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The primary market is the first place where a company offers its shares to people like you and me. This is where we get the first chance to invest our money in a company’s shares. In this blog, we’ll dive deep into what exactly the primary market is, why it’s so important, and how it works.
What is a primary market?
Before a company becomes publicly traded, meaning you can buy and sell its shares, it needs to raise money. In the primary market the company offers its shares to the public for the first time. This process is also known as an Initial Public Offering or IPO.
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Functions of the primary market
- Raising capital
When a company needs funds to expand its operations, develop new products, or acquire assets, it can issue shares to the public through the primary market.
- Initial public offering (IPO)
When a privately-held company decides to go public, it issues shares for the first time through an IPO.
- Rights issues
Current shareholders are offered the right to purchase additional shares, usually at a discounted price. Rights issues are a win-win: shareholders get a deal, and the company raises the capital it needs without having to seek external financing.
- Debt financing
Debt finance lets companies and governments issue bonds to raise funds. These bonds are loans to the issuer in exchange for interest payments and the bond’s face value when it matures.
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Features of the primary market
- Direct purchase mechanism: When a company decides to go public and issue shares, it does so without any intermediaries.
- Robust regulatory framework: The primary market isn’t a free-for-all arena. Companies desiring to issue new shares or bonds are mandated to adhere to stringent guidelines set by SEBI.
- Pricing dynamics: Investment banks assist companies in navigating the multifaceted process of going public, including determining the initial price of a stock or bond.
Distinguishing between the primary market and the secondary market
| Primary Market | Secondary Market |
| New securities are sold | Existing securities are traded |
| Transaction is between company and investor | Transaction is between two investors |
| Price is determined by the company | Price is determined by market demand and supply |
| Funds go to the issuing company | Funds go to the selling shareholder |
Types of primary market
There are five key types of primary market issuances, each serving unique purposes and targeting different kinds of investors.
- Public issue: This is done through an Initial Public Offering (IPO). A private company goes public and lists its shares on stock exchanges. The proceeds often fund business expansion, debt repayment, and infrastructure improvements.
- Private placement: Instead of a public offering, the company offers its securities to a small, select group of investors.
- Preferential issue: This is neither a public issue nor a rights issue. Those who own preferential shares receive dividends before ordinary shareholders.
- Qualified institutional placement (QIP): This involves issuing securities to Qualified Institutional Buyers (QIBs), who are generally savvy about market conditions.
- Rights and bonus issues: Existing investors are given the opportunity to buy more shares at a predetermined price or receive additional free shares.
Primary market instruments
Equity shares
You acquire a small part of the company when you buy an equity share. Equity shareholders have voting rights and a portion of the company’s income, generally dividends.
Debentures
Debentures are essentially debt instruments used by companies to raise capital. Debentures offer fixed interest payments, which can be an attractive feature for risk-averse investors looking for stable returns.
Government bonds
These are bonds issued by the government to fund public projects, manage debt, or handle other financial needs. They are considered one of the safest investment options.
Advantages of the primary market
Transparency
One of the standout features of the primary market, particularly in India, is the level of transparency enforced by regulatory bodies like SEBI.
Accessibility
Through IPOs, the primary market lets average individuals invest in financial markets. This goes beyond institutional and affluent investors.
Potential for high returns
Being among the first to invest in a company via the primary market provides the potential for high returns.
The role of intermediaries in the primary market
- Investment banks: They assist companies in determining the price of their shares and how many to issue.
- Legal advisors: Legal advisors help in drafting offer documents and ensuring compliance with regulatory requirements.
- Regulators: Bodies oversee the operations to ensure transparency.
Let’s summarise
Understanding the primary market is crucial if you’re planning to dive into the investment world. As with any investment, it’s crucial to do your due diligence and possibly consult with financial advisors.
FAQs
The primary market’s main purpose is to enable people to turn their savings into investments, which promotes capital growth. It enables businesses to issue new shares in order to directly obtain funds from consumers for debt repayment or company growth.
Investors may simply exchange their assets on secondary marketplaces. In the secondary market, investors may sell their assets at any moment to a vast pool of potential buyers. Investors may easily raise money by selling their assets and positions.
Investing in promising companies when they go public via initial public offerings (IPOs) is often a great opportunity to make money. This is because the stock price will increase in value and you will be able to make significant gains if the company has long-term growth potential.
No, IPOs do not guarantee profits. A company’s stock price can often drop after the initial public offering (IPO) and never reach the IPO value that investors paid for, meaning they end up losing money instead of gaining any. This happens when a company is overpriced or assessed incorrectly.
In general terms, there are two primary categories of secondary markets: stock exchanges and over-the-counter sales marketplaces. The trading of securities takes place on stock exchanges, which are centralised platforms that do not involve any interaction between the buyer and the seller.
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