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Introduction to Primary & Secondary Markets

Learn about how & why private companies go public by issuing shares to the public.

Gopal Kavalireddi
2 minutes read
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Every company that desires to raise equity capital has the option of offering its shares to a select group of investors, to limit the number of investors to less than 50, while raising a large amount of money. This is termed as Private Placement. Large financial institutions with the capability to invest a huge sum of money are approached by the companies and are presented with their current working and future prospects, while highlighting the financials, business strategy and other aspects of the company.

These private investors bring in the necessary capital and stay invested for a pre-decided period of time. After a certain period of time, the company can decide to offer the shares to the public investors at large. The process of offering the shares to the public for the first time is called the Initial Public offering (IPO). This mechanism also provides an exit option for early investors, who wish to liquidate either shareholding either in part or in full.

Public investors including retail investors, can bid for these shares, and based on the subscription, the shares are allotted at a price formulated through a book building process. Once these shares have been sold in the primary market, these shares continue to trade in the secondary market. Private investors can sell their shares and gain back their earlier investment along with profits. Secondary market transactions are referred to as trades, where one investor buys shares from another investor at the prevailing market price or at a mutually agreed price, facilitated by an intermediary like the broker.

Though there are more than 7000 listed companies on the BSE, as of 2017, less than 3000 stocks are actively traded with good volumes. Shares of companies traded with low volumes may make the investment illiquid and difficult to sell, in case of a stock market down trend or low investor interest in that company, due to bad business prospects or unfavourable working prospects of the company.


Next Chapter

Primary Market Terminology

16 Lessons

This chapter helps to understand IPOs in greater depth. Learn about the concepts and processes involved in the public issue of shares.

Introduction to Secondary Markets

Learn what happens after companies issue IPOs.

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Samika commented on April 22nd, 2019 at 12:03 PM  
Could you tell me why companies prefer a private placement first and then opt for IPO. Why don't they have an IPO in the beginning?

Gopal commented on April 24th, 2019 at 8:10 AM  
A company expects to raise capital - small or large - based on its business growth requirements.
There could be many reasons for a Company to opt for a private placement before an immediate IPO. When a Company has a reputed name as its shareholder or as an anchor investor, it becomes easy for the promoters (including BRLMs etc) to actually promote and sell the IPO, successfully.
Imagine a promoter announcing in an interview/roadshow - "Rakesh Jhunjhunwala and Ramesh Damani together hold 'X'% stake in our company and they have been initial investors since 'Y' years ago". This instills a sense of confidence in retail investors. In addition, when the IPO is priced (even a little expensively) retail investors might feel comfortable & valuations justifiable with Rakesh being an investor already.
In some cases, when the business is very young & the credibility of the promoters is not known in the stock market scenario, it becomes difficult to raise capital or sell an IPO to its best. Also, the capital requirements at that time would be smaller, and hence, a private placement bodes well for the Company/promoters, as the regulations are comparatively lesser for a pvt. placement vs. an IPO.
There have been many IPOs which have failed due to lack of credible initial/anchor investors or bad pricing coupled with unknown/unethical promoters.
So, a pvt. placement is a step forward in ensuring initial capital, a little risk mitigation and is an essential & useful part of the credibility building exercise for the Company.

Suryanshi commented on May 9th, 2019 at 4:20 PM  
Do we need to have a Demat account to trade in the primary market?

Gopal commented on May 9th, 2019 at 4:25 PM  
Primary Market involves applying for shares of a particular IPO and if allotted, the shares would be credited to your demat account. There is no trading in the primary market by retail investors.

tejas commented on May 9th, 2019 at 7:16 PM  
In addition to what Gopal has said, it is compulsory to have a demat account. You cannot participate in the primary market without it.

Ankit Garg commented on May 16th, 2019 at 2:22 PM  
After IPO, if I am buying share of any company, would that company getting something from that money as an investment? or is it between buyer and sellers after IPO, company does not get anything after IPO ?

Gopal commented on May 16th, 2019 at 9:58 PM  
After IPO (primary market transaction) is completed, the shares that you are buy are from the secondary market, which means, you are buying from other investors who bought the shares earlier. Hence, that segment of the transaction is between the buyer and seller and the company doesn't get any of those proceeds.