Primary Market Concepts

A market that serves as a link between the savers and borrowers by transferring the capital or
money from those who have a surplus amount of money to those who are in need of money or
investment is known as Financial Market. Simply put, Financial Market is a market that creates
and exchanges financial assets. In general, the investors are known as the surplus units and
business enterprises are known as the deficit units. Hence, a financial market acts as a link
between surplus units and deficit units and brings the borrowers and lenders together. The
financial market can be classified into two broad categories; namely, Capital Market (Primary
Market and Secondary Market) and Money Market.

Primary Market (New Issue Market)

A market in which the securities are sold for the first time is known as a Primary Market. It
means that under the primary market, new securities are issued from the company. Another name
for the primary market is New Issue Market. This market contributes directly to the capital
formation of a company, as the company directly goes to investors and uses the funds for
investment in machines, land, building, equipment, etc.

Methods of Floatation of Securities in Primary Market

One can issue the securities in the primary market with the help of the following methods:

1. Public Issue through Prospectus

The first method of floatation of securities in a primary market is ‘Public Issue through
Prospectus’. Under this method, a company issues a prospectus to inform the general public and
attract them to invest in the company. The prospectus of a company contains information
regarding the purpose for which it wants to raise funds, its past financial performance, its
background, and future prospects. The information provided in the prospectus helps the general
public, get to know about the earning potential of the company and the risks involved in
investing in the company. Based on this information, the public decides whether or not they want
to invest in the company.Initial public offer (IPO) and follow-on public offer (FPO) are two
types of public issue.

Initial public offering or IPO is the first time a company goes public. When it is said a company
has gone public, it means it has offered its shares to the public at large and is ready to get listed
at the stock exchanges of the country. There are two exchanges: Bombay Stock Exchange (BSE)
and National Stock Exchange (NSE). The first time a company gets listed at BSE, NSE, or both
and offers its shares to be publicly traded the offering is called an IPO.

FPO is a follow up to the IPO as the name suggests. A follow on public offer is the issuance of
shares after the company is listed on a stock exchange. In other words, an FPO is an additional
issue whereas an IPO is an initial or first issue.
2. Offer for Sale
The second method is ‘Offer for Sale’, and under this method, the new securities are offered to
the general public not by the company directly, but by an intermediary who has bought a whole
lot of securities from the company. These intermediaries are generally the firms of brokers. As
the intermediaries offer the new securities to the general public, the company is saved from the
complexities and formalities of issuing the securities directly to the public.

The sale of securities through Offer for Sale takes place in two steps:
Firstly, when the company issues the new securities to the intermediary at face value.
Secondly, when the intermediaries issue securities to the general public at a higher price with the
motive of earning profit.

3. Right Issue (For Existing Companies)

Under this method, new shares are issued to the existing shareholders of a company. It is known
as the right issue because it is the pre-emptive right of the shareholders that the company must
offer them the new issue of shares before subscribing them to outsiders. The existing
shareholders have the right to subscribe to the new shares in the proportion of the shares they
already hold.

The Companies Act, 1956 states that it is compulsory for a company to issue a Right Issue to the
existing shareholders. It means that the stock exchange does not allow a company to issue new
shares in the market before giving the pre-emptive rights to the existing shareholders. It is
because if the company directly issues the new issue to the new subscribers, then the existing
shareholders of the company may lose their share in the capital of the company and cannot have
control over the company.

4. Bonus Issue
A bonus issue is an offer given to the existing shareholders of the company to subscribe for
additional shares. Instead of increasing the dividend payout, the companies offer to distribute
additional shares to the shareholders. The issue of bonus shares is one of the common features in
the corporate world. When the Company has accumulated large surplus of profits and it decides
to convert this surplus into share capital, then the Company can issue bonus shares to its
shareholders in proportion to their respective holding.

Bonus Shares are issued by way of capitalisation of profits or reserves of the Company. It is also
popularly known as “Capitalisation Shares” as these shares are issued on capitalisation of profits
or reserves.

Companies also issue bonus shares to encourage retail participation and increase their equity
base. When price per share of a company is high, it becomes difficult for new investors to buy
shares of that particular company. Increase in the number of shares reduces the price per share.
When companies are not able to pay a dividend to its shareholders due to shortage of funds in
spite of earning good profits, in such cases also bonus shares are issued. For example, the
company may decide to give out one bonus share for every ten shares held.
5. Private Placement
It is a method in which a company sells securities to an intermediary at a fixed price, and then
the intermediaries sell these securities to selected clients at a higher price instead of the general
public. The company issuing securities issues a prospectus providing details about the objective
and future prospects of the company so that the reputed clients will prefer to purchase the
securities from the intermediary. The selected clients to whom securities are issued by the
intermediaries are LIC, UTI, General Insurance, etc. As the company does not have to incur
expenses on manager fees, brokerage, underwriter fees, the listing of the company’s name on the
stock exchange, agent’s commission, etc., it is considered as a cost-saving method. This method
is preferred by small-scale companies and new companies that cannot afford to raise funds from
the general public.

6. Preferential Allotment
Preferential allotment of shares is a procedure to allot a bulk of fresh shares to a specific group of
individuals, investors, or venture companies. It is an issue of shares or convertible securities and
can be by listed or unlisted companies. Any company, whether private, public, listed, or unlisted,
can go for the process of preferential allotment of securities. The companies choose this method
because it is one of the fastest ways to raise the capital and increase the shares of the firm. A
person holding preferential shares has the right to be paid before the common shareholders at the
time of winding up of the company. The issue is made at a pre-determined price. A company
issues such shares in favour of those investors and venture capitalists who wish to gain a higher
stake in the firm and can subsequently add value to the company. It can also be a chance for
those shareholders who were not able to purchase the shares at the time of Initial Public Offer. It
can prove to be a win-win situation for the company as well as shareholders. It is because the
company will be able to raise a large amount of capital and increase the flow of money in the
firm and the investors or the shareholders shall get a larger share in the company.

7. Employee Stock Option

Employees stock option as the option given to the directors, employees or officers of the
company or of its holding or subsidiary company, the right to purchase or benefit or subscribe
for the shares of the company at a predetermined price on a future date. Thus, ESOP is a scheme
where a company proposes to increase its subscribed share capital by issuing further shares to its
employees at a predetermined rate. ESOP benefits the company as well as its employees.

5. e-IPOs (Electronic Initial Public Offer)

A new method of issuing securities in which an online system of stock exchange is used is
known as e-IPO. Under this method, a company appoints registered brokers to accept
applications and place orders. The company which is issuing the security has to apply for the
listing of its securities on any exchange. However, it cannot be the same exchange where it has
earlier offered its securities. For this method, the manager coordinates the activities with the help
of various intermediaries connected with the Issue.

6. Indian Depository Receipt

An IDR is in Indian rupees and is created by a domestic depository (custodian of securities
registered with SEBI (Securities and Exchange Board of India). It is issued against the
underlying equity of the company to enable foreign companies to raise funds from the Indian
securities Markets. As foreign companies are not allowed to list on Indian equity markets, IDR is
a way to own shares of those companies. These IDRs could be listed on the Indian stock
exchanges. Through the IDRs, you could directly invest money into international companies.

These are foreign companies that have subsidiaries working in India. Since these offshoots are
not listed, the firms offer shares to Indian investors. Standard Chartered Plc is the first company
to come out with an IDR issue.

Indian Depository Receipts are based on American Depository Receipts introduced in 1927.
Securities and Exchange Board of India (SEBI) first operationalised the rules of IDRs. The
Reserve Bank of India (RBI) issued operations under the Foreign Exchange Management Act.

The Indian depository receipts had their inception on the BSE and the NSE on June 11, 2010.