The Primary Market

The primary market is a market for new issues. It is also called the new issues market. It is market for fresh capital. Funds are mobilized in the primary market through

i) Prospectus
ii) Rights issuers, and
iii) Private placement

Bonus issue is also one of the ways to raise capital but it does not bring in any fresh capital. Some companies distribute profits shareholders by way of fully paid bonus shares instead of paying them a dividend. Bonus shares are issued in the ratio of the existing shares held. The shareholders do not have to pay for bonus shares but the retained earnings are converted into capital. Thus, bonus shares enable the company to restructure its capital.

In India, new capital issues are floated through prospectus, rights, and private placement by government companies, non-government public limited companies (private sector), public sector undertakings banks, and financial institutions.

Issues are offered to the public through prospectus and the public subscribes directly. Section 67 of the Companies (Amendment) Act 2000 provides that where the offer or invitation to subscribe for shares or debentures is made to 50 or more persons, then such an offer or invitation shall be deemed to be a public offering and shall have to comply with all the provisions of the Act as well as the SEBI guidelines applicable to such public offerings. Public issues are open to the general public. Wide publicity about the offer is given through the media. In the past, the job of organizing public issues was generally entrusted to prominent brokers but that practice has now given way to the appointment of a merchant banker for the purpose.

Rights issue is the issue of new shares in which existing shareholders are given preemptive rights to subscribe to the new issue on a pro-rata basis. The right is given in the form of an offer to existing shareholders to subscribe to a proportionate number of fresh, extra shares at a price. Companies issue right shares by sending a letter of offer to the shareholders whose names are recorded in the books on a particular date. A shareholder has four options in case of rights. The first is to exercise his rights, that is, buy new shares at the offered price, renounce his rights and sell them in the open market, renounce part of his rights and exercise the remainder, and lastly choose to do nothing.

The direct sale of securities by a company to some select people or to institutional investors is called private placement. No prospectus is issued in private placement. Private placement covers equity shares, preference shares, and debentures. It offers access to capital more quickly than the public issue and is quite inexpensive on account of the absence of various expenses.

There are three categories of participants in the primary market. They are the issuers of securities, investors in securities and intermediaries. The last render services to both the issuers and investors to enable the sale and purchase of securities. The lead merchant banker performs most of the pre-issue and post issue activities. The pre-issue activities relate to drafting, examining and issuing of prospectus, application forms, advertisement, and so on. Post issue activities relate to the allotment refund and dispatch of certificates. It is now mandatory to issue all new initial public offerings (IPOs) in dematerialized form as all new IPOs are compulsorily traded in dematerialized form.

Free Pricing Regime:

Before 1992, the controller of Capital Issues (CCI) used to regulate the new issues market under the capital Issues (Control) Act, 1947. Companies had to obtain approval from the CCI for raising funds in the primary market. The timing, quantum and pricing of the issue wee decided by the controller. New companies could issue shares only at par, while the existing companies with substantial reserves could issue shares at a premium. This premium was based on a prescribed formula set by the CCI. The formula was based on balancing the two criteria viz the net assets value and price earnings value. The issue price was set far below the market price of the company’s share. This fixed price mechanism resulted in under pricing of many issues.