Overview of Primary market Chapter 1

CBCS: Fundamentals of Stock Markets

Chapter 1

AN OVERVIEW OF
PRIMARY MARKET
CONTENTS:

1.0: CONCEPT OF FINANCIAL MARKETS

1.1: CLASSIFICATION OF FINANCIAL MARKETS
1.2: CONCEPT OF CAPITAL MARKETS
1.3: INTRODUCTION OF PRIMARY MARKETS
1.4: METHODS OF FLOATING NEW ISSUE
1.5: MERITS & DEMERITS OF PUBLIC ISSUE
1.6: MERITS & DEMERITS OF PRIVATE PLACEMENT
1.7: STEPS OR PROCEDURE FOR PUBLIC ISSUE (ISSUE MECHANISM)
1.8: SIGNIFICANCE, ROLE OR FUNCTIONS OF CAPITAL/PRIMARY OR FINANCIAL MARKET
1.9: PLAYERS IN THE NEW ISSUE MARKET/PRIMARY OR CAPITAL MARKET
1.10: IPO GRADING PROCESS
1.11: FACTORS CONSIDERED FOR GRADING IPO
1.12: GLOSSARY

Course Instructor:
Mohammed Umair | M.Com, PGDBA, NET
Faculty Member, Department of Commerce
St. Joseph’s College, Bangalore
Feedback & Questions|mdumair@sjc.ac.in

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Overview of Primary market Chapter 1

1.0: CONCEPT OF FINANCIAL MARKETS

A financial market is a market in which people and entities can trade financial securities, commodities, and other fungible
items of value at low transaction costs and at prices that reflect supply and demand. Securities include stocks and bonds,
and commodities include precious metals or agricultural goods.

Financial Markets 1. Banks

Made up of: 2. Financial Institutions
3. Stock Exchange
4. Foreign Exchange
Lenders Financial Borrowers
Intermediaries
‘Financial markets are the “arena” where potential borrowers and lenders “meet” and
“trade” in financial instruments’.
Individuals Banks Individuals A financial instrument (also called financial asset or financial securities) is the written
legal obligation of one party to transfer something of value, usually money, to another
Insurance party at some future date, under certain conditions.
Companies Companies Companies
Financial markets attract funds from investors and channel them to
corporations—they thus allow corporations to finance their operations
Central and achieve growth. Money markets allow firms to borrow funds on a
Pension Funds Government short term basis, while capital markets allow corporations to gain long-
term funding to support expansion.

Mutual Funds Municipalities Without financial markets, borrowers would have difficulty finding
lenders themselves. Intermediaries such as banks, Investment Banks, and
Boutique Investment Banks can help in this process. Banks take deposits
Public from those who have money to save. They can then lend money from this
Corporations pool of deposited money to those who seek to borrow. Banks popularly
lend money in the form of loans and mortgages.

1.1: CLASSIFICATION OF FINANCIAL MARKETS

Primary Market
Industrial Securities
Market
Secondary Market
Government Securities
Capital Market Market
Term Loan Market

Long Term Loan Market Market for Mortgage

Organized Market
Call money market Market for financial
Guarantees
Financial Market

Commercial bill market

Unorganized Market
Money Market
Treasury bill market
Money lenders and
indigenous bankers
Short term loan market

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1. Organized Financial Markets: In the organized markets, there are standardized rules and regulations governing
the financial dealings. There is also a high degree of institutionalization and instrumentalisation. These markets are
subject to strict supervision and control by the RBI or other regulatory bodies.

2. Unorganized Financial Market: The unorganized Market includes money lenders, indigenous bankers, and traders
etc., who lend money to the public. They also collect deposits from the public. The activities under the Unorganized
Market like private companies, chit funds etc. are not controlled by the RBI. Recently the RBI has taken steps to hold
the unorganized sector under the organized fold.

1.2: CONCEPT OF CAPITAL MARKETS

Capital market is a market that facilitates companies and enterprises in raising income by mobilizing the savings of
individuals, corporate houses and other lenders. It helps companies to in raising long term investment credit. Modern capital
markets are almost invariably hosted on computer-based electronic trading systems; most can be accessed only by entities
within the financial sector or the treasury departments of governments and corporations, but some can be accessed directly
by the public.
Meaning & Definition
 The capital Market is a market for financial assets which have a long (More than one year) or indefinite maturity. It deals with long term
securities which have a making them available to industrial and commercial undertakings.
Or
 Capital Market is a part of a financial system concerned with raising capital by dealing in shares, bonds, and other long-term investments.
Or
 Capital market refers to facilities and institutional arrangements through which long-term funds, both debt and equity are raised and invested

Features of Capital Markets

Capital Market is one of the significant aspect of every financial market. Hence it is necessary to study its correct features.
Broadly speaking the capital market is a market for financial assets which have a long or indefinite maturity. Unlike money
market instruments the capital market instruments become mature for the period above one year. It is an institutional
arrangement to borrow and lend money for a longer period of time. The following are the key features of Capital Markets:
1. It deals with long and medium term funds.
2. It consists of primary and secondary market and special financial institutions.
3. It covers both individual and Institutional investors.
4. It makes funds available to industrial and commercial undertakings.

Financial Instrument of Capital Markets (Products available in Capital market)

Industrial Securities Market Government Securities Market Long Term Loans Market
 Equity Shares  Stock certificates  Secured Loans
 Preference Shares  Promissory notes  Unsecured loans
 Debentures  Bearer Bonds  Collateral based loans
 Bonds  Treasury bills

Classification of Capital Markets

As discussed earlier, capital market is simply any market where a government or a companies can raise money (capital) to
fund their operations and long term investment. Selling bonds and selling stock are two ways to generate capital. Any
government or corporation requires capital (funds) to finance its operations and to engage in its own long-term investments.
To do this, a company raises money through the sale of securities - stocks and bonds in the company's name. These are bought
and sold in the capital markets. The capital markets can broadly classified into following ways:
Classification of Capital Markets
Industrial Securities Market Government Securities Market Long Term Loans Market

A. Industrial Securities Market

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It comprises of the most popular instruments i.e. Equity shares, Preference shares, bonds and debentures. It is a market
where industrial concerns raise their capital by issuing appropriate instruments. It is further sub-divided into two:-
1. Primary Market (New issue market)
2. Secondary Market (Stock Exchange)
Industrial Securities Markets are of two types Primary Secondary
Market Market
1. Primary Market
It is also known as the new issues market, it deals with those securities which are issued to the public for the
first time. Primary market facilitates capital formation. The essential function of a primary market is to
facilitate the transfer of investable funds from savers to entrepreneurs seeking to establish new enterprises
or to expand existing ones through the issue of securities for the first time. The investors in this market are
banks, financial institutions, insurance companies, mutual funds and individuals.

2. Secondary Market
The secondary market, also called stock market, is the financial market in which previously issued financial
instruments in primary market such as stock, debentures and bond are bought and sold. In other words
Secondary market in which an investor purchases a security from another investor rather than the issuer,
subsequent to the original issuance in the primary market.

B. Government Securities Market

It is also called gilt Edged Securities market. It is a market where government securities (G-secs) are traded. In India
there are many kinds of G-secs are traded. G-secs are sold through Public Debt Office of the RBI. They offer a good
source of raising inexpensive finance for the government exchequer and the interest on these securities affect pricing
and yields in the market.

C. Long Term Loans Market

Commercial banks and development banks play a significant role in this market by supplying long term loans to
corporate customers. It is classified into 3 categories:

I. Term Loans Market: Industrial financing institutions have been created by Government at the National and
Regional levels to supply long and medium term loans to corporate customers directly as well as indirectly.
Institutions like IDBI, ICICI, IFCI, and other state financial corporations come under this category. These
Institutions meet the growing and varied long term financial requirements of industries by supplying long
term loans. They help in identifying investment opportunities, encourages new entrepreneurs and support
modernization efforts.
II. Mortgages: A mortgage loan is a loan against the security of immovable property like real estate. The
mortgage market may have primary market as well as secondary market. The primary mortgage is of
original extension of credit and secondary market has sales and re-sales of existing mortgages at prevailing
prices. The Housing and Urban Development Corporation (HUDCO) and LIC play a dominant role in financing
residential projects. Land Development Bank provides cheap mortgage loans for the development of lands,
purchase of equipment etc.
III. Financial Guarantees Market: A guarantee market is a center where finance is provided against the
guarantee of a reputed person in the financial circle. Guarantee is a contract to discharge the liability of
a third party in case of his default.

1.3: INTRODUCTION OF PRIMARY MARKETS

The industrial securities market in India consists of New Issue Market and Stock Exchange. The primary market deals with the
new securities which were not previously available to the investing public, i.e., the securities that are offered to the investing
public for the first time. It is also known as Primary Market. The new issue market deals with the new securities which were
not previously available to the investing public, i.e., the securities that are offered to the investing public for the first time.
The market, therefore, makes available a new block of securities for public subscription. All financial institutions which
contribute, underwrite and directly subscribe to the securities are part of new issue market. There are various intermediaries
like registrars, custodians and merchant bankers that are involved in this activity of issuing new securities.
Meaning & Definition
 The primary market is that part of the capital markets that deals with the issuance of new securities [or]
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Overview of Primary market Chapter 1
 A Financial market in which newly issued securities are offered to the public. [or]
 The primary market is the part of the capital market that deals with issuing of new securities.
Note: Primary Market is also called as New Issue Market

Features of Primary Markets (or New Issue Market)

As disused earlier primary market is the part of capital market where issue of new securities takes place. Public sector
institutions, companies and governments obtain funds for further growth of the company after the sale of their securities or
bonds in primary market. The following are the key features of primary market:
1. It is related with New Issues
2. This is the market for new long term capital
3. Securities are issued by the company directly to investors
4. Capital is raised for starting new ventures and expansion
5. It has No Particular Place
6. On receiving the money from the new issues, the company will issue the security certificates to the investors.

1.4: METHODS OF FLOATING NEW ISSUE

A company can raise capital through the primary market in the form of equity shares, preference shares, debentures, loans
and deposits. Funds raised may be for setting up new projects, expansion, diversification, modernization of existing projects,
mergers and takeovers etc. There are various ways in which a company may raise capital in a primary market, which are
discussed below:
Methods of floating new issue
Made up of:

Public Issue Right Issue Bonus Issue Private ESOP Fast track issue Offer for Sale
IPO & FPO Placement

1. Public Issue
Under this method, this issuing company directly offers to the general public/ institutions a fixed number of shares at
a stated price through a document called prospectus. This is the most common method followed by joint stock
companies to raise capital through the issue of securities. Public issues can be further classified into Initial Public
offerings and further public offerings. In a public offering, the issuer makes an offer for new investors to take part
in company’s capital:

I. Initial Public Offer: IPO

The first sale of stock by a company to the public. More generally, it refers to the actual first sale of stock
to the public. Companies looking for a new source of financing offer most IPOs. When a company reaches
a certain stage in its growth, it may decide to issue stock, or go public, with an initial public offering (IPO).
The goal may be to raise capital, to provide liquidity for the existing shareholders, or a number of other
reasons. Any company planning an IPO must register its offering with the Securities and Exchange Board of
India (SEBI).

II. Follow on Public Offer: FPO

When a company that is already listed on an exchange further issue of securities to the public it is called
follow-on public offer. In other words an issue of shares of stock that comes after a company has already
issued an initial public offering (IPO). A company opts for the FPO route when it wishes to raise additional
capital from the shareholders and new investors.

Difference between an IPO and FPO

Point of Difference IPO FPO

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An Initial Public Offer is primarily for companies Follow on Public Offers are conducted by companies
Concept
which are not listed on a stock exchange. which are listed.
The purpose of an IPO is to enable a new company
The purpose of an FPO is to make additional funds
Purpose to approach shareholders for the first time to raise
available from the public for a company’s expansion.
capital and get listed on a stock exchange.

2. Offer For Sale

i. OFS by Promoter:
An offer for sale (OFS) is method a company’s Promoter or promoter group entities sell their shareholding in the company
public. OFS enables promoters to dilute their holdings in listed companies in a transparent manner with a
wider participation through exchange based bidding. The OFS route helps the promoters of an already
listed company to sell their existing shareholdings through an exchange-based bidding platform. The
promoters of the company are sellers in the OFS process. They can only sell the shares and not buy them.
The buyers include QIBs, RII and HNI. An OFS is open for only a single trading day. The company shares are
sold in a single trading day and only during the normal trading hours i.e. between 9:15 a.m. and 3:30 p.m.

ii. OFS fresh Issue: Also Known as Bought out deals and Outright Purchase
It is a method in which a company raises funds from the public, however the shares are not sold direct to the
public instead a company sells bulk its shares at an agreed price to brokers or merchant bankers, who in
turn resell then to the public. The difference between purchase price and offer price is the profit to the
intermediaries.

3. Right Issue
A rights issue is an issue of rights to buy additional securities in a company made to the company's existing security holders.
Rights shares are offered to the existing shareholders in a particular proportion to their existing share ownership.
The ratio in which the new shares or debentures are offered to the existing share capital would depend upon the
requirement of capital. The rights themselves are transferable and sale-able in the market. Section 81 of the
Companies Act deals with rights issue. The cost of issue is minimum. There is no underwriting, brokerage, advertising
and printing of prospectus expenses. It prevents the directors from issuing new shares in their own name or to their
relatives at a lower price and get controlling right.

4. Bonus Issue
When an issuer makes an issue of securities to its existing shareholders as on a record date, without any considerati
on from them, it is called a bonus issue. As the new shares are issued out of the company’s reserves (accumulated
profits), shareholders need not pay any money to the company for receiving the new shares. The shares are issued
in a particular ratio to the number of securities held on a record date.

5. Issue of Indian Depository Receipts (IDR)

Issue of Indian Depository Receipts (IDR): A foreign company which is listed in stock exchange abroad can raise
money from Indian investors by selling (issuing) shares. These shares are held in trust by a foreign custodian bank
against which a domestic custodian bank issues an instrument called Indian depository receipts (IDR).IDR can be
traded in stock exchange like any other shares and the holder is entitled to rights of ownership including receiving
dividend.

6. Fast-tract Issue
Generally companies should go through a fairly lengthy process to issue shares to public, in an effort to provide a
faster and cost effective method of raising capital by listed companies, SEBI has decided to introduce Fast Track
Issuance of Securities (FTIs). It is available to listed companies who satisfy the following requirements:

1. Listed on BSE or NSE, for at least three years

2. Excellent track record in redressing Shareholders
3. Average free float market capitalization of at least Rs.10,000 crore or more during last one year
4. No prosecution proceedings or show cause notice issued by SEBI
5. Trading on the stock exchanges constitute at least 2% of total listed shares during the previous one year

1.5: MERITS & DEMERITS OF PUBLIC ISSUE

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Advantages of Going Public (IPO, FPO, Rights Issue and OFS) or Primary Markets
 More Capital: A company can raise huge amount of funds to finance its capital expenditure programs like expansion,
modernization, diversification, etc. as well as working capital requirements.
 No Cost of Capital: Company is not required to pay interest on capital raised from the public. There is no need of repayment of
capital as well except on winding up of company where it has to pay the residual amount after it pays all other creditors like bank
loans, debentures, preferential shares etc.
 Easy to raise new capital: It is difficult for private companies to raise capital. By going public, raising capital becomes
comparatively easier task.
 Pricing and Valuations: Commands better pricing than placement with private investors. Enables correct valuation for the
company because share price is a true reflection of the financial soundness of a company and it would aid in case company wants
to opt for mergers and acquisitions.
 Owner Diversification: Most of the funds of the founders are blocked in the firm till the firm grows and becomes more valuable.
By means of IPO, they can sell some stake to diversify their holdings and can reduce the risk of their personal portfolios.
 Brand Image: It increases the visibility and reputation of the company and thereby enhances the brand image of the company.
 Increased Liquidity: The shares when get listed on the stock exchange, can be easily traded, providing more liquidity.
 Employee Prestige and Retention: Employee pride and confidence in the company may increase. Company can attract as well
as retain employees by offering them equity incentives like stock options/stock purchase plans.

Disadvantages of Going Public (IPO, FPO, Rights Issue and OFS) or Primary Markets
 Dilution of control: Dilution of ownership stake makes company vulnerable for future takeovers.
 Time consuming and expensive: Takes substantial amount of management time and efforts. It involves very high expenses
like that of underwriter, lead manager, investment banker, etc.
 Regulations: Increased regulatory monitoring to ensure that firm is making filings along with relevant disclosures.
 Accountability: It is accountable to investors and cost of maintaining investor relations are high.
 Disclosures: The Company is subject to disclosure of information from time to time and maintaining secrecy over expansion
plans/market strategies becomes difficult.

7. ESOP- EMPLOYEE STOCK OPTION PLAN

Employee Stock Option Plan (ESOP) means a plan under which the company grants options to employees. Many companies use
employee stock options plans to retain and attract employees, the objective being to give employees an incentive
to behave in ways that will boost the company's stock price. If the company's stock market price rises above the call
price, the employee could exercise the option, pay the exercise price and would be issued with ordinary shares in
the company. The employee would experience a direct financial benefit of the difference between the market and
the exercise prices. If the market price falls below the stock exercise price at the time near expiration, the employee
is not obligated to exercise the option, in which case the option will lapse. Restrictions on the option, such as vesting
and non-transferring, attempt to align the holder's interest with those of the business shareholders.

8. Private Placement
The sale of securities to a select group of private investors instead of general public. "Private placement" usually refers to non-
public offering of shares in a public company since, of course, any offering of shares in a private company is and
can only be a private offering. Investors involved in private placements are usually large banks, mutual funds,
insurance companies and pension funds. Private placement is the opposite of a public issue, in which securities are
made available for sale on the open market. Private placement of shares or convertible securities by listed issuer
can be of two types:
[1] Preferential allotment [2] Qualified institutions placement (QIP)
i. Preferential allotment:

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Preferential Allotment is the process by which allotment of securities/shares is done on a preferential basis
to a select group of investors. Generally, preferential allotments are made to people who wish to take a
strategic stake in the company. For instance, venture capitalists, existing shareholders like promoters who
wish to enhance their stake in the company, financial institutions, buyers of the company's products or its
suppliers.

ii. Qualified institutional placement (QIP)

Qualified institutional placement (QIP) is a method of raising capital whereby a listed company can issue
equity shares and debentures or any securities which are convertible to equity shares to a qualified
institutional buyer (QIB).
Qualified Institutional Buyers are those institutional investors who are generally perceived to possess
expertise and the financial muscle to evaluate and invest in the capital markets. Apart from preferential
allotment, this is the only other speedy method of private placement whereby a listed company can issue
shares or convertible securities to a select group of persons. QIP scores over other methods because the
issuing firm does not have to undergo elaborate procedural requirements to raise this capital.

1.6: MERITS & DEMERITS OF PRIVATE PLACEMENT

Advantages of Private Placement
1. Cost effective method: Private placement is a cost effective method of raising funds as it doesn’t involves floatation cost. Flotation costs
include the costs of printing the certificates, paying the underwriters, government fees, and other associated costs.
2. Time effective: In the public issue the time required for completing the legal formalities and other formalities takes usually six months or
more. But in the private placement the requirements to be fulfilled are less and hence, the time required to place the issue is less, mostly 2 to
3 months.
3. Structure effectiveness: It can be structured to meet the needs of the entrepreneurs. It is flexible to suit the entrepreneurs and the financial
intermediaries. To make the issue more attractive the corporate can provide discounts to the intermediaries who are buying it.

Disadvantages of Private Placement

1. Limited Investors: If only a few investors are interested, and don’t want to invest a large amount of money it becomes difficult to raise the
amount of capital. Suitable investors may be difficult to locate.
2. Low pricing: Sometimes, private investors only buy in when the shares cost substantially less than the projected cost of the company, requiring
you to sell more shares for the same amount of income. Privately placed securities are often sold at a deep discount below their market value.
3. Short Selling: Private Investments in Public Equities investors are not usually long term investors because they are more interested in share
price, trading volume and market capitalization.

1.7: STEPS OR PROCEDURE FOR PUBLIC ISSUE (ISSUE MECHANISM)

A Company proposing to raise resources by a public issue should first select the type of securities i.e. share and /or debentures
to be issued by it. The decision regarding the issue of shares to be made at par or premium should be decided keeping in
view the SEBI guidelines.
The primary market is the part of the capital market that deals with issuing of new securities. Companies, governments or
public sector institutions can obtain funds through the sale of a new stock or bond issues through primary market. This is
typically done through an investment bank or merchant bank. To avoid exploitation of the investors, the Government and
SEBI have imposed lot of restrictions on the companies. To initiate the process the Company to pass a Board Resolution and
proceed to appoint a Merchant Banker (Lead Manager), with whom a memorandum of understanding may be entered into.
Subsequent sequential steps are as under:

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No. Steps Description
The company offering its shares, called the "issuer", enters into a contract with a lead underwriter to sell
Appointment of Merchant Bankers (Lead its shares to the public. The investment bank which has primary responsibility for organizing a given issue
1
Manager Or Investment Bank) of shares. This bank will find other lending organizations or underwriters to create the syndicate,
negotiate terms with the issuer, and assess market conditions.
Checking Compliance with Entry Norms of The SEBI has laid down certain parameters for accessing the primary market. If a company fulfills these
2
SEBI parameters (entry norms), then only it can enter into the primary market.
Prospectus is a document inviting public or inviting offers from the public for the subscription or purchase
3 Preparing and Filing Prospectus of any shares in, or debentures of, a body corporate. Lead manager after studying company prepares a
prospectus and get files it SEBI for approval. After prospectus is approved by SEBI it is issued to the public.
They are appointed to shoulder the liability and subscribe to the shortfall in case the issue is under-
4 Appointment of Underwriters subscribed. For this commitment they are entitled to get a maximum commission of 2.5% on the amount
undertaken.
Bankers act as collecting agents I.e., the banks along with their branch network act as collecting agencies
5 Appointment of Bankers
and process the funds during the public issue.
They are recognized members of the stock exchange and are appointed as brokers to the issue for
6 Brokers to the issue
marketing the issue. They are eligible for a maximum brokerage of 1.5%
Registrars are independent financial institutions registered with stock exchanges and appointed by the
7 Appointing Registrar to Issue
company going public for mainly to keep record of the issue and ownership of company shares.
The draft prospectus, along with the copies of the agreements entered into with the lead manager,
8 Filing of Documents underwriters, bankers, registrars and brokers to the issue have to be filed with the Registrar of companies
of state where the registered office of the company is located.
The price discovery process is the process of determining the price of an shares to be offered in the
9 Price Discovery
marketplace through the interactions of buyers and sellers
The process of allocating shares between shareholders usually pro rata or according to some prior
10 Allotment of shares
agreement. The allotment may have conditions, which must be satisfied before the shares are issued.
Listing refers to the company's shares being on the list (or board) of stock that are officially traded on a
11 Listing the Issue
stock exchange. Normally the issuing company is the one that applies for a listing.

1. Appointment of Merchant Bankers (Lead Manager or Investment Bank)

The merchant or investment bank which has primary responsibility for organizing a given credit or share issuance.
Lead managers are independent financial institution appointed by the company going public. Companies appoint
more than one lead manager to manage big IPO's. They are known as Book Running Lead Manager. Their main
responsibilities are to initiate the IPO processing, help company in road shows, creating draft offer document and
get it approve by SEBI and stock exchanges and helping company to list shares at stock market.
Every lead managers has to enter into an agreement with the issuing companies setting out their mutual rights,
liabilities and obligation relating to such issues and in particular to disclosures, allotment and refund. A statement
specifying these is furnished to the SEBI at least one month before the opening of the issue for subscription. In case
of more than one lead manager, the statement has to provide details about their respective responsibilities. A lead
merchant banker cannot manage an issue if the issuing company is his associate. He can also not associate with a
merchant banker who does not hold a certificate of registration with the SEBI.

Role, function, responsibilities or importance of lead managers

Pre-issue process Post-issue process
1. Due diligence 1. Management of Escrow Account
2. Preparation of the Budget 2. Allotment of shares and refund
3. Suggest on timing of issue 3. Finalization of trading & Listing
4. Prepare & design offer documents 4. Dispatch and de-materialization of shares
5. Advice on appointment of registrar, underwriters, brokers, bankers & advertising
5. Redressal of investor grievances
agency.
6. Management of Escrow Account
6. Ensure compliance of regulations of Stock Exchange, RoC, SEBI
7. Allotment of shares and refund
Merchant bankers play an important role as one of the intermediaries in the primary capital in India. They help
companies in the total management of issue of securities. Therefore, they are called ‘Issue Managers’ (Lead
Managers). They undertake all activities related to capital issues and play different roles as lead managers, co-
managers, underwriters, consultants and advisors to the issue.
2. Checking Compliance with Entry Norms of SEBI (SEBI requirements for issuing shares to public)
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The SEBI has laid down certain parameters for accessing the primary market. If a company fulfills these parameters
(entry norms), then only it can enter into the primary market. Entry forms are different routes available to an issuer
for accessing the capital market by way of a public issue. They are meant for protecting the investors by restricting
fund raising by companies if they do not satisfy the entry requirements. Eligibility norms for an unlisted company for
making a public issue.
An unlisted company has to satisfy the following criteria to be eligible to make a public issue (IPO)

1) Net Tangible Assets of at least Rs. 3 crores in each of the preceding three full years of which not more than
50% are held in monetary assets. However, the limit of fifty percent on monetary assets shall not be applicable
in case the public offer is made entirely through offer for sale.
2) Minimum of Rs. 15 crores as average pre-tax operating profit in at least three of the immediately preceding
five years.
3) Net worth of at least Rs. 1 crore in each of the preceding three full years.
4) If the company has changed its name within the last one year, at least 50% revenue for the preceding 1 year
should be from the activity suggested by the new name.
5) The aggregate of the proposed issue and all previous issues made in the same financial year in terms of issue
size does not exceed five times its pre-issue net worth as per the audited balance sheet of the preceding
financial year
In case an unlisted company does not satisfy any of the above criterion, it can come out with a public issue only
through the Book-Building process. In the Book Building process the company has to compulsorily allot at least sixty
percent (60%) of the issue size to the Qualified Institutional Buyers (QIBs), failing which the full subscription monies
shall be refunded.
A listed Company making a public issue (i.e. FPO) is required to satisfy the following requirements:
1) If the company has changed its name within the last one year, at least 50% revenue for the preceding 1
year should be from the activity suggested by the new name.
2) The aggregate of the proposed issue and all previous issues made in the same financial year in terms of
issue size does not exceed five times its pre-issue net worth as per the audited balance sheet of the preceding
financial year
Any listed company not fulfilling these conditions shall be eligible to make a public issue (i.e. FPO) by complying with
QIB Route as specified for IPOs i.e. issue shall be through book building route, with at least 75% to be mandatory
allotted to the Qualified Institutional Buyers (QIBs).
3. Preparing and Filing Prospectus
A public offering requires the issuing company to publish a prospectus detailing the terms and rights attached to the
offered security (share or debenture), as well as information on the company itself and its finances.
What is a Prospectus?
‘Prospectus is a document containing detailed information about the company and an invitation to the investors for subscribing shares and debentures
issued’. — Prospectus includes any notice, circular, advertisement or other document.

Objectives: What is the purpose of issuing prospectus?

This information is in the form of ‘Prospectus’ which also includes information regarding the size of the issue, the current
status of the company, its equity capital, its current and past performance, the promoters, the project, cost of the
project, means of financing, product and capacity etc. It also contains lot of mandatory information regarding
underwriting and statutory compliances. This helps investors to evaluate short term and long term prospects of the
company.
Prospectus is issued with the following broad objectives:
 It informs the company about the formation of a new company.
 It serves as written evidence about the terms and conditions of issue of shares or debentures of a company.
 It induces the investors to invest in the shares and debentures of the company.
 It describes the nature, extent and future prospectus of the company.
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 It maintains all authentic records on the issue and makes the directors liable for the misstatement in the
prospectus.

Types of Prospectus
Draft Offer document
• Offer document in draft stage.
• The Draft Offer document is available on the SEBI website for public comments for a period of 21 days from the filing of the
Draft Offer Document with SEBI.
• SEBI may specifies changes, if any, in the draft Offer Document and the issuer or the Lead Merchant banker shall carry out
such changes in the draft offer document
Offer document
• Once draft offer document is approved it becomes Offer document
• It is filed with Registrar of Companies (ROC) and Stock Exchanges.
• An offer document covers all the relevant information to help an investor to make his/her investment decision.
Red Herring Prospectus (DRHP)
• Prospectus which does not have details of either price or number of shares being offered or the amount of issue.
• In such a case will notify the floor price or a price band by way of an advertisement one day prior to the opening of the issue.
• Only on completion of the bidding process, the details of the final price are included in the offer document. The offer
document filed thereafter with ROC is called a prospectus.
Placement Document
• Document prepared by Merchant Banker for the purpose of Qualified Institutions placement.
Letter of Offer
• Offer document prepared by company for its rights issue.
• It is filed with the Stock Exchanges.

Contents of prospectus
The following important matters are included in the prospectus:
1. Name and address of registered office
2. Details of Lead managers, Underwriters, Bankers to Issue, Registrar to issue, Brokers
3. Industry & Business overview
4. History and certain corporate matters
5. Management &Promoter information
6. Dividend policy
7. Financial information
8. Description of share capital
9. Disclosure of directors and officers
10. Objectives of issue
11. Use of proceeds
12. Plan of Allotment
13. Risk factors

4. Appointment of Underwriters
Investment banks are the main underwriters in the primary markets and thus are the major facilitators of these types
of markets. They normally decide the base price of the securities on sale and then administer the entire process of
its sale to the investors. The underwriters also play the important role of safeguarding the issue related risks for the
companies that are offering the shares for sale.
What is Underwriting & Who is an underwriter?
‘Underwriting is guarantee given by underwriters to take up whole or part of the issue of securities not subscribed by the public’.

 Underwriting is an agreement whereby the underwriters ensure the company that in case the shares and debentures
offered to the public are not subscribed by the public to the extent, the balance of shares and debentures will be

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taken up by the underwriters. The firms or persons who are engaged in underwriting are called underwriters. The
commission payable to underwriters for underwriting is known as underwriting commission.

 The underwriting commission is limited to 5% of issue price in case of shares and 2.5% in case of debentures.
The amount or rate of commission should be disclosed in the prospectus.
Types of Underwriting or Underwriters
Firm Underwriting Sub-Underwriting Syndicate Underwriting
Agree to buy, securities not to be taken up by the Main UW enters into a contract with other Agreement between the issuing company and 2-3 or
public. underwriters to share the risk. more firms of underwriters to underwriters a large
issue.

Advantages, functions and Importance of underwriting: Disadvantages of underwriting:

1. Relieved from the tension of marketing of securities and of uncertainties in the market. 1. Very costly method
2. Fulfilling the statutory regulation of minimum subscription. 2. Provide secret information
3. Guarantee to adequacy of CapitaLand help companies in raising capital. 3. Secure control on the company
4. Quick sale of securities

What is Green Shoe Option?

A provision contained in an underwriting agreement that gives the underwriter the right to sell investors more shares (15%) than originally planned by the issuer.
5. Appointment of Bankers to Issue
Bankers to the issue, as the name suggests, carries out all the activities of ensuring that the funds are collected and
transferred to the Escrow accounts. The Lead Merchant Banker shall ensure that Bankers to the Issue are appointed
in all the mandatory collection centers as specified in DIP (Disclosure and Investment Protection) Guidelines 2000.
The LM also ensures follow-up with bankers to the issue to get quick estimates of collection and advising the issuer
about closure of the issue, based on the correct figures.
What is a Banker to Issue and what are their responsibilities?
Bankers to issue are banks responsible for collecting money on behalf of the company from the share applicants.
1. Application management (Receiving application from investors, both offline and online)
2. Determine basis of allotment
3. Finalize allotment of securities
4. Processing refunds.
What is an Escrow Account?
It is an account in which the bankers to the issue have keep the funds collected from share applicants (bidders).
6. Appointment of Registrar
“Registrars are independent financial institutions registered with stock exchanges and appointed by the company going public for mainly to keep record
of the issue and ownership of company shares”.
The Lead Manager coordinates with the Registrar to ensure follow up so that that the flow of applications from
collecting bank branches, processing of the applications and other matters till the basis of allotment is finalized,
dispatch security certificates and refund orders completed and securities listed. Investors can contact the Registrar to
the Issue in case of any pre-Issue or post-Issue related problems such as non-receipt of letters of allotment, credit of
allotted shares in the respective beneficiary accounts, refund orders etc.
Responsibility of a registrar/Functions
 Collecting application forms from investors,
 Keeping a record of applications and money received from investors
 Deleting the invalid applications
 Assisting Lead managers in determining the basis of allotment of securities
 Finalizing the list of persons entitled to allotment of securities
 Processing and dispatching allotment letters
 Refund orders or certificates and other related documents.

7. Filing of Documents

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The draft prospectus along with the copies of the agreements entered into with the lead manager, underwriters,
Bankers, registrars and brokers to the issue have to be filed with the registrar of companies of the state where the
registered office of the company is located. After filling the above documents, the prospectus and application forms
are printed and dispatched to all merchant bankers, underwriters and brokers to the issue.

8. Pricing of New Issues- Price Discovery

The price discovery process is the process of determining the price of shares to be offered in the marketplace through
the interactions of buyers and sellers. The most important, yet most difficult, part of the public offering process is
setting the offer price. In a Public Offer, the issuer aided by an intermediating Lead Manager, plans to sell a
relatively large number of shares of common stock in which there is at that point no market. Investors who believe
the price to be too high will sell; investors who believe the price to be too low will buy. The key outcome of this
competitive trading is the market price of the stock.

The issuer determines the price of the equity shares in consultation with the lead merchant banker, there are two
methods of pricing shares in a public issue. The first is to sell shares at a single fixed price and second method is book
building method.

1) Fixed Priced Method

It is a traditional method of pricing the IPOs. Here the issuer and the merchant banker agree on the issue
price before making the actual issue and the investors are required to fill in an application form at this price
and subscribe to the issue. To estimate the market price as best as they can, issuers and their advisers (lead
Mangers) conduct a costly analysis to estimate the value of the firm.

2) Book Building Method

Book building is actually a price discovery method in which the issuing company doesn't fix up a particular
price for the shares, but instead gives a price range or band. Bids are collected from different types of
investors at various prices (Between the price bands) which are above or equal to floor price. The book is
filled with the prices that investors indicate they are willing to pay per share, and when the book is closed,
the issue price is determined by a BRLM (Book Running Lead Manager) by analyzing these values.

Note There is no fixed price per share. Instead, the company issuing the shares arrives at a price band.

Step 1 Appointment of book runner- BRLM

Step 2 Selection of price Band

Step 3 Applicants then bid for the shares.

Step 4 The final price is then discovered based on these bids.

Working of Book building Method Explained:

Book building is actually a price discovery method. In this method, the company doesn't fix up a particular price for the shares, but instead gives a price
range, e.g. Rs 80-100.
 When bidding for the shares, investors have to decide at which price they would like to bid for the shares, for e.g. Rs 80, Rs 90 or Rs 100. They
can bid for the shares at any price within this range.
 Based on the demand and supply of the shares, the final price is fixed. The lowest price (Rs 80) is known as the floor price and the highest price
(Rs 100) is known as cap price.
 The spread between the floor and the cap of the price band shall not be more than 20%.
 The price at which the shares are allotted is known as cut off price. The entire process begins with the selection of the lead manager, an
investment banker whose job is to bring the issue to the public.
 Both the lead manager and the issuing company fix the price range and the issue size. Next Bankers to Issue are hired to obtain bids from the
investors. Normally the issue is kept open for 5 days.

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 Once the offer period is over, the lead manager and issuing company fix the price at which the shares are sold to the investors. If the issue
price is less than the cap price, the investors who bid at the cap price will get a refund and those who bid at the floor price will end up paying
the additional money.
 For e.g. if the cut off in the above example is fixed at Rs 90, those who bid at Rs 80, will have to pay Rs 10 per share and those who bid at Rs
100, will end up getting the refund of Rs 10 per share. Once each investor pays the actual issue price, the shares are allotted.
Price Band Describes a price range in a Book Building within which the investors can bid.
Floor price The lower end of the price band is referred to as the ‘floor price’
Cap price The higher end of the price band is called the ‘cap price’
Cut off Price Price at which the shares are allotted after booking building is known as cut off price.
Lot size Lot size is the minimum quantity of shares than investor can apply while bidding in an IPO.
Tick size Cut of price × Lot size = Tick size

3) Differential Pricing Method: When one category of investors is offered shares at a price different from the
other category it is called differential pricing. An issuer company can allot the shares to retail individual
investors at a discount of maximum 10 percent to the price at which the shares are offered to other categories
of public.

Types of Bidders or What are the different types of investor categories?

RII HNI or NIIs QIBs (FII+DII)

"Retail individual investor"  HNI: High Net worth Individual  DII: Domestic Institutional Investors
means an investor who applies  NII: Non-institutional Investor  FII: Foreign Institutional Investors
or bids for securities for a value If retail investor applies more than Rs. Financial Institutions, Banks, FII's and Mutual Funds who are
of not more than Rs. 2,00,000. 2,00,000 /- of shares in an IPO, they are registered with SEBI are called QIB's. They usually apply in very
considered as HNI. high quantities.

Difference between Fixed price and Book Building

Differential Factor Fixed Pricing Book Building
Knowledge of Price Know to investor in Advance Only an indicative price range is given
Demand Demand for the issue is known only after the closure of the Demand for shares is known everyday as the book is built
issue
Payment Payment is made at the time of subscription. Refund is Payment is made only after allocation.
given after allocation.
Reservations 50 % of the shares offered are reserved for applications 50 % of shares offered are reserved for QIBS, 35 % for
below Rs. 1 lakh and the balance for higher amount small investors and the balance for all other investors.
applications.
9. Allotment of shares
The process of allocating shares between shareholders usually pro rata or according to some prior agreement. The allotment may have conditions, which
must be satisfied before the shares are issued.
After the closures of the issue, the bids received are aggregated under different categories i.e., firm allotment,
Qualified Institutional Buyers (QIBs), Non-Institutional Buyers (NIBs), Retail, etc. The over subscription ratios are then
calculated for each of the categories as against the shares reserved for each of the categories in the offer document.
Within each of these categories, the bids are then segregated into different buckets based on the number of shares
applied for.
The over subscription ratio is then applied to the number of shares applied for and the number of shares to be
allotted for applicants in each of the buckets is determined. Then, the number of successful allottees is determined.
This process is followed in case of proportionate allotment. In case of allotment for QIBs, it is subject to the discretion
of the post issue lead manager.

Retail Investors 35%, Non-Institutional Investors 15% and Qualified Institutional Investors 50%

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Firm Allotment Proportional Allotment Lottery Allotment
In this shares are allotted as per If the shares are oversubscribed After making proportional
the quantity applied by the then proportion of the number of allotment if shares are left, then
investors. This method is used specified shares applied for in allotment is then on lottery basis.
when there is an under or full respect of a particular reserved
subscription category to the number of specified
securities reserved for that
category.
No of shares issued No of applications received Over subscription ratio Lot size
1000 3000 3 times 30 & multiples thereof
Person Lot Applied Calculation How much he will get?
No. of share applied (in Lot) ÷ No.
Mr. X 30+30 (60)=2 Lots of time of oversubscription in Lottery Method
particular category -60/3=20
Mr. Y 30+30+30+30(120)=4 Lots 120/3=40 40 shares (Proportional Method)

10. Listing the Issue or Shares

“A listing refers to the company's shares being on the list (or board) of stock that are officially traded on a stock exchange”.
Listing means admission of securities of an issuer to trading privileges on a stock exchange through a formal
agreement. The prime objective of admission to dealings on the Exchange is to provide liquidity and marketability
to securities, as also to provide a mechanism for effective management of trading. It is essential to send a letter to
the stock exchange concerned where the is proposed to be listed giving all necessary details and stating the intention
of getting the shares listed on the stock exchange.

Objectives/Importance and Benefits of Listing

1. Fund Raising and exit route to investors
Listing provides an opportunity to the corporates entrepreneurs to raise capital to fund new projects/undertake
expansions/diversifications and for acquisitions. Listing also provides an exit route to private equity investors as well
as liquidity to the ESOP-holding employees.
2. Ready Marketability of Security
Listing brings in liquidity and ready marketability of securities on a continuous basis adding prestige and importance
to listed companies.

3. Ability to raise further capital

An initial listing increases a company's ability to raise further capital through various routes like preferential issue,
rights issue, Qualified Institutional Placements and ADRs/GDRs/FCCBs, and in the process attract a wide and varied
body of institutional and professional investors.

4. Supervision and Control of Trading in Securities

The transactions in listed securities are required to be carried uniformly as per the rules and bye-laws of the
exchange. All transactions in securities are monitored by the regulatory mechanisms of the stock exchange, preventing
unfair trade practices. It improves the confidence of small investors and protects them.

5. Fair Price for the Securities

The prices are publicly arrived at on the basis of demand and supply; the stock exchange quotations are generally
reflective of the real value of the security. Thus listing helps generate an independent valuation of the company by
the market.

6. Timely Disclosure of Corporate Information

The listing agreement signed with the exchange provides for timely disclosure of information relating to dividend,
bonus and right issues, book closure, facilities for transfer, company related information etc. by the company. Thus
providing more transparency and building investor confidence.

7. Collateral Value of Securities

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Listed securities are acceptable to lenders as collateral for credit facilities. A listed company can also borrow from
financial institutions easily as it is rated favorably by lenders of capital; the company can also raise additional funds
from the public through the new issue market with a greater degree of assurance.

8. Better Corporate Practice

Since the violation of the listing agreement entails the de-listing/suspension of securities from the rings of the
exchange, the listed companies are expected to follow fair practices to the advantage of investors and public.

9. Benefits to the Public

The data daily culled out by the stock exchange in the form of price quotations and others; provide valuable
information to the public which can be used for project and research studies. The stock exchange prices can be an
index of the state of the economy. Financial institutions, NRl, individual investor’s etc. can take wise decisions before
making investments.

10. Subdivision and Consolidation of Holdings

Stock exchange bye-laws provide for explicit rules for sub division and consolidation of securities as desired by the
investors. There is special trading sessions in the exchange for conversion of odd lots into market lots arranged by
financial and institutional investors. Thus listing helps to provide flexibility to investors in the subdivision and
consolidation of their holdings with speed and earnestness.

1.8: SIGNIFICANCE, ROLE OR FUNCTIONS OF CAPITAL/PRIMARY OR FINANCIAL MARKET

Like the money market capital market is also very important. It plays a significant role in the national economy. A
developed, dynamic and vibrant capital market can immensely contribute for speedy economic growth and
development. Let us get acquainted with the important functions and role of the capital market.
1. Mobilization of Savings: Capital market is an important source for mobilizing idle savings from the economy. It
mobilizes funds from people for further investments in the productive channels of an economy. In that sense it activate
the ideal monetary resources and puts them in proper investments.

2. Capital Formation: Capital market helps in capital formation. Capital formation is net addition to the existing stock
of capital in the economy. Through mobilization of ideal resources it generates savings; the mobilized savings are
made available to various segments such as agriculture, industry, etc. This helps in increasing capital formation.
3. Provision of Investment Avenue: Capital market raises resources for longer periods of time. Thus it provides an
investment avenue for people who wish to invest resources for a long period of time. It provides suitable interest rate
returns also to investors. Instruments such as bonds, equities, units of mutual funds, insurance policies, etc. definitely
provides diverse investment avenue for the public.

4. Speed up Economic Growth and Development: Capital market enhances production and productivity in the national
economy. As it makes funds available for long period of time, the financial requirements of business houses are met
by the capital market. It helps in research and development. This helps in, increasing production and productivity in
economy by generation of employment and development of infrastructure.

5. Proper Regulation of Funds: Capital markets not only helps in fund mobilization, but it also helps in proper allocation
of these resources. It can have regulation over the resources so that it can direct funds in a qualitative manner.

6. Service Provision: As an important financial set up capital market provides various types of services. It includes long
term and medium term loans to industry, underwriting services, consultancy services, export finance, etc. These services
help the manufacturing sector in a large spectrum.
7. Continuous Availability of Funds: Capital market is place where the investment avenue is continuously available
for long term investment. This is a liquid market as it makes fund available on continues basis. Both buyers and seller
can easily buy and sell securities as they are continuously available. Basically capital market transactions are related
to the stock exchanges. Thus marketability in the capital market becomes easy.

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1.9: PLAYERS IN THE NEW ISSUE MARKET/PRIMARY OR CAPITAL MARKET:

(MARKET INTERMEDIARIES)
The primary market enables the government as well corporates in raising the capital that is required to meet their
requirements of capital. Players in primary market are appointed to assist in taking forward the companies’ shares issuance
plans. The important players in the new issue or primary market are:
A. Merchant Bankers: The merchant or investment bank which has primary responsibility for organizing a given credit
or share issuance. Lead managers are independent financial institution appointed by the company going public.

B. Underwriters: Underwriters and the brokers: Underwriting is a contract by means of which a person gives an
assurance to the issuer to the effect that the former would subscribe to the securities offered to the event on non-
subscription by the person to whom they were offered. The person who assures is called an underwriter.

C. Bankers to Issue: Bankers to issue also called Collecting and Co-coordinating are banks responsible for collecting
money on behalf of the company from the share applicants.

D. Registrars to the issue: Registrars are independent financial institutions registered with stock exchanges and
appointed by the company going public for mainly to keep record of the issue and ownership of company shares.

E. Advertising agents: Advertising plays a key role in promoting the public issue. Tentative programs of each
advertising agency along with the estimated cost are called for. After comparing the effectiveness and cost of each
programmers with the other, a suitable advertising agency is selected in consultation with the lead managers to the
issue. The media may be newspaper/magazines/hoardings/press release or a combination of all.

1.10: IPO GRADING PROCESS

IPO grading is the grade assigned by a Credit Rating Agency registered with SEBI, to the initial public offering
(IPO) of equity shares or other convertible securities. The grade represents a relative assessment of the
fundamentals of the IPO in relation to the other listed equity securities. Disclosure of “IPO Grades”, so obtained
is mandatory for companies coming out with an IPO. Grading of an initial public offer or IPO, which had earlier
been made mandatory, is now optional.
The grade represents a relative assessment of the fundamentals of that issue in relation to the other listed equity securities in
India. Such grading is generally assigned on a five-point point scale with a higher score indicating stronger fundamentals
and vice versa as below.
 IPO grade 1: Poor fundamentals
 IPO grade 2: Below-average fundamentals
 IPO grade 3: Average fundamentals
 IPO grade 4: Above average fundamentals
 IPO grade 5: Strong fundamentals

1.11: FACTORS CONSIDERED FOR GRADING IPO

1. Business Prospects and Competitive Position
a. Industry Prospects
b. Company Factors
2. Financial Position
3. Management Quality
4. Corporate Governance Practices
5. Compliance and Litigation History
6. New projects – Risks and prospects

1.12: GLOSSARY

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ASBA: Application Supported by Blocked Amount (ASBA) refers to an application mechanism for subscribing to initial public
offers (IPO). The system, which ensures that the applicant's money remains in his/her bank account till the shares are allotted,
was introduced by SEBI for retail investors in 2008.

Safety Net: A scheme wherein the company promoters assure buying back of shares from retail applicants at the IPO price
if the stock falls sharply during the first six months of listing.

Objective type questions:

1. Define is primary Market?
2. What is secondary Market?
3. Who is an underwriter?
4. What is listing of shares?
5. What is a public issue?
6. Give the meaning of offer for sale?
7. What do you understand by private placement?
8. What is a prospectus?
9. What is buy back of shares?
10. Mention various types of investors in Primary market
11. What is safety net?
12. State the difference between book building method and fixed pricing method of price discovery
13. What is capital market? State it’s components
14. What is “Green Shoe Option”?
15. Give the meaning of (a) Price band (b) Floor price and (c) Cut off price
16. What is allotment of shares and on what basis shares are allotted?
17. Expand (A) DRHP (B) BRLM (C) SEBI (D) IPO (F) FPO (G) ASBA
18. Write the instruments of capital markets
Analytical type questions:
1. Briefly explain various types of prospectus
2. Explain the SEBI in primary market
3. Outline the role of market intermediaries
4. Briefly explain the functions of (A) Lead Mangers (B) Underwriters (C) Bankers to issue
5. What are the advantages and disadvantages of underwriting?
6. Bring out the advantages and drawbacks of private placements
7. Discuss book building mechanism
8. Enumerate the features of capital markets
9. Mention various types of investors in Primary market
10. State the difference between book building method and fixed pricing method of price discovery
11. What is capital market? State it’s components
12. Bring out the benefits of listing shares on stock exchange
13. Present a summary of various players in capital markets
14. Highlight the SEBI Norms for issue of shares
Descriptive type questions:
1. Explain in detail issue mechanism?
2. Describe different method of floating a new issue
3. Trace the importance of Capital markets
4. Discuss IPO grading and factors considered for IPO grading

Mohammed Umair |Department of Commerce| St. Joseph’s College, Autonomous 18 | P a g e