This module discusses various components of the Primary Market and methods to determine offer price of the IPO.

1. PRIMARY MARKET
Dr. Vinita Kalra

2. INTRODUCTION
 The primary market is a market for new issues.
 It is also called the new issues market or market for
fresh capital.
 Four ways to raise capital through primary market:-
1)Prospectus
2)Rights issues
3)Private placement
4)Bonus issue

3.  According to section 67 of the companies
(Amendment) Act, 2000 Prospectus means ‘where the
offer or invitation to subscribe for shares or debenture
is made to 50 or more persons, then such an offer or
invitation shall be deemed to be a public offering and
shall have to comply with all the provisions of the act
as well as the SEBI guidelines applicable to such
public offerings.
PROSPECTUS

4. Why Bonus Issue?
 Bonus is the capitalization of free reserves. Higher
the free reserves, higher are the chances of a bonus
issue. Companies convert their retained earnings
into capital.
1) To boost liquidity of companies stock
2) To bring down the stock price
3) To restructure companies capital

5. Participants in the Primary Market
1. Merchant Bankers or BRLM
2. Registrar to the issue
3. Bankers to the issue
4. Agents/Brokers
5. Auditors of the company
6. Syndicate members

6. Methods for Determining the Offer Price
1. Fixed Price
2. Book Building
 Book building is a mechanism through which an offer
price for IPOs based on the investors’ demand is
determined.
 In other words, it is a process by which demand for the
proposed issue is elicited and built-up and the price at
which the securities will be issued is determined on the
basis of the bids received.

7. Difference between Fixed Price and Book-
Building Process
Features Fixed Price Process Book-building Process
Pricing Price at which the securities
are offered/allotted is
known in advance to the
investor.
Price at which the securities are
offered/allotted is not known in
advance to the investor. Only an
indicative price range is known.
Demand Demand for the securities
offered is known only after
the closure of the issue.
Demand for the securities offered
can be known everyday as the book
is built.
Payment Payment is made at the time
of subscription wherein
refund is given after
allocation.
Payment only after allocation.

8. BOOK BUILDING PROCESS
Flow chart showing book building process

9. BOOK BUILDING OPTIONS

10. Benefits of Book Building Method
Enables issuers to reap benefits arising from price and
demand discovery.
The cost and time for making public issues is
lowered.
The procedures are also simplified.
The possibility of price falling below par after listing
is remote.

11. Limitations of Book Building Method
The book building process adopted in India is quite different
from the USA.
In India, unlike the developed markets, the process is still
dependent on good faith.
There is a lack of transparency at critical steps and the absence
of strong regulation.
Since the price fixed for the public portion as well as for the
placement portion is the same, issues may not succeed in
inviting the desired public response.

12. Limitations of Book Building Method
Advertisement about book built issues to retail investors are
not necessary. This increases the chances of negotiated deals.
It has not proved to be a good price discovery mechanism
because many issues have been listed below their issue price.
Issuers may have to sell cheap due to the collective bargaining
power of institutions.
The role of retail investors in determining the pricing
decreases. Moreover, retail investors may not have the
information to judge the issue.

13. REVERSE BOOK BUILDING
 Reverse book building is a process wherein the
shareholders are asked to bid for the price at which
they are willing to offer their shares.
 This process helps in discovering the exit price and is
used by companies who want to delist their shares or
buy-back shares from the shareholders.
 Delisting of securities means permanent removal of
securities of a listed company from a stock exchange.

14. REVERSE BOOK BUILDING
 The reverse book building route is a difficult and
costly process.
 Price discovery is a problem in case of small
companies as their shares are thinly traded, making it
difficult to delist through the reverse book building
route. Unless the shares are delisted, the small
companies have to pay all listing charges.

15. GREEN-SHOE OPTION
 Green-shoe option is also referred to as an over allotment
option. It is a mechanism to provide post-listing price
stability to an initial public offering.
 The green shoe company was the first to issue this type of
option, hence the name green-shoe option.
 The first ever exercise of a green-shoe option in the
course of a public issue was carried out by the ICICI
bank. The LIC became the first institution to lend shares
in the primary market.

16. BENEFITS OF GREEN-SHOE OPTION
 Investor protection measure- especially for protection of
small investors during the post-listing period.
 Benefits the underwriters in both bullish and bearish
conditions.
 In a bull market, underwriters will opt for additional
allotment of 15 per cent due to index riding high.
 In a bearish market, the underwriting option may not be
exercised or the underwriters may buy up to 15 per cent
at prices lower than the issue price from the market.

17. ON-LINE IPOs
 The on-line issue of shares is carried out via the electronic
network of the stock exchanges.
 The company proposing to make a public issue through the
on-line system of stock exchange has to comply with sections
55-68A of the companies act, 1956 and Disclosure and
Investor Protection (DIP) guidelines.
 The issuer company is required to enter into an agreement
with stock exchanges which have the requisite system for an
o-line offer and has to appoint brokers and registrars to the
issue having electronic connectivity with stock exchanges.

18. BENEFITS OF ON-LINE IPOs
 Reduces the time taken for the issue process.
 Securities get listed within 15 days from the closure of the
issue, thereby enabling faster access to funds.
 If allotment made after 15 days then interest at the rate of 15
per cent should be paid to investors.
 Corporates can reduce their stationery, printing and other
expenses.
 The investor also benefits as the system eliminates refunds
except in case of direct application.

19. PRIMARY ISSUES-PUBLIC ISSUE
1. Initial Public Offering (IPO):
It is an offering of either a fresh
issue of securities or an offer for sale of existing securities, or
both by an unlisted company for the first time to the public.
IPO enables listing and trading of the issuer’s securities.
 The availability of information regarding the past
performance of the company and its track record is generally
inadequate and may lack credibility. The SEBI has laid down
entry norms to protect the interest of investors and to enable
investors to take informed decisions.

20. PRIMARY ISSUES-PUBLIC ISSUE
 Eligibility Norms for Entities Raising Funds through an IPO
and an FPO:
 Entry Norm I:
 Net tangible assets of atleast Rs 3 crores for 3 full years, of which not
more than 50 per cent is held in monetary assets.
 Distributable profits in atleast 3 out of the preceding 5 years.
 Net worth of atleast Rs 1 crore in 3 years.
 If there is a change in company’s name, atleast 50 per cent revenue
for preceding 1 year should be earned from the new activity.
 The issue size should not exceed 5 times the pre-issue net worth.

21. PRIMARY ISSUES-PUBLIC ISSUE
 Entry Norm II:
 Issue shall be through a book building route, with atleast 50
per cent of the issue to be mandatorily allotted to the QIBs,
failing which the money shall be refunded.
 The minimum post-issue face value capital shall be Rs 10
crore or there shall be compulsory market making for atleast
2 years.
OR

22. PRIMARY ISSUES-PUBLIC ISSUE
 Entry Norm III:
 The ‘project’ is appraised and participated to the extent of 15
per cent by FIs/Scheduled commercial banks of which atleast
10 per cent comes from the appraiser(s).
 The minimum post-issue face value capital shall be Rs 10
crore or there shall be a compulsory market making for
atleast 2 years.

23. PRIMARY ISSUES-PUBLIC ISSUE
 The SEBI has exempted the following entities from entry
norms:
1. Private sector banks.
2. Public sector banks.
3. Rights issue by a listed company.

24. PRIMARY ISSUES-PUBLIC ISSUE
2. Follow-on Public Offering (FPO):
It is an offer of sale of
securities by a listed company. FPO is also known as
subsequent or seasoned public offering. Listed companies
issue FPOs to finance their growth plans. Listed companies
with a good track record find it easier to raise funds through
FPOs.
 Due to cumbersome procedural requirements and high cost
and time, the FPOs are no longer an attractive route to raise
funds. Listed companies are preferring the QIP route .

25. PRIMARY ISSUES-RIGHTS ISSUE
3. Rights Issue:
Rights issue is an offer of new securities by a listed
company to its existing shareholders on a pro-rata basis. Companies
issue rights by sending a letter of offer to the shareholders whose
names are recorded in the books on a particular date.
 A shareholder has four options in case of rights:
a) To exercise the rights.
b) Renounce rights and sell them in the open market.
c) Renounce part of the rights and exercise the reminder.
d) To do nothing.

26. PRIMARY ISSUES-RIGHTS ISSUE
 Promoters offer rights issues at attractive price due to
following reasons:
a) They want to get their issues fully subscribed to.
b) To reward their shareholders.
c) It is possible that the market price does not reflect a stock’s true
worth or that it is overpriced, prompting promoters to keep the
offer price low.
d) To hike their stake in their companies, thus, avoiding the
preferential allotment route which is subject to lot of restrictions.

27. PRIMARY ISSUES-PRIVATE PLACEMENT
4. Private Placement:
Private placement refers to the direct sale of
newly issued securities by the issuer to a small number of investors
through merchant bankers. The investors are selected clients such
as financial institutions, corporates, banks.
 There are some advantages to the issuer like the time taken by, as
well as the cost of issue is much less as compared to the public and
rights issue. These issues can be tailor-made to suite the
requirements of both the parties. Moreover private placement does
not require detailed compliance of formalities, rating and disclosure
norms as required in public or rights issues.

28. PRIMARY ISSUES-PREFERENTIAL ISSUE
 Due to cumbersome statutory provisions of a public/rights issue,
many companies opt for preferential allotment of shares for raising
funds.
 Such allotments are made to various strategic groups including
promoters, foreign partners, technical collaborators and private
equity funds. Companies need to seek approval from shareholders
for preferential allotment of shares.
 It is done by listed companies, whose entire shareholding is held in
dematerialised form, to a select group of persons under section 81
of the companies act, 1956 which is neither a rights issue or a
public issue.

29. PRIMARY ISSUES-PREFERENTIAL ISSUE
 Reasons for raising capital through preferential allotment:
a) To enhance the promoters’ holding.
b) As part of debt restructuring/conversion of loans.
c) For the purpose of strategic investments by
institutional/foreign investors.
d) To issue shares by way of Employees Stock Option Plans
(ESOPs).
e) For fresh issue to shareholders other than promoters.
f) For take over of company by management group.

30. PRIMARY ISSUES-QIP
6. Qualified Institutions Placement (QIP):
QIP is a private
placement of equity shares or convertible securities by a
listed company to QIBs.
 It has emerged as a new fund raising investment for listed
companies in India.
 Through a QIP issue, funds can be raised from foreign as well
as domestic institutional investors without getting listed on a
foreign exchange, which is a lengthy and cumbersome affair.

31. PRIMARY ISSUES-QIP
 The issue process is not only simple but can be completed
speedily since the company issues equity shares and does not
create a derivative investment as is the case with GDR/ADR.
 Unlike GDRs, a QIP issue can be offered to a wide set of
investors including Indian mutual funds, banks and insurance
companies, as well as, FIIs.
 As there is no new stock exchange listing, the issue is free
from the hassles of continuing disclosures and administrative
costs.

32. Resource Mobilisation from International
Capital Market
 Global Depository Receipts (GDRs):
GDRs are listed o the
European stock exchanges or on the Asian stock exchanges
such as the Dubai and Singapore stock exchanges.
 American Depository Receipts (ADRs)
 External Commercial Borrowings (ECBs)
 Foreign Currency Convertible Bonds (FCCBs)

33. INDIAN DEPOSITORY RECEIPTS (IDRs)
 Enable foreign companies to raise capital in India.
 Enable Indian investors to diversify risk.
 Enable globalisation of Indian stock exchanges.

34. Steps to Improve Primary Market Infrastructure
 The IPO process should be automated wherein the investor
will have to provide his name and depository umber or the
unique identification number while subscribing to an IPO.
 The book running lead manager should be made more
accountable and should be empowered to pick up his team.
 To increase retail participation in public issues and to
maintain the retail character of the primary market, there
must be direct retailing of primary issues and allotment
incentives for early bid investors.
 There must be 10 per cent margin imposed on all QIB bids.

35. Steps to Improve Primary Market Infrastructure
 Issue expenses should be reduced by way of issuing
electronic prospectus rather than application forms.
 Internet and digital signatures should also be considered to
prevent the use of paper and save precious natural resources.
 Certified brokers should be used for even non-online
applications.