primary market

PRIMARY MARKET

Dr. Vinita Kalra

INTRODUCTION The primary market is a market for new issues.

It is also called the new issues market or market for

fresh capital.

Four ways to raise capital through primary market:-

1) Prospectus

2) Rights issues

3) Private placement

4) Bonus issue

According to section 67 of the companies

(Amendment) Act, 2000 Prospectus means ‘where

the offer or invitation to subscribe for shares or

debenture 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.

PROSPECTUS

Why Bonus Issue?

Bonus is the capitalization of free reserves. Higher

the free reserves, higher are the chances of a bonus

issue. Companies convert their retained earnings

into capital.

1) To boost liquidity of companies stock

2) To bring down the stock price

3) To restructure companies capital

Participants in the Primary Market

1. Merchant Bankers or BRLM

2. Registrar to the issue

3. Bankers to the issue

4. Agents/Brokers

5. Auditors of the company

6. Syndicate members

Methods for Determining the Offer Price

1. Fixed Price

2. Book Building

Book building is a mechanism through which an offer

price for IPOs based on the investors’ demand is

determined.

In other words, it is a process by which demand for the

proposed issue is elicited and built-up and the price at

which the securities will be issued is determined on the

basis of the bids received.

Difference between Fixed Price and Book- Building Process

Features Fixed Price Process Book-building Process

Pricing Price at which the securities are offered/allotted is known in advance to the investor.

Price at which the securities are offered/allotted is not known in advance to the investor. Only an indicative price range is known.

Demand Demand for the securities offered is known only after the closure of the issue.

Demand for the securities offered can be known everyday as the book is built.

Payment Payment is made at the time of subscription wherein refund is given after allocation.

Payment only after allocation.

BOOK BUILDING PROCESS

Flow chart showing book building process

BOOK BUILDING OPTIONS

Benefits of Book Building Method

Enables issuers to reap benefits arising from price and

demand discovery.

The cost and time for making public issues is

lowered.

The procedures are also simplified.

The possibility of price falling below par after listing

is remote.

Limitations of Book Building Method

The book building process adopted in India is quite different

from the USA.

In India, unlike the developed markets, the process is still

dependent on good faith.

There is a lack of transparency at critical steps and the absence

of strong regulation.

Since the price fixed for the public portion as well as for the

placement portion is the same, issues may not succeed in

inviting the desired public response.

Limitations of Book Building Method

Advertisement about book built issues to retail investors are

not necessary. This increases the chances of negotiated deals.

It has not proved to be a good price discovery mechanism

because many issues have been listed below their issue price.

Issuers may have to sell cheap due to the collective bargaining

power of institutions.

The role of retail investors in determining the pricing

decreases. Moreover, retail investors may not have the

information to judge the issue.

REVERSE BOOK BUILDING

Reverse book building is a process wherein the

shareholders are asked to bid for the price at which

they are willing to offer their shares.

This process helps in discovering the exit price and is

used by companies who want to delist their shares or

buy-back shares from the shareholders.

Delisting of securities means permanent removal of

securities of a listed company from a stock exchange.

REVERSE BOOK BUILDING

The reverse book building route is a difficult and

costly process.

Price discovery is a problem in case of small

companies as their shares are thinly traded, making it

difficult to delist through the reverse book building

route. Unless the shares are delisted, the small

companies have to pay all listing charges.

GREEN-SHOE OPTION Green-shoe option is also referred to as an over allotment

option. It is a mechanism to provide post-listing price

stability to an initial public offering.

The green shoe company was the first to issue this type of

option, hence the name green-shoe option.

The first ever exercise of a green-shoe option in the

course of a public issue was carried out by the ICICI

bank. The LIC became the first institution to lend shares

in the primary market.

BENEFITS OF GREEN-SHOE OPTION Investor protection measure- especially for protection of

small investors during the post-listing period.

Benefits the underwriters in both bullish and bearish

conditions.

In a bull market, underwriters will opt for additional

allotment of 15 per cent due to index riding high.

In a bearish market, the underwriting option may not be

exercised or the underwriters may buy up to 15 per cent at

prices lower than the issue price from the market.

ON-LINE IPOs

The on-line issue of shares is carried out via the electronic

network of the stock exchanges.

The company proposing to make a public issue through the on-

line system of stock exchange has to comply with sections 55-

68A of the companies act, 1956 and Disclosure and Investor

Protection (DIP) guidelines.

The issuer company is required to enter into an agreement with

stock exchanges which have the requisite system for an o-line

offer and has to appoint brokers and registrars to the issue

having electronic connectivity with stock exchanges.

BENEFITS OF ON-LINE IPOs

Reduces the time taken for the issue process.

Securities get listed within 15 days from the closure of the

issue, thereby enabling faster access to funds.

If allotment made after 15 days then interest at the rate of 15

per cent should be paid to investors.

Corporates can reduce their stationery, printing and other

expenses.

The investor also benefits as the system eliminates refunds

except in case of direct application.

PRIMARY ISSUES-PUBLIC ISSUE

1. Initial Public Offering (IPO):

It is an offering of either a fresh

issue of securities or an offer for sale of existing securities, or

both by an unlisted company for the first time to the public.

IPO enables listing and trading of the issuer’s securities.

The availability of information regarding the past performance

of the company and its track record is generally inadequate

and may lack credibility. The SEBI has laid down entry norms

to protect the interest of investors and to enable investors to

take informed decisions.


Eligibility Norms for Entities Raising Funds through an IPO

and an FPO:

Entry Norm I:

Net tangible assets of atleast Rs 3 crores for 3 full years, of which not

more than 50 per cent is held in monetary assets.

Distributable profits in atleast 3 out of the preceding 5 years.

Net worth of atleast Rs 1 crore in 3 years.

If there is a change in company’s name, atleast 50 per cent revenue

for preceding 1 year should be earned from the new activity.

The issue size should not exceed 5 times the pre-issue net worth.


Entry Norm II:

Issue shall be through a book building route, with atleast 50

per cent of the issue to be mandatorily allotted to the QIBs,

failing which the money shall be refunded.

The minimum post-issue face value capital shall be Rs 10

crore or there shall be compulsory market making for atleast

2 years.

OR


Entry Norm III:

The ‘project’ is appraised and participated to the extent of 15

per cent by FIs/Scheduled commercial banks of which atleast

10 per cent comes from the appraiser(s).

The minimum post-issue face value capital shall be Rs 10

crore or there shall be a compulsory market making for

atleast 2 years.


The SEBI has exempted the following entities from entry

norms:

1. Private sector banks.

2. Public sector banks.

3. Rights issue by a listed company.


2. Follow-on Public Offering (FPO):

It is an offer of sale of securities

by a listed company. FPO is also known as subsequent or

seasoned public offering. Listed companies issue FPOs to

finance their growth plans. Listed companies with a good

track record find it easier to raise funds through FPOs.

Due to cumbersome procedural requirements and high cost

and time, the FPOs are no longer an attractive route to raise

funds. Listed companies are preferring the QIP route .

PRIMARY ISSUES-RIGHTS ISSUE

3. Rights Issue:

Rights issue is an offer of new securities by a listed

company to its existing shareholders on a pro-rata basis. Companies

issue rights 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:

a) To exercise the rights.

b) Renounce rights and sell them in the open market.

c) Renounce part of the rights and exercise the reminder.

d) To do nothing.

PRIMARY ISSUES-RIGHTS ISSUE

Promoters offer rights issues at attractive price due to

following reasons:

a) They want to get their issues fully subscribed to.

b) To reward their shareholders.

c) It is possible that the market price does not reflect a stock’s true

worth or that it is overpriced, prompting promoters to keep the

offer price low.

d) To hike their stake in their companies, thus, avoiding the

preferential allotment route which is subject to lot of restrictions.

PRIMARY ISSUES-PRIVATE PLACEMENT

4. Private Placement:

Private placement refers to the direct sale of newly

issued securities by the issuer to a small number of investors

through merchant bankers. The investors are selected clients such as

financial institutions, corporates, banks.

There are some advantages to the issuer like the time taken by, as

well as the cost of issue is much less as compared to the public and

rights issue. These issues can be tailor-made to suite the

requirements of both the parties. Moreover private placement does

not require detailed compliance of formalities, rating and disclosure

norms as required in public or rights issues.

PRIMARY ISSUES-PREFERENTIAL ISSUE

Due to cumbersome statutory provisions of a public/rights issue,

many companies opt for preferential allotment of shares for raising

funds.

Such allotments are made to various strategic groups including

promoters, foreign partners, technical collaborators and private

equity funds. Companies need to seek approval from shareholders

for preferential allotment of shares.

It is done by listed companies, whose entire shareholding is held in

dematerialised form, to a select group of persons under section 81 of

the companies act, 1956 which is neither a rights issue or a public

issue.

PRIMARY ISSUES-PREFERENTIAL ISSUE

Reasons for raising capital through preferential allotment:

a) To enhance the promoters’ holding.

b) As part of debt restructuring/conversion of loans.

c) For the purpose of strategic investments by

institutional/foreign investors.

d) To issue shares by way of Employees Stock Option Plans

(ESOPs).

e) For fresh issue to shareholders other than promoters.

f) For take over of company by management group.

PRIMARY ISSUES-QIP

6. Qualified Institutions Placement (QIP):

QIP is a private

placement of equity shares or convertible securities by a

listed company to QIBs.

It has emerged as a new fund raising investment for listed

companies in India.

Through a QIP issue, funds can be raised from foreign as well

as domestic institutional investors without getting listed on a

foreign exchange, which is a lengthy and cumbersome affair.

PRIMARY ISSUES-QIP

The issue process is not only simple but can be completed

speedily since the company issues equity shares and does not

create a derivative investment as is the case with GDR/ADR.

Unlike GDRs, a QIP issue can be offered to a wide set of

investors including Indian mutual funds, banks and insurance

companies, as well as, FIIs.

As there is no new stock exchange listing, the issue is free

from the hassles of continuing disclosures and administrative

costs.

Resource Mobilisation from International Capital Market

Global Depository Receipts (GDRs):

GDRs are listed o the European

stock exchanges or on the Asian stock exchanges such as the Dubai

and Singapore stock exchanges.

American Depository Receipts (ADRs)

External Commercial Borrowings (ECBs)

Foreign Currency Convertible Bonds (FCCBs)

INDIAN DEPOSITORY RECEIPTS (IDRs)

Enable foreign companies to raise capital in India.

Enable Indian investors to diversify risk.

Enable globalisation of Indian stock exchanges.

Steps to Improve Primary Market Infrastructure

The IPO process should be automated wherein the investor

will have to provide his name and depository umber or the

unique identification number while subscribing to an IPO.

The book running lead manager should be made more

accountable and should be empowered to pick up his team.

To increase retail participation in public issues and to maintain

the retail character of the primary market, there must be direct

retailing of primary issues and allotment incentives for early

bid investors.

There must be 10 per cent margin imposed on all QIB bids.

Steps to Improve Primary Market Infrastructure

Issue expenses should be reduced by way of issuing

electronic prospectus rather than application forms.

Internet and digital signatures should also be considered to

prevent the use of paper and save precious natural resources.

Certified brokers should be used for even non-online

applications.

primary market

Economy & Finance