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?
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 – private placement 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
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.
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:
The underwriting group consists of investment banks that do the work of origination and price determination for a given security and then oversee its distribution directly to investors.
Securities are created in the primary market. They stay there for a small amount of time as they are sold at the stock exchange 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 has been a guide to what is Primary Market, underwriting process, the cost involved, primary market examples. You may have a look at other Investment Banking articles for more information