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Primary Market – Definition, Types, and Functions of Primary Market

Updated on :  

08 min read.

The primary market is that segment of the capital market where major entities like governments, institutions, and companies get funds through the sale of equity and debt-based securities. 

If a company plans to go public for the first time through an Initial Public Offering (IPO), it does so through the primary market. As securities are sold for the first time here, primary markets are also called New Issue Markets (NIMs). 

After the company’s shares are listed in the secondary market through an IPO, they are purchased and sold by investors and traders. 

What are the functions of the primary market?

Some of the main functions of the primary market are:

New issue offer:

The primary market facilitates a new issue offer which has not previously been traded on any stock exchange. So it is called a new issue market. 

However, a new issue offer is not an easy task. It involves a complete evaluation of a project’s feasibility. 

For instance, financial arrangements must include liquidity ratio, debt-equity ratio, promoters equity, and foreign exchange demand. 

Underwriting services:

Underwriting is critical for a company which is launching a new issue offer where the underwriter must purchase all unsold shares if the company cannot sell the requisite shares to the public. 

Many financial institutions play the role of underwriters and earn commissions. Investors fall back on underwriters to determine if taking up the risk is worth the return. Sometimes underwriters buy the entire IPO issue and then sell it to the investors. 

Distribution of New Issue:

The primary market has another vital function. The distribution process is initiated through a new prospectus issue. Moreover, the general public is invited to purchase the new issue, and thorough information is given about the company, issue, and the underwriters. 

What are the types of the primary market?

Public Issue:

Public issue is a common method of issuing securities such as equity shares to the public. The public issue is done mainly through IPO, whereby firms raise capital for their businesses. Moreover, the securities are subsequently listed on stock exchanges such as NSE and BSE for investors to trade.  

One of the main features of the primary market is that private limited companies may become publicly-traded entities through an IPO. The capital a company raises could be used to improve the company’s infrastructure or to repay debts. 

The capital may be used to improve the firm’s liquidity. SEBI, the capital market regulator, monitors IPOs to prevent misuse and fraudulent practices. 

Private Placement:

Under private placement, the company offers its securities to a small number/group of investors. For example, primary securities could be stocks, bonds, or other securities. Moreover, investors may be either individual or institutional under the private placement. 

Companies prefer private placement over an IPO as far lesser regulatory norms exist. Moreover, companies incur reduced costs and firms that have newly commenced operations prefer private placement over the IPO route. 

Qualified Institutional Placement:

Qualified Institutional Placement (QIP) is a popular fundraising tool preferred by listed firms to raise capital from the domestic market. However, only investors who SEBI accredits can indulge in QIPs. Prior to Qualified Institutional Placements, companies raised capital from the International markets. 

QIPs, unlike IPOs, are limited to qualified institutional buyers (QIBs) or institutions. Retail investors cannot invest through QIPs, and only SEBI accredited QIBs can take up QIPs.

Preferential Issues:

Preferential issues are one of the quickest routes for companies to raise capital to expand their businesses. For instance, listed and unlisted firms issue securities for a particular group of investors under preferential issues. 

However, preferential issues are neither rights nor public issues. Under preferential issues, the preference shareholders will be paid dividends before the ordinary shareholders.

Rights and Bonus Issues:

Rights issues are basically those issues where companies offer rights to their existing shareholders to buy additional shares of the company at discounted prices to the market price within a stipulated time. 

However, companies give additional shares, called bonus shares to their existing shareholders. Moreover, bonus issues are distributed out of a company’s accumulated profits or earnings. 

 These are converted into free or additional shares instead of being given out as dividends. It is distributed to existing shareholders in proportion to their stake in the company without any additional charge or cost. 

Current shareholders don’t need to opt for the rights issue. Companies come out with rights issues when they seek to infuse fresh capital into the business. Companies prefer rights issues for capital infusion rather than high-interest bank loans. 

Bonus shares are issued by companies when they accumulate large free cash reserves. Companies make bonus issues out of their reserves to reward their shareholders. The bonus share issue will not impact the company’s net assets as this action doesn’t involve cash flow. It only means the number of shares called share capital has increased. 

Conclusion:

  1. Primary markets are sources of new securities where companies, governments and groups raise finances.
  2. In the primary market, equity-based, debt-based, and asset-based securities are created.

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