Primary market (NISM Series XV, chapter 2)

Two markets that cannot exist without each other

The securities market has two segments. The primary market, also called the new issue market, is where issuers raise capital by selling freshly created securities to investors. The secondary market is where those securities change hands afterwards, letting one investor exit and another enter. The primary market creates financial assets; the secondary market makes them tradable. Neither works without the other, which is why the syllabus calls them interdependent and inseparable.

A primary market offering can be made to the public or to a select group through a private placement, and the shares on offer can be new shares the company creates or existing shares that a large holder is selling. Keep those two axes in mind: public or private, fresh or existing. Every term below sits somewhere on them.

Public issues

A public issue offers securities to members of the public; anyone eligible may apply, and it is primarily a retail issue.

IPO

An initial public offer is a company's first sale of ordinary shares to investors at large, mainly to raise equity for growth. SEBI's regulations set eligibility (minimum net tangible assets, profitability and net worth), impose timelines, require listing on a nationwide exchange and require the shares to be offered in dematerialised form.

FPO

A follow-on public offer is an already listed company either issuing fresh securities to the public or making an offer for sale to the public. Fresh issues fund growth or retire debt; the offer-for-sale route is often used to raise public shareholding to the regulatory minimum.

ConceptWho gets what in an IPO

In an eligible issue, at least 35% of the shares go to retail investors, defined as those applying for up to two lakh rupees. At most 50% may go to qualified institutional buyers. The rest goes to other investors. Since 2009 there is also the anchor investor: a qualified institutional buyer applying for ten crore rupees or more in a book-built public issue. Anchors can receive up to 60% of the QIB portion, their bidding opens one day before the issue opens to the public, and the syllabus notes their allocation price can be lower than the final price discovered through book building. The size and value of anchor subscriptions signal the quality of the offer.

Private placements

A private placement issues a large quantity of shares to a select set of investors. Under the Companies Act 2013 the number of investors must not exceed fifty. It takes two forms.

QIP

A qualified institutional placement is a private placement by a listed company to qualified institutional buyers, a category that includes financial institutions, mutual funds and banks. SEBI sets the eligibility for issuers and the terms, including quantum and pricing.

Preferential issue

An issue of specified securities by a listed issuer to a select person or group on a private placement basis. It excludes public issues, rights, bonus, employee stock option and purchase schemes, QIPs, sweat equity, and depository receipts or securities issued abroad. SEBI's provisions on pricing, disclosures in the notice and lock-in apply on top of the Companies Act.

The SEBI regulations that govern public issues do not apply to private placements. A privately placed security can still be listed if it meets SEBI's and the exchange's listing requirements, and a company can privately place securities whether or not it has ever made a public offer.

Rights and bonus

Both go to existing shareholders as on a record date, in a ratio to the shares they hold.

A rights issue lets holders buy more shares at a specified price. A holder has three choices: exercise the right, transfer it to another investor, or let it lapse by doing nothing.

A bonus issue hands out additional shares for no consideration, in lieu of dividends. A company can do this only with sufficient retained earnings, and when it does, an amount equal to the value of the shares issued moves from retained earnings to share capital.

Exam trapBonus is a book entry, not new money

No cash enters the company in a bonus issue; reserves are reclassified as share capital. A rights issue does bring in cash, because holders pay the rights price. Chapter 9 works through what each does to the share price and earnings per share.

Offer for sale and the geography of an issue

Offer for sale (OFS)

Shares offered in an IPO or FPO that are not fresh but already allotted to existing holders, typically promoters or large investors, who are selling. Share capital does not increase, because nothing new is issued, and the proceeds go to the sellers, not the company. Government disinvestment in public sector undertakings is the standard example. The syllabus calls it a secondary market transaction done through the primary market route.

Onshore and offshore

Capital raised from the domestic market is an onshore offering; capital raised from investors outside the country is offshore.

Worked exampleFollowing the money

A listed company's promoter sells 5% of his holding to the public through an OFS at 400 rupees a share. The company's share count is unchanged, its bank balance is unchanged, and the promoter receives the cash. If instead the company had issued 5% new shares at 400, the share count would rise, the company would receive the cash, and every existing holder would own a slightly smaller fraction.

Shares as reward: sweat equity and ESOPs

Under Section 54 of the Companies Act 2013 a company may issue sweat equity to employees, promoters, technocrats or others as a reward for their contribution. The purpose is motivation, and the syllabus frames it as reducing agency risk, the risk that arises because the people who manage a company are not the people who own it. Raising capital is not the aim, though new shares are issued.

Employee stock options give employees the option to buy the company's shares at a pre-determined price after a vesting period, typically longer than a year and possibly subject to further conditions. Employees gain only if the market price rises above the exercise price; if they exercise, the company must issue the shares.

Take these into the exam

Primary market: issuers raise fresh capital by issuing securities to investors. Secondary market: investors trade securities that already exist. The two are interdependent and inseparable.
IPO allocation: at least 35% to retail (applications up to two lakh rupees), at most 50% to qualified institutional buyers, the balance to others. Anchor investors are QIBs applying for ten crore or more, allotted up to 60% of the QIB portion, bidding a day before the issue opens.
Private placement goes to a select set of investors, not more than fifty under the Companies Act 2013; QIPs are private placements by listed companies to QIBs, preferential issues to select persons, and public-issue regulations do not apply to either.
An offer for sale sells shares that already exist, so the company's share capital does not rise and the money goes to the sellers. Rights let existing holders buy more at a set price; bonus gives them free shares funded from retained earnings.