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How Shares are Issued in the Primary Market

    IndianMoney.com Research Team | Wednesday, March 24,2010, 04:08 PM
 

A company needs capital if it wants to expand its business or diversify its business or in order to modernize its whole structure no matter if it is a public company or public sector undertaking. To get the capital that is required by the company it usually goes for the issue of shares and the process of issuing of shares is done in the primary market.

Public issue

A public limited company can raise the amount of capital by selling its shares to the public. Therefore, it is called public issue of shares or debentures. For this purpose the company has to prepare a 'Prospectus'. A prospectus is a document that contains information relating to the company such as;

  • Name
  • Address
  • Registered Office
  • Names And Addresses of;
      -- Company Promoters
      -- Managers
      -- Managing Director
      -- Directors
      -- Company Secretary
      -- Legal Advisors
      -- Auditors
      -- Bankers.

It also includes the details about project, plant location, technology, collaboration, products, export obligations etc. The company has to appoint brokers and underwriters to sell the minimum number of shares and it has to fix the date of opening and closing of subscription list. The new issue of shares or debentures of a company are offered for exclusive subscription of general public. But the prospectus should be approved by SEBI. A minimum of 49 per cent of the amount of the issue at a time is to be offered to public.

The company makes a direct offer to the general public to subscribe the securities of a stated price. The securities may be issued at par, at discount or at a premium. An existing company may sell the shares at a premium. There is no practice of selling shares at a discount in India. Public issue is a popular method of raising capital. It provides wide distribution of ownership securities. It also promotes confidence of investors through transparency and non-discriminatory basis of allotment. It satisfies compliance with the legal requirements. However, the issue of securities through prospects is time consuming because there are various formalities to be completed by the company. The cost of raising capital is also very high due to underwriting, commission, brokerage, publicity, legal, and other administrative costs.

Ways of Issuing stocks in Primary Market

  • Initial public offer
  • Private placement
  • Offer for sale
  • Bought out deals
  • Right issue
  • Bonus issue
  • Book-building

Initial Public Offer (IPO)


When a company makes public issue of shares for the first time, it is called Initial Public Offer. The securities are sold through the issue of prospectus to successful applicants on the basis of their demand. The company has to appoint underwriters in order to guarantee the minimum subscription.

An underwriter is generally an investment banking company. They agree to pay the company a certain price and buy a minimum number of shares, if they are not subscribed by the public. The underwriter charges some commission for this work. He can sell these shares in the market afterwards and make profit. There may be two or more underwriters in case of large issue.

Process of IPO
  • Company has to issue a prospectus giving full information about the company and the issue.
  • It has to issue share application forms through the brokers and underwriters.
  • The brokers collect orders from their clients and place orders with the company.
  • The company then makes the allotment of shares with the help of stock exchange.
  • The share certificates are delivered to the investors or credited to their Demat accounts through the depository.
  • This method saves time and avoids complicated procedure of issue of shares. With more and more companies coming out with tempting IPO or additional offers, there is greater need to exert caution and pick the best IPO investments.

Factors should be studied in an IPO offer document

Following four critical factors should be studied in an IPO offer document, before making an IPO investment:

  • Promoter
  • Performance
  • Prospects
  • Price.

Private placement


In Private placements the securities are offered for sale privately to individuals and institutions privately. They do not follow the procedure of issuing the prospectus. This method is usually adopted to save time of issuing and the cost involved in the same. Most of the new and small companies are involved in such offerings. This method has become very popular in the recent days. Since the shares are concentrated in few hands, there lies an artificial scarcity which intern increases the prices temporarily and is sold to the common and small investors. Thus this method proves beneficial for the company but is a loss for the investors.

Offer for sale


Offer for sale is almost similar to private placement where the securities are sold to issue houses and stockbrokers. Some negotiations take place between the company and stockbrokers on the price and other terms and conditions. The intermediaries after the negotiations come to a common agreement and buy the shares from the company. These securities are then sold to the common investors at a higher price in order to earn some profit. This method is adopted to save time, cost and the procedure involved in the share issue. The middlemen get the maximum benefit out of this method.

Bought out deals


In case of Bought out Deals any company who wants to bring shares to the market makes the sale of all the equity shares to a single sponsor or the lead sponsor. This is an agreement between the company and the sponsors for a particular quantity of equity shares. The sale price is finalized through negotiations as similar to that of offer for sale.

Factors Influence the Negotiation

Various factors that influence the negotiation are;

  • Project evaluation
  • Reputation of the promoter
  • Market sentiments etc.

Bought out deals are in the nature of fund-based activity where the funds of the merchant bankers are locked in at least for a minimum period. These shares are sold at over the Counter Exchange of India or at a recognized stock exchange. When the company earns profit and performs well they get listed.

Right issue


Rights issue is made by an existing company to its existing shareholder in the proportion to the number of shares that they possess. The guidelines for the issue of right share have been clearly given by SEBI. Certain rules regarding the right issue of share are;
  • Only listed company can make right issue
  • Right issue can be made only in respect of fully paid up shares.
  • Company will have to make announcement before such issue and this cannot be withdrawn
  • The rights issue should be open for minimum period of 30 days, and maximum up to 60 days.
  • Company will have to make an agreement with the depository to issue the share in demat form.
  • A no complaints certificate is to be filed by the Lead Merchant Banker with the SEBI after 21 days from the date of issue of offer document.
  • A minimum subscription of 90 per cent of the issue should be received.

Bonus issue


Bonus shares are usually issued when a company earns extra profit or have extra reserves and they want to convert the same into share capital. These shares are issued in proportion to the number of shares held by the shareholders. Rules regarding issue of bonus shares are given in the SEBI. Issue of bonus shares reduces the market price of the company's shares and keeps it within the reach of ordinary investors. Issue of bonus shares is generally indicates future growth.

Book-building


In the actual public offer process, investors are not involved in determining the offer price, whereas in book building pricing is determined on the basis of investor feedback which assures investor demand. Since the issue price after the issue marketing there is flexibility in the issue size and the price of the shares. The option of book building is available to all body corporate, which are otherwise eligible to make issue of capital to the public. The initial minimum size of issue through book-building process was fixed at Rs. 100 crores/-. However, issue of any size was allowed since 1996. Book-Building facility is available as an alternative to firm allotment. A Company can opt for book-building process for the sale of securities to the extent of the percentage of the issue that can be reserved for firm allotment.

Stages are involved in the book-building

he following stages are involved in the book-building process:

  • 1. Appointment of book-runners.
  • 2. Drafting of prospectus and getting approval from SEBI.
  • 3. Circulating draft prospectus.
  • 4. Maintaining offer details.
  • 5. Intimation of aggregate orders to the book-runner.
  • 6. Bid analysis.
  • 7. Mandatory underwriting.
  • 8. Filing copy of prospectus with registrar of companies.
  • 9. Opening bank accounts for collection of application money.
  • 10. Collection of applications.
  • 11. Allotment of shares.
  • 12. Payment schedule and listing of shares.

IndianMoney.com Research Team

The research team at IndianMoney.com comprises of certified and experienced professionals who share the company's vision to make every Indian financially literate by equipping every Indian with right and unbiased advice. IndianMoney.com research team provides newsletters, articles, videos and FAQs on various financial products and concepts only to help you make wise financial decisions.

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