Satinder Kaur

Faculty in Management
satinder@ibusinessinstitute.org
Primary Market
Primary market is a market for new issues or new
financial claims. Hence, it is also called New Issue
Market.

The primary market deals with those securities which

are issued to the public for the first time. In the primary
market, borrowers exchange new financial securities for
long term funds. Thus, primary market facilitates capital
formation.
Primary Market
There are three ways by which a company may raise capital in a
primary market. They are:

(i) Public issue

(ii) Rights issue
(iii) Private placement

 The most common method of raising capital by new companies is

through sale of securities to the public. It is called public issue.

 When an existing company wants to raise additional capital,

securities are first offered to the existing shareholders on a pre-
emptive basis. It is called rights issue.

 Private placement is a way of selling securities privately to a small

group of investors.
SEBI Guidelines pertaining to Capital Issue
Activities
In order to
 remove inadequacies and systematic deficiencies,
 protect the interests of investors
 for the orderly growth and development of the securities market,

the SEBI has put in place guidelines as ground rules relating to new issue
procedures/activities. These are in addition to the company law
requirements in relation to issues of capital/securities.
They are applicable to :

(i) Public issues and offers for sale by listed/unlisted companies

(ii) Rights issue by listed companies, except in cases where the aggregate
value of securities, including premium, is less than Rs. 50 lac
ELIGIBILITY NORMS
The companies issuing securities (capital) through
offer document, that is
(i) Prospectus or offer for sale in the case of public
issue
(ii) letter of offer in case of a rights issue
Filing of Offer Document
In case of public issue of securities by any company as well as
any type of securities by a listed company through a rights
issue in excess of Rs. 50 lac, a draft prospectus should be filed
with the SEBI through an eligible registered merchant banker,
at least 21 days prior to filing it with the Registrar of
Companies (RoCs).

In case of rights issues of less than Rs. 50 lac, the company
should prepare the letter of offer in accordance with the
disclosure requirements and file the same with the SEBI for its
information and for being put on the SEBI website.
OFFER DOCUMENTS
Offer document mean prospectus in case of a public
issue or offer for sale and letter of offer in case of a
right issue which filed with the Registrar of
companies (ROC) and Stock Exchange.

An offer document covers all the relevant information

to help investor to make investment decision.
Prospectus
 A company issuing shares to public must issue a 'prospectus'. The
prospectus is an 'invitation to offer'. It is an invitation to the public to take
shares or debentures in the company or deposit money in the company.

 Section 2(36) of the Companies Act, 1956 defines prospectus means "any
document described or issued as a prospectus and includes any notice,
circular advertisement or other document inviting deposits from the public
or inviting offers from the public for the subscription or purchase of any
shares in, or debentures of a body corporate. “

 Prospectus includes information regarding the size of issue, the current

statues of company, its equity capital, its current and past performance, the
promoters, project, cost of project, product etc. it also contain lot of
mandatory information regarding underwriting and statuary compliances.
This help investor to evaluate short term and long term prospectus of
company. It also provides a guide to future prospectus as per view of
company management.
Abridged Prospectus
Section 2 (1) of the Companies Act, 1956 defines
abridged prospectus means 'a memorandum
containing such salient features of a prospectus as
may be prescribed. It contains all the salient features
of a prospectus. A company cannot supply application
forms for shares or debentures unless the form is
accompanied by abridged prospectus.
 Red-Herring Prospectus
 A prospectus is said to be a red-herring prospectus which contains all
information as per prospectus contents but does not have information on
price of securities offered and number of securities (quantum) offered
through such document. Thus, a red-herring prospectus lacks price and
quantity of the securities offered. This is used in book building issues only.

 In the case of book built issues, it is a process of price discovery and the
price cannot be determined until bidding process is completed. Hence, such
details are not shown in Red-herring prospectus filed with RoC in terms of
the provisions of the Companies Act.

 Only on completion of the bidding process, the details of the final prices are
included in the offer document. The offer document filed thereafter with
RoC is called a 'prospectus'.
PUBLIC ISSUES
The eligibility norms for issue of equity shares and
convertible securities relate to
(1) unlisted companies
(2) listed companies
Initial Public Offerings (IPO’s) by Unlisted
Companies
An unlisted company can make an IPO only if it meets all
the following conditions:

1. It has net tangible assets (i.e. total net assets, excluding

intangible assets) of at least Rs. 3 crore in each of the
preceding 3 full years (of 12 months each) of which not
more than 50 per cent should be in monetary assets

2. It has a track record of distributable profits in terms of

Section 205 of the Companies Act for at least 3 out of the
immediately 5 years; extraordinary items should not be
considered to compute the distributable profits.
3. It has a net worth i.e. the aggregate value of paid-up equity capital and
free reserves (excluding revaluation reserve) minus the aggregate value
of accumulated losses and deferred expenditure not written off
(including miscellaneous expenses not written off) as per the audited
balance sheet of at least Rs.1 crore in each of the preceding 3 full years
(of 12 months each).

4. In case of change of its name within the last one year, at least 50 per
cent of the revenue for the preceding one full year is earned by the
company 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 size (i.e. offer through offer document
plus firm allotment and promoters contribution through the offer
document) does not exceed 5 times its pre-issue net worth as per the
audited balance sheet of the last financial year.
(IPO’s) by Unlisted Companies………cont…
 If an unlisted company does not comply with any of the five conditions
specified above, it may make an IPO only if it satisfies both the following
conditions :
(1) The issue is made through the book-building process with at least 60 per
cent of the issue size being allotted to the Qualified Institutional Buyers
(QIBs) failing which the full subscription would be refunded; or the
project has at least 15 per cent participation by banks/financial institutions.
In addition, at least 10 per cent of the issue size should be allotted to the
QIBs failing which the full subscription should be refunded
(2) The minimum post-issue issue face value of capital of the company would
be Rs. 10 crore or there would be a compulsory market-making for at least
2 years from the date of listing of the shares subject to the following

An unlisted company satisfying above conditions outlined can allot equity

shares only if the number of the prospective allottees is not less than
1,000.
Market Maker
Market maker is the person who undertake to
Offer buy and sell quotes for a minimum depth of 300
share
And ensure that bid and ask spread for their quotes
not exceed 10 per cent at any time.
Public Issue By Listed Companies
All listed companies are eligible to make public issue of equity
shares on the condition that the issue size in terms of the aggregate of
the proposed issue and all previous issues made in the same financial
year (i.e. offer through offer document plus firm allotment plus
promoters' contribution through the offer document) does not exceed
5 times its pre-issue net worth as per the audited balance sheet of the
last financial year.

In case of a change in the name of the issuer company within the last
one year (reckoned from the date of filing of the offer document), the
revenue accounted for by the activity suggested by the new name
should not be less than 50 per cent of its total revenue in the
preceding one full year.

A listed company which does not fulfill the above conditions, would
be eligible to make a public issue through book-building process
with the same conditions as are applicable to unlisted companies
Exemptions
The eligibility norms specified above for IPO’s are not
applicable in the following cases
Private/public sector banks
Infrastructure companies, wholly engaged in the
business of developing, maintaining and operating
infrastructure
Rights issue by a listed company.
 Right Issue
 If an existing company intends to raise additional funds, it can do so
by borrowing or by issuing new shares. One of the most common
methods for a public company to use is to offer existing shareholders
the opportunity to subscribe further shares. This mode of rising
finance is called rights issues'.

 The existing shareholders have right to entitlement of further shares

in proportion to their existing shareholding. A shareholder who does
not want to buy the rights shares, his right of entitlement can be sold
to someone else. The price of rights shares is generally fixed above the
nominal value but below the market price of the shares. The issue of
quoted shares at below the nominal value is not allowed, and it would
be rare for this to happen for unquoted shares. Section 81 of the
Companies Act provides for the further issue of shares to be first
offered to the existing members of the company, such shares are
known as 'Rights shares' and the right of the members to be so offered
is called the right of pre-emption'.
Reasons for a Right Issue
 'In times of inflation, the replacement costs of assets will be high,
unless the company can retain cash from substantial profits; the only
alternative is to raise cash from a fresh issue of shares.
 For funding expansion projects, a company may make rights issue.
 If a company has a proportion of interest bearing loan capital, the
company can suffer from a squeeze on profits. The company can
improve the capital structure position by obtaining extra share capital.
 At a time when the share prices were relatively high, companies found
it easy to persuade their shareholders to subscribe cash for new issues
with a view to expansion by takeover.
Advantages of Rights Issue
 To Companies : The company benefits from lower issue costs, in that
administration and underwriting costs are lower and the issue is made
at the direction of the directors rather than via a general meeting of
the company. This is because issue of equity through the stock
exchange will alter the balance of ownership.
 To the Shareholders: The main attraction of the rights issue for
current shareholders is that they are able to maintain their original
proportion of share ownership. Furthermore, any transfer of wealth
away from them due to an equity issue being under priced, is avoided.
 Pricing of Rights
 The rights issue has to be priced in a way to make it attractive to
existing shareholders and it must, therefore, be priced below the
current market price for the shares. However, the price must not be
set too low, due to the adverse effects on earnings per share. Thus in
calculating the number of shares to issue to raise a given sum, account
is taken of the resulting reduction of earnings per share at various
issue prices. In practice, the most common pricing mechanism is to
apply a discount of 15-20 per cent to the current market price.

 When a rights issue is announced, all existing shareholders have the

right to subscribe for new shares, and so there are rights attached to
the existing shares. The shares are therefore described as being 'cum-
rights’ (with rights attached) and are traded cum rights. On the first
day of dealings in the newly issued shares, the rights no longer exist
and the old shares are now 'ex-rights' (without rights attached).

 After the issue has actually been made, the market price per share will
normally fall, because there are more shares in issue and the new
shares were issued at a discount price.
 PRIVATE PLACEMENT
 In the primary capital market corporate can raise resources through public
issues and rights issues and 'private placement'. While public issues involve
allotting securities to the general public, rights issues entail allotment of
securities to the shareholders.

 Private placement, in contrast, refers to direct sale of newly issued

securities by the issuer to a small number of investors. Private placement of
issues is arranged through merchant bankers, with the issuer entering into
an arrangement regarding the various features of the issue being privately
placed with the selected clients, which are financial institutions, corporates
and high net-worth individuals.

 The time taken as well as the cost of issue for the private placement route is
much less for the issuer as compared with a public issue. Thus the private
placement is a cost and time effective way of raising funds for the
corporates. The privately placed issues offer greater flexibility to the issuers
as the instruments can be structured according to the needs of the
entrepreneurs. Moreover, private placement does not require detailed
compliance of formalities as required in public or rights issues.
Private placement market in India
 The private placement market is subject to some regulations rather
than the other developed markets. In sharp contrast to this, the
private placements in India are not bound by any regulatory system.

 Information relating to various details of private placement is

contained in "Memorandum of Information" and deals are struck
through negotiations between the ultimate borrowers and lenders. In
the case of equity issues, companies are free to fix the quantum of
private placement and only follow the rule of pricing for preferential
allotment as stipulated by SEBI.

 Such private placements have no lock-in-period excepting those in

favour of promoters. There is no compliance system for merchant
bankers in private placement as in the case of public issues. In view of
this, the private placement has become a favoured route for
corporates and financial institutions in India for mobilising resources
during the last few years
Qualified institutional
placement
 Securities issued by company by this way have to issue securities only
to QIB on a discretionary basis, with just 10% reservation for mutual
fund.
 This route is available only to listed company whose equity share of
same class listed on any nationwide stock exchange, the issuer will
have compliance with the prescribed minimum public shareholding
requirement of the exchange.
 Securities allotted under this regime shall not to any lock in period,
however for a period of one year, they may only be traded on the floor
of stock exchange in bulk or block transaction. So off-market deal are
possible only after one year.
PRICING OF ISSUES
A listed /unlisted company can freely price shares through
a public/rights issue. There is no price formula stipulated
by SEBI.

However the company required to give full disclosure of

the parameters which they considered while deciding the
price.

There are two type of issue , one where company fix a

fixed priced and other is where company stipulate a floor
price and price band and leave to market force to
determine the final price of issue. Called Book-Building
process.
Book Building
Book-building means a process by which a demand for the
securities proposed to be issued by a body corporate is
elicited and built up and the price for such securities is
assessed for the determination of the quantum of such
securities to be issued by means of a Notice /circular /
advertisement / document or information memoranda or
offer document.

A company proposing to issue capital through book-

building has to comply with the requirements issued by
SEBI
100% BOOK BUILDING
PROCESS
 Reservation or firm allotment to the extent of the percentage
specified in the relevant SEBI guidelines can be made only
to promoters, permanent employees of the issuer company

 The cap of the price band should not exceed 20 per cent of
the floor.

 The price band can be revised during the bidding period.

The maximum revision on either side should not exceed 20
per cent. In other words, floor price of the band can move up
or down to the extent of 20 per cent of floor of the price
band disclosed and the cap of the revised price should be
fixed
100% BOOK BUILDING
PROCESS
 Any revision in the price band should be widely
disseminated by informing the stock exchanges, issuing
press releases and indicating the change on the relevant
website and the terminals of the syndicate members.

 The bidding period should be extended by 3 days subject to

a maximum of bidding period of 13 days.

 The manner in which the short fall in the project financing

resulting from lowering of price band to the extent of 20 per
cent would be met should be disclosed. It should also be
disclosed that allotment would not be made unless the
financing is tied up.
Difference between book building and fixed price
process
In fixed price the price is well known in advance to
investor and in book building process it is known only
after closure of the issue.

In case of book building demand can be known

everyday but in case of fix price it known at the close
of the issue.
GREEN SHOE OPTION
 A company making an initial public offer of equity shares though the
book building mechanism can avail of the green shoe option (GSO)
for Mobilising the post-listing price of its shares.

 The GSO means an option of allocating shares in excess of the shares

included in the public issue and operating a post-listing price
stabilising mechanism through a stabilizing agent (SA).

 The concerned issuing company should seek authorisation for the

possibility of allotment of further issues to the SA at the end of the
stabilisation period together with the authorisation for the public
issue in the general meeting of its shareholders. It should appoint one
of the lead book runners as the SA who would be responsible for the
price stabilisation process.
Differential Pricing
 Listed/unlisted companies may issue securities to applicants in the
firm allotment category (i.e. allotment on a firm basis made to Indian
and multilateral development finance institutions, Indian mutual
funds, foreign institutional investors including non resident Indians/
overseas corporate bodies and permanent/regular employees of the
issuing company) at a price different from the price at which the net
offer to the public is made, provided the price at which the security is
offered to the applicants in firm allotment category is higher than the
price at which securities are offered to the public.
Promoter contribution
Promoter should contribute at least 20% of post issue
capital.
Promoter should bring in the full amount of their
contribution, including premium, at least one day before
the public issue open date and should be kept in escrow
account with a bank. However where promoter
contribution already been deployed by company should
disclosed in offer document where such fund used by cash
flow statement.
Lock in Requirement
The minimum promoter contribution would be
locked in for a period of three years.
The excess contribution by promoter from minimum
requirement would be locked for one year.
ISSUE ADVERTISEMENT
The term advertisement is defined to include notices,
brochures, pamphlets, circulars, show cards, catalogues,
hoardings, placards, posters, insertions in newspapers,
pictures, films, cover pages of offer documents, or any
other print medium, radio, television programmes
through any electronic medium. The lead merchant
banker should ensure compliance with the guidelines on
issue advertisement by the issuing companies
Important Features of Issue Advertisement
 It should be truthful, fair and clear and should not contain any
statement that is untrue/misleading.

 It should reproduce information contained in an offer document in

full and disclose all relevant facts, and not be restricted to select
extracts relating to that item.

 It should be set forth in a clear, concise and understandable language

 It should not contain statements that promise or guarantee rapid

increase in profits

 No models, celebrities, fictional characters, landmarks, or the like

should be displayed on or form part of the offer documents or issue
advertisements.
Important Features of Issue Advertisement
 No slogans, expletives or non-factual and unsubstantiated titles should
appear in the issue advertisements or offer documents.

 If any advertisement carries any financial data, it should also contain

data for the past three years and include particulars relating to sales,
gross profit, net profit, share capital, reserves, earnings per share,
dividends and the book values.

 (a) All issue advertisements in newspapers, magazines, brochures,

pamphlets containing highlights relating to any issue should also
contain risk factors given equal importance in all respects, including the
print size, (b) the print size of highlights and risk factors in issue
advertisements should not be less than point seven size

 No incentive, apart from the permissible underwriting commission and

brokerage, should be offered through any advertisement to anyone
associated with marketing the issue.
 BOUGHT OUT DEAL (BOD)
 BOD is a process of investment by a sponsor or a syndicate of
investors/sponsors directly in a company.

 Such direct investment is being made with an understanding between

the company and the sponsor to go for public offering in a mutually
agreed time. Bought out deal, as the very name suggests is a type of
wholesale of equities by a company.

 A company allots shares in full or in lots to a sponsors at a price

negotiated between the company and the sponsor(s). After a particular
period of agreed upon between the sponsor and the company the
shares are issued to the public by the sponsor with a premium.

 The holding cost of such shares by the sponsor may either be

reimbursed by the company or the sponsor may absorb the profit in
part or full as per the agreement, arising out of the public offering at a
premium. After the public offering the shares are listed in one or more
stock exchanges.
Advantages of BOD
The company has the advantage of using the fund immediately without

waiting as in the case of direct public issue. In case of BOD the
company instantly gets funds and is able to focus its attention on project
implementation without worrying for source of investment. Bought out
deals are ideally suited in circumstances when money needs to be
arranged fast without which the project may suffer. Lowering or
eliminating issue cost from the preliminary expenses is another
advantage to the company.

 The time taken to raise money in the capital market by a company takes
as much as six months and this time is very high for a company in an
infancy stage. The waste of time in the initial stage can be avoided by
going for BOD.

 In case of a new and untried product it is easier to convince an

investment banker for an investment in the company rather than the
general public. Hence BOD is an innovative method of financing for
such companies.
Advantages of BOD
 When the market sentiment is low and the secondary market is
undergoing a bear phase, a company may not like to come to the market
with a public issue. In such case BOD is a superior process to get fund
for the company.

 The merchant bankers also gain handsomely from a BOD. The

merchant bankers expect a return of around 30 per cent from a BOD
whereas private financing institutions expect a return of 40 per cent to
60 per cent from a BOD. The gain can be tremendous provided the
sponsors select proper issues and price it attractively to the investors.

 The investors also gain from the BOD in a way that they get good issues
where some merchant banker has already invested in it. The common
investors do not have enough scope and information for proper
evaluation of a company. The merchant bankers are professionals and
can make proper appraisal of a company.
Drawbacks of BOD
 There is a fear of loss of management control because the sponsor is a
holder of a large chunk of equities at one time. The sponsor may also
influence the policy decision which may affect the functioning of the
company.

 The investment banker who has to off-load the equities in the primary
market at a later date is entitled to ask for a higher price for the risk taken
by him. But this price may scare away the common investors.

 If a company does not perform as per the expectations of sponsor or if the

promoter does not cooperate with the sponsor later, the sponsor may have
tough time and may find its entire investment has eroded.

 If a merchant banker does not make proper analysis of the company it may
face a lot of problems with the BOD. Unless it evaluates all the risks
associated with the project, there is every chance that the sponsor may burn
its fingers.
ISSUE OF DEBT INSTRUMENTS
A company offering converting and non-convertible debt instruments through an
offer document should complies with the following provisions:

 Requirement of Credit Rating

 Creation of Debenture Redemption Reserves

 Redemption

 Disclosure and Creation of Charge

 Requirement of Letter of Option

 Rollover of Non-Convertible Portions of Partly Convertible Debentures

(PCD/ Non-Convertible Debentures (NCDs) by Company not Being in
Default

 Rollover of NCDs/PCDs By a Listed Company Being In Default

Requirement of Credit Rating

Public or rights issue of all debt instruments (i.e.

convertible as well as non-convertible) can be made
only if credit rating of a minimum investment grade is
obtained from at least two registered credit rating
agencies and disclosed in the offer document.
Creation of Debenture Redemption Reserves
(DRR)
 If debentures are issued for project finance, the DRR can be created up to the
date of commercial production, either in equal installments or higher
amounts if profits so permit.

 In the case of partly convertible debentures, the DRR should be created with
respect to the non-convertible portion on the same lines as applicable for fully
non-convertible debenture issue.

 The drawal from DRR is permissible only after 10 per cent of the debenture
liability has actually been reduced by the company. The requirement of
creation of DRR is not, however, applicable in the case of issue of debt
instruments by infrastructure companies.
Creation of Debenture Redemption
Reserves (DRR)
 In case of convertible issues by new companies, the creation of DRR
should commence from the year the company earns profits for the
remaining life of debentures.

 The DRR should be treated as a part of the general reserves for

consideration of bonus issue proposals and for price fixation related to
post-tax return.

 The company should create the DRR equivalent to 50 per cent of the
amount of debenture issue before the commencement of debenture
redemption.
Disclosure and Creation of Charge
The offer document should specifically state the assets on
which the security would be created as also the ranking of
the charge(s). In case of second/residual charge or
subordinated obligation, the associated risks should also
be clearly stated. The relevant consent for creation of
security such as pari passu letter, consent of the lesser of
the land in case of leasehold land, and so on, should be
obtained and submitted to the debenture trustee before
opening of the debenture issue.
Other Requirements
 No company should Issue fully convertible debentures (FCDs) have a
conversion period of more than 36 months unless conversion is made
optional with "put" and "call" option.

 If the conversion takes place at or after 18 months from the date of

allotment, but before 36 months, any conversion, in part or whole, of
the debenture should be optional and in the hands of the debenture-
holders. However, the issue of debenture cannot be made for
acquisition of shares or providing loan to any group company.

 This requirement would not apply to the issue of fully convertible

debentures providing conversion within a period of 18 months. The
premium amount and time of conversion should be determined and
disclosed by the issuer company. The interest rate for debentures can
be freely determined by the issuer company.