Primary Market in India: Functions, Activities, and Issue Mechanisms

When a private company—whether an established manufacturing conglomerate or a new-age tech startup like Zomato or Nykaa—decides to expand by raising hundreds of crores directly from the public, it enters the Primary Market.

Also known as the New Issue Market (NIM), this is the exact marketplace where fresh financial securities are born and issued for the very first time.

1. What is the Primary Market?

The primary market is the segment of the capital market that facilitates the mobilization of fresh long-term capital by issuing new securities directly to the investing public, institutions, or select groups of investors.

• Direct Transfer of Funds: Unlike the secondary market (where money transfers from one investor to another), in the primary market, investor funds flow directly into the treasury of the issuing company in exchange for newly created share certificates or debt debentures.
• Capital Formation: The primary market directly facilitates net capital formation in the real economy by funding new factories, machinery, acquisitions, and infrastructure projects.

2. Core Activities and Functions of the Primary Market

The primary market performs three vital functions:

1. Origination:
   • Preliminary analysis of the feasibility of the proposed capital project.
   • Determining the capital structure, class of securities (equity vs debentures), face value, timing of issue, and drafting the Draft Red Herring Prospectus (DRHP) under SEBI (Issue of Capital and Disclosure Requirements) Regulations (ICDR).
2. Underwriting:
   • Institutional insurance against market risk. If public demand falls below the statutory minimum subscription threshold (90% of net offer mandated by SEBI), the underwriters (merchant banks and investment institutions) step in to purchase the remaining balance.
3. Distribution:
   • Selling the securities across institutional buyers (Qualified Institutional Buyers - QIBs), High-Net-Worth Individuals (Non-Institutional Investors - NIIs), and retail individual investors using nationwide broker networks and the electronic ASBA (Application Supported by Blocked Amount) system.

3. Methods of Issuing Securities in the Primary Market

A corporation can raise primary capital through several distinct issuance mechanisms:

Method 1: Public Issue

Securities are offered openly to the general public through an offer document (prospectus):

• Initial Public Offering (IPO): An unlisted company offers its shares to the public for the first time, leading to subsequent listing on recognized stock exchanges (BSE/NSE).
  • Fresh Issue: The company creates brand new shares, expanding its equity base and receiving all proceeds.
  • Offer for Sale (OFS): Existing promoters or venture capital investors liquidate their personal holdings to the public; proceeds flow to the selling shareholders rather than company coffers.
• Follow-on Public Offering (FPO): An already listed public company issues additional shares to the public to raise supplementary funds.

Method 2: Rights Issue (Section 62 of Companies Act, 2013)

• When an existing listed company issues fresh shares, it must first offer them to its existing equity shareholders in proportion to their current holding (pre-emptive right).
• Usually offered at a discount to the prevailing secondary market price.
• Shareholders have three options:
  1. Exercise the right and purchase the shares.
  2. Renounce the rights entitlement in favor of someone else for cash.
  3. Let the right lapse unexercised.

Method 3: Bonus Issue

• Shares issued free of cost to existing shareholders in a fixed ratio (e.g., 1:1 or 2:1) by capitalizing accumulated free reserves and securities premium.
• It increases the liquidity and number of shares but does not bring any new cash into the company.

Method 4: Private Placement

• Direct sale of securities to a selected group of sophisticated institutional or accredited investors (not exceeding 200 persons in a financial year), avoiding the expensive and time-consuming public IPO process.
• Qualified Institutional Placement (QIP): A fast-track mechanism enabling listed Indian companies to issue equity shares or convertible securities exclusively to Qualified Institutional Buyers (mutual funds, insurance firms, foreign portfolio investors).
• Preferential Allotment: Allotment of shares to specific strategic partners, promoters, or anchor investors approved by a special shareholder resolution.

4. Issue Pricing Mechanisms: Book Building vs. Fixed Price

The ASBA Process (Application Supported by Blocked Amount)

Under SEBI mandates, retail investors applying for IPOs do not pay cash upfront. Instead, funds are simply lien-marked / blocked in their bank accounts via UPI or net-banking:

• If allotted shares: Exact money is debited and shares are credited to the demat account within 2-3 business days.
• If unallotted: The bank instantly releases the hold on funds, eliminating refund processing delays.

5. Key Intermediaries in the Primary Market

A successful public issue requires the coordinated efforts of specialized SEBI-registered intermediaries:

1. Merchant Bankers (Book Running Lead Managers - BRLMs):
   • The quarterback of an IPO. They structure the issue, conduct financial due diligence, draft the DRHP prospectus, liaise with SEBI and stock exchanges, price the band, and manage roadshows.
2. Underwriters:
   • Financial institutions that commit to absorbing unsubscribed portions of an issue, protecting the company from issue failure.
3. Registrar to the Issue:
   • Independent agency (e.g., KFin Technologies, Link Intime) that validates bids, ensures valid PAN/Demat linkages, calculates basis of allotment, and handles share crediting.
4. Bankers to the Issue (Escrow Collection Banks):
   • Scheduled commercial banks that manage escrow accounts and release blocked ASBA funds upon allotment.

Important Exam Questions for Revision

1. Short Answer Question (3-4 Marks): What is the difference between a Fresh Issue of shares and an Offer for Sale (OFS) in an IPO?
2. Medium Answer Question (7-8 Marks): Explain the Book Building process of pricing securities. How does it differ from the Fixed Price method?
3. Long Essay Question (14-15 Marks): Discuss the nature, functions, and activities of the Primary Market in India. Describe the various methods available to an Indian company for raising primary capital.