants to rejig its capital structure by retiring debt and raising equity.

This public offer can be through an offer for sale in cases when company’s promoters want to dilute their holding in the company after the lock-in period imposed when IPO gets over, or to provide exit opportunity to early investors or when it is necessary to increase the public holding to meet the requirements laid down in the listing agreement between the company and the stock exchange or as prescribed from the regulator.

3. Private Placement of Shares:

Private placement is when shares are issued to a select set of institutional investors rather than offering them to public. These institutional investors bid for shares and purchase them. This is primarily a whole issuance of shares.

4. Preferential Issue of Shares:

A preferential issue is when shares are issued by listed or unlisted companies to a select group of investors on preferential terms rather than offering them to public via an IPO or FPO or existing shareholders via a rights issue.

Such shares are normally issued to promoters, strategic investors, employees and other such preferential groups and it is the fastest way for a company to raise capital.

A person holding preferential shares has the right to be paid from company assets before common stockholders if the company goes into bankruptcy. However preference shareholders usually do not have voting rights, and are rewarded only by higher dividends.

5. Rights Issue:

A rights issue is a way by which a listed company can raise additional capital. Instead of going to the public again, the company gives its existing shareholders the right to subscribe to newly issued shares in proportion to their existing holdings.

Usually the price at which the new shares are issued to the existing shareholders by way of rights issue is less than the prevailing market price of those shares, i.e. the shares are offered at a discount.

If a shareholder does not want to exercise the right to buy additional shares then he/she can sell the right as the rights are usually tradable. Alternatively, investors can just let the rights issue lapse.

Foreign Capital Issuance:

Apart from raising capital from public in India, Indian companies can raise capital in foreign currency. Here companies can raise debt capital by issuance of foreign currency convertible bonds (FCCBS) or raise equity capital by issuance of ordinary shares through depository receipts namely American Depository Receipts (ADR) or Global Depository Receipts (GDR).

FCCBS (Foreign Currency Convertible Bonds):

FCCBs are foreign currency (usually dollar or euro) denominated debt raised by companies in international markets but which has an option of conversion of it into
equity shares of the company before maturity.

The payment of interest and repayment of principal amount is in foreign currency. The conversion of this debt into equity shares takes place normally takes place at a premium to the current market price of the shares. FCCB allows Indian companies to quickly raise debt abroad and at lower rates. They are regulated by RBI notifications under the Foreign Exchange Management Act (FEMA).

Depository Receipts:

Depository Receipts (DRS) are financial instruments that represent shares of an Indian company but are listed and traded on a stock exchange located outside India. Such instruments are issued in foreign currency (usually dollar or euro). They constitute an important mechanism through which issuers can raise funds outside their home jurisdiction.

To issue a depository receipt, a company has to deposit a specific quantity of its underlying shares with a custodian bank, which then issues “depository receipt” against those shares. These depository receipts are issued abroad which can be purchased by foreign investors.

Depending on the location in which these receipts are issued they are called ADR or GDR.

When depository receipts are issued by an U.S. custodian bank and are listed on a stock exchange in USA, such as the New York Stock Exchange (NYSE), American Stock Exchange (AMEX) or NASDAQ, then they are known as American Depository Receipts (ADR).

When depository receipts are listed on a stock exchange located outside USA and then they are known as Global Depository Receipts (GDR).

Some of the common stock exchanges where GDRs are listed include the Frankfurt Stock Exchange, Luxembourg Stock Exchange, the London Stock Exchange, the Hong Kong Stock Exchange, Dubai Stock Exchange, etc.

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