Primary Market

What are Primary Markets?

Primary market is the place where debt-based, equity-based or any other asset based securities are created, under written and sold off to investors. In simple words, it is a part of the capital market where new securities are created are directly purchased by the investors from the issuer.

How to Raise Capital in Primary Market?

Primary Markets

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Raising capital can happen in one of the four ways.

  • Public Issue – This term refers to the company’s issuing of new securities through its initial public offer (IPO) and is “going public.”  A large number of investors can purchase these newly issued securities in this open primary market.
  • Rights Issue – Rights issue is an invitation to the existing shareholders to purchase additional new shares (in the proportion of their holdings) within a fixed time period.
  • Private Placement of Shares – it refers to raising equity capital (not public) from selected investors like Venture Capital, Funds, and insurance companies.
  • Preferential Allotment – It is the process by which allotment of shares is done on a preferential basis to a select group of investors.

As noted above, such a market where companies can issue new securities to raise external capital, and investors get their first chance to purchase new security is called the “primary market” (also known as the new issues market).

Primary Market Examples

Alibaba IPO

On 6th May 2014, Chinese E-commerce heavyweight Alibaba filed a registration document to go to public in the US in what may be the mother of all Initial Public Offerings in the US history. Alibaba is a fairly unknown entity in the US and other regions, though its massive size is comparable or even bigger than Amazon or eBay.

Reading through Alibaba’s S-1 Filing was very interesting, educating and makes me realize how big their business is and how complex is the Chinese Internet Web. I prepared a full excel-based financial model, which you may download from Alibaba Financial Model here.

Box IPO

On 24th March 2014, Online storage company Box filed for an IPO and unveiled its plans to raise US$250 million. The company is in a race to build the largest cloud storage platform, and it competes with larger companies like Google Inc and its rival, Dropbox.

I quickly browsed through Box S1 Filing, and when I was hoping to see a Cool Blue Box, it turned out to be a diffused “Black Box.” I also prepared a quick and dirty Box Financial Model to further access the gravity of the situation and realized that Box Financials were full of horror stories. You may also want to download the Box IPO Financial Model for further details.

Functions of Primary Market

A beginner would wonder how this IPO is carried out and how the initial price of the new securities being issued is determined. The answer is the “underwriting groups,” which facilitate this process for the issuer entity. The underwriter is an important entity in the primary market which carries out the following three functions:

Functions of Primary MArkets

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The underwriting group consists of investment banksInvestment BanksInvestment banking is a specialized banking stream that facilitates the business entities, government and other organizations in generating capital through debts and equity, reorganization, mergers and acquisition, etc.read more that do the work of origination and price determination for a given security and then oversee its distribution directly to investors.

Conclusion

Securities are created in the primary market. They stay there for a small amount of time as they are sold at the stock exchangeStock ExchangeStock exchange refers to a market that facilitates the buying and selling of listed securities such as public company stocks, exchange-traded funds, debt instruments, options, etc., as per the standard regulations and guidelines—for instance, NYSE and NASDAQ.read more by the institutional investors who bought them during the IPO. But it is extremely important for the company that has decided to go public.

The price determination method is not different from the general concept of demand-supply balance and perceived value of the offering. However, it is equally resourced consuming, as is a product launch. But that is worth it. After all, the amount of money that the company is able to raise by going public is determined by how the primary market behaves!

Video on Primary Market

 

This article has been a guide to what is Primary Market, the underwriting process, the cost involved, primary market examples. You may have a look at other Investment Banking articles for more information

Reader Interactions

Comments

  1. Calvin Stentson says

    Thanks for this wonderful blog. Could you please tell me what market capitalization is and how it is calculated?

    • Dheeraj Vaidya says

      Market capitalization is an important concept to the investors who are looking for investing in company shares. In simple terms market capitalization is the value of company in the market and it is computed on the market value of the outstanding shares of the company in the market. The formula to calculate Market Capitalization is (Market Capitalization = Outstanding shares * Market Price of each Share). Please have a look at this detailed article on Market Capitalization

  2. Dominick Haiden says

    Excellent work. Thank you very much for explaining this in detail. Do you know what is Forex market and what does it do?

    • Dheeraj Vaidya says

      Thanks for your note. Forex market is a worldwide regionalized market for the trading of currencies. Forex market regulates the relative values of different currencies; it also functions on different stages and woks through financial institutions. Hope this was useful for you.