Understanding Primary Market and its Functions

Summary:

Stocks are created for the first time in the primary market, where purchasers and issuers are directly involved in a stock’s sale process.

An integral part of stock markets, a primary market is the birthplace of securities. It’s the primary market where investors get stocks for the first time. It’s in this market where issuers and purchasers get involved directly in the sale process, and it serves as the platform where companies raise capital by offering their stocks directly to investors.

What is a primary market?

The primary market is where stocks are created for the first time for you, the investor, to purchase. You can think of it as the initial phase of a security’s lifecycle before entering the secondary market. By selling stocks for the first time to the public, firms raise funds to address various needs, such as financing projects, expanding operations, and bringing down debt, among others.

Working of the primary market

Here’s how the primary market works:

• Issuer

The issuer is at the heart of the primary market, and it could be a company or government entity that decides to raise funds by issuing new securities. 

• Underwriters

Issuers don’t come directly to sell securities to investors. Instead, they take the help of underwriters who assist in structuring the offering in line with regulatory compliance. Underwriters can be banks who buy the newly issued securities and then sell them to you.

• Initial public offering (IPO)

Once underwriters complete the underwriting process, you get the securities through IPO. You can participate in IPOs and place your bid through your broker.

Functions of the primary market

Given below are the major functions of this market:

• Facilitates the raising of capital

Primary markets help in capital formation for companies. When firms want to expand and grow their business, they require substantial funds. Governments need money for various initiatives such as building infrastructure, undertaking social programmes, etc. By issuing securities for the first time in the primary market, companies and governments raise money for the same.

• Offers early investment opportunities

The primary market offers you investment opportunities that may not be available directly in the secondary market. By purchasing securities directly from the issuing company, you stand a chance of having a potentially early entry into an investment.

Companies offer securities at an attractive price point for the first time to investors to attract them. The initial pricing can be more favourable than the pricing in the secondary market.

• Presents transparency

Primary markets operate within strict regulatory guidelines that safeguard your interest as an investor. These regulations require a company to provide accurate information about its financials and potential investment risks. This ensures transparency and enables you to make well-informed decisions. 

Companies must also provide detailed information about their business operations and events that may impact their prospects. All these go a long way in ensuring you make intelligent investment decisions.

Types of primary market issues

The different types of primary market issues are as follows:

• IPOs

It is the most common type of primary market issue. It occurs when a company offers its stocks to the public for the first time. Investing in a company’s IPO allows you to join its growth journey and build wealth.

• Follow-on Offer

A follow-on offer occurs when an already listed company issues additional shares to the public. Companies do this to raise additional funds to meet their needs.

• Rights issue

A rights issue is a type of primary market issuance where companies allow you to buy additional shares at a discounted price in proportion to your current ownership. For example, a company may offer rights issues in the proportion of 1:10, meaning for every 10 stocks you hold, you have the right to buy 1 stock at a price lower than the current market price. 

• Private placement

In this type of primary market issuance, companies offer securities to a small group of people and not the general public. Firms go for private placement when they want to raise fresh funds without extensive regulatory requirements associated with IPOs.

• Preferential allotments

Also known as preferential issue, it involves issuing securities to a group of existing shareholders at a predetermined price. It is one of the quickest methods through which companies can raise money.

To conclude

The primary market is the place where you get the opportunity to give shape to your financial dreams. At the centre of the stock markets, the primary market plays a crucial role in catalysing India’s economic growth while providing you the avenue to be an early participant in buying stocks across industry verticals.