Primary Market – Basic Concepts

"Primary market" may also refer to a market in art valuation. The primary market is the part of
the capital market that deals with the issuance and sale of equity-backed securities to investors
directly by the issuer. Investors buy securities that were never traded before. Primary markets
create long term instruments through which corporate entities raise funds from the capital
market. It is also known as the New Issue Market.

Since the securities are issued directly by the company to its investors, the company receives the
money and issues new security certificates to the investors. The primary market plays the crucial
function of facilitating the capital formation within the economy. The securities issued at the
primary market can be issued in face value, premium value, and at par value.

Functions of Primary Market

The main service functions of the primary market are origination, under writing and distribution.

a) Origination
It refers to the work of investigation, analysis and processing of new project proposals. This
function starts before an issue is actually floated in the market. There are two aspects of this
function. A careful study of the technical, economic and financial viability is necessary to ensure
soundness of the project. This is a preliminary investigation undertaken by the sponsors of the
issue. The other aspect is advisory services, which improve the quality of capital issues and
ensure its success. The function of origination is done by merchant bankers who may be
commercial banks, all India financial institutions or private firms.

b) Underwriting
It is an agreement whereby the underwriter promises to subscribe to a specified number of shares
or debentures or a specified quantity of stock in the event of public not subscribing to the issue.
If the issue is fully subscribed, then there is no liability for the underwriter. If a part of share
issues remain unsold, the underwriter will buy the unsold shares.

c) Distribution
Distribution is the function of sale of securities to ultimate investors. This service is performed
by brokers and agents who maintain regular and direct contact with the ultimate investors.

PARTIES INVOLVED IN THE NEW ISSUE:

In the sixties and seventies, public issue was managed by the company and its personnel. But, at
present public issue involves a number of agencies. The rules and regulations, the changing
scenario of the capital market necessitated the company to seek for the support of many agencies
to make the public issue a success. As a student of investment management, one should know the
number of agencies involved and their respective role in the public issue. The promoters also
should have a clear idea about the agencies to coordinate their activities effectively in the public
issue. The main issue, registrars to the issue, underwriters, bankers, advertising agencies,
financial institutions and government /statutory agencies.
The functionaries in the new issue market are those concerned with the formation of joint stock
companies and the issue of their securities to the public. There are many functionaries in the new
issue market. The important of them are discussed below.
Managers to the issue
Registrar to the issue
Underwriters
Bankers
Advertising agencies
Financial institutions
Government or statutory agencies.

Managers to the issue:

The issuing company appoints the managers to manage activities relating to the issue. The
merchant banking division, subsidiary of commercial banks, foreign banks, private banks and
private agencies are competent to act as managers to the issue. Generally, they perform the
following duties:
 Drafting of prospectus.
 Preparing budgeted expenses related to the issue.
 Determining the appropriate timing of the issue.
 Advising the company on the matters related to the appointment of registrars,
underwriters, brokers, bankers to the issue, advertising agencies, etc.

Promoters
Modern industrial enterprises require large amount of capital which can be raised only by
resorting to the joint stock form of organization. Company promoters and syndicates do the work
of establishing a joint stock company. It is the promoter who is responsible for conception or
discovery of the idea to exploit the possibility of some industrial proposition. They work up
details, formulate the financial plan which they usually do with the help of an issue house and
finally they have to procure funds to put the proposition into active operation.

In case the company is successfully established and investors come forth to take up its shares, the
promoter is duly rewarded. If the venture fails, he stands to lose not only his money he had sunk
in the venture but his reputation as well. The promoters, in the case of projects of large
dimensions, form a syndicate. All members of the syndicate work up the possibilities of the
proposition and undertake the investigation and examination of the scheme. After completing the
financial plan, the work of drawing up the prospectus, the memorandum of association and
articles of association for the formal incorporation as a company is launched. After all the
formalities are completed, the new company is ready to be launched and its issue is to be placed
before the public.

Registrar to the issue:

Registrars are appointed in consultation with the lead managers to the issue. SEBI has laid down
guidelines relating to the appointment of a registrar. Companies having competency and
expertise, manpower, infrastructure and capital adequacy are allowed to appoint registrar to the
issue. A registrar is an important intermediary who performs all the activities connected with the
new issue management. Usually, the registrar to the issue performs those functions connected
with the allotment of securities.

Duties of the Registrar to the issue:

 The registrars help in identifying the collection centres and collecting banker. They
receive share applications from various collection centres.
 They reclassify valid applications for allotment of securities.
 They approach regional stock exchange and finalize the basis of allotment. Then they
finalize the allotment of securities on the basis of approval by the stock exchange.
 The registrars arrange for the dispatch of the share certificates.
 The registrars make arrangements to pay the brokerage and underwriting commission.
 They also assist the company in getting the shares listed on the stock exchange.

Underwriters:
Underwriting is a contract in which the underwriter guarantees subscription to the issue.
Underwriters may be financial institutions, banks and approved investment companies. While
appointing an underwriter, his financial strength, experience in the primary market, past
underwriting performance, outstanding underwriting commitment, investor clientele etc., are
considered by the issuing company.

After the closure of subscription, the company furnishes the details of shares which are not
subscribed to the underwriter. He would take up the agreed portion of the shares. If he fails to do
so, the company may claim damages from the underwriter for any loss suffered by it.

Underwriters are divided into two categories (i) financial institutions and banks (ii) brokers and
approved investment companies. Some of the underwriters are financial institutions, commercial
banks, merchant bankers, members of the stock exchange, Export and Import Bank of India etc.
The underwriters are exposed to the risk of non-subscription and for such risk exposure they are
paid an underwriting commission.

Before appointing an underwriter, the financial strength of the prospective underwriter is

considered because he has to undertake the agreed non-subscribed portion of the public issue.
The other aspects considered are (a) experience in the primary market (b) past underwriting
performance and default (c) outstanding underwriting commitment (d) the network of investor
clientele of the under underwriter and (e) his overall reputation.

Bankers:
The role of bankers in connection with issue is very important. They collect application money
along with application forms. They charge commission in consideration of the services
performed for the issuing company. If the issue is large, more than one banker may be appointed.
The banker should have branches in those collection centres specified by the central government.
Bankers may be coordinating bankers or collecting bankers. Collecting bankers collect
subscription, while coordinating bankers coordinate the collection work. They also monitor the
issue and report to the registrars.

The bankers to the issue should have branches in the specified collection centres. In big or
metropolitan cities more than one branch of the various bankers to the issue are designated as
collecting branches are designated in the different towns of the state where the project is being
set up. If the collection centres for application money are located nearby people are likely to
invest the money in the company shares.

Advertising Agencies:
Advertising plays an important role in promoting the issue. So, while selecting an advertising
agency, the competency and the past record of the advertising agency are the factors that are
considered before its appointment. Moreover, the tentative programmes (proposals) and
estimated costs of various advertising agencies are scrutinized before selecting one. Finally, a
suitable advertising agency is appointed in consultation with the lead managers to the issue.
Advertising agencies undertake to give wide publicity to the issue through media such as
newspapers, magazines, bill boards, television, etc.

Financial Institutions:
In India, financial institutions also underwrite the issue. They also extend term loans to the
issuing company. The lead manager a sends copy of the prospectus and the proposed programme
for public issue to the financial institutions. On the strength of these documents, the financial
institutions agree to underwrite and give financial help.

Government and Statutory Agencies:

The following are the some important government and statutory agencies related to the new issue
in the primary market.
 Securities Exchange Board of India (SEBI)
 Registrar of Companies.
 Reserve Bank of India in case of issue involving foreign investments.
 Stock Exchange on which the issue is to be listed.
 Industrial licensing authorities; and,
 Pollution Control authorities, whose clearance is obtained for the project, is to be stated
in the prospectus.