Primary Market

It's where brand-new financial products, like stocks, bonds, or other assets, are first created and sold to investors

Author: Sid Arora
Sid Arora
Sid Arora
Investment Banking | Hedge Fund | Private Equity

Currently an investment analyst focused on the TMT sector at 1818 Partners (a New York Based Hedge Fund), Sid previously worked in private equity at BV Investment Partners and BBH Capital Partners and prior to that in investment banking at UBS.

Sid holds a BS from The Tepper School of Business at Carnegie Mellon.

Reviewed By: Rohan Arora
Rohan Arora
Rohan Arora
Investment Banking | Private Equity

Mr. Arora is an experienced private equity investment professional, with experience working across multiple markets. Rohan has a focus in particular on consumer and business services transactions and operational growth. Rohan has also worked at Evercore, where he also spent time in private equity advisory.

Rohan holds a BA (Hons., Scholar) in Economics and Management from Oxford University.

Last Updated:November 2, 2023

What is the Primary Market?

The primary market is a part of the capital markets where new securities, financial products, and assets are created and sold for the first time.

Assets in this market are purchased directly from the issuing entity. Once the initial security issuance is completed, all further trading is moved to the secondary market, where a company or an individual buys and sells existing financial products. 

For example, the New York Stock Exchange (NYSE) and Nasdaq are places where you trade these financial products in the secondary market.

Different from that of the primary market, securities in the secondary market can be traded between investors as opposed to being bought directly from an issuer.

It serves two main purposes. Firstly, it acts as an intermediary, connecting parties that need funding with investors who have money.

This diminishes transaction costs for both parties as they sign contracts with the intermediary rather than dealing with each other directly. 

Secondly, because the primary market is generally very resourceful, it can help set a price range for a given security, providing both the buy- and sell-sides with reasonable compensation.

These markets are classified according to the types of securities sold. For instance, the sale of stocks from corporations to investors takes place in the primary capital market. In contrast, corporate or sovereign bonds are sold in the primary debt market.

Below are the key players:

  1. Issuers 
    • Corporations are looking for funding, trying to sell themselves, or combining themselves with other companies.
  2. Intermediaries (sell-side)
    • Investment banks
    • Public accounting firms
  3. Investors (buy-side)
    • Individual investors
    • Institutional investors (both domestic or foreign)

It is worth noting that all the financial products issued in the primary market in the U.S. need to be approved by the Securities and Exchange Commission (SEC) before they can be sold to investors.

Key Takeaways

  • The primary market is where new securities and financial products are created and sold directly from the issuing entity.
  • After the initial issuance, trading moves to the secondary market, where existing financial products are bought and sold between investors.
  • The primary market involves underwriting or funding, which includes raising capital through debt or equity financing.
  • Issuers (corporations), intermediaries (investment banks, accounting firms), and investors (individual and institutional) are the vital participants in the primary market.

How Does Primary Market Work?

There are two main activities in the primary market:

  1. Underwriting/funding 
  2. Buying/selling companies.

1. Underwriting or funding

When a company needs money, it will approach the sell-side for help to raise money through debt or equity financing. This process of raising capital is called underwriting or funding.

Debt financing occurs when a company raises money by issuing bonds. On the other hand, equity financing happens when a company raises money by issuing stocks through an initial public offering (IPO) or another issuance method. More on this is below.

Here is an example of how underwriting or funding works:

Let’s say private Corporation Z is going to issue its stocks to the public through an IPO. Corporation Z would reach out to some investment banks to announce its intention to go public. In turn, the investment banks (also known as the underwriters) would generate something similar to a proposal and give it to Corporation Z.

Corporation Z would then do its due diligence by examining the quoted prices and resources provided by the investment banks. Next, it would pick one or multiple investment banks to do the deal with.

The investment banks, representing Corporation Z now, would reach out to institutional investors to pitch the investment opportunity, facilitating the deal’s completion.

In this example, the sell-side investment banks take a cut from the transaction as a fee for their middleman work, while most of the money raised from the IPO goes to Corporation Z.

2. Buying or selling companies

When a company intends to acquire other companies or sell itself, it would most likely engage itself in the mergers and acquisitions (M&A) process. This involves transferring partial or full ownership of a company to other entities.

Even though mergers and acquisitions are often used interchangeably, they are different. A merger happens when two companies combine forces to form a new joint organization, while an acquisition occurs when another absorbs one company. 

Here is an example of how buying/selling a company works:

Corporation B wants to sell itself. It would also reach out to a sell-side investment bank to help find a buyer.

This buyer would be the buy-side. However, in an M&A case, the buy-side is no longer an institutional investor but another corporation or private equity firm.

In this case, the investment banks again charge an advisory fee for facilitating various complex transactions.

Raising Funds from the Primary Market

A few of the ways are:

1. Public issue - IPO

In simple terms, an initial Public Offering (IPO) refers to when a private company issues its stocks for the first time to the public. It is the most common way to issue securities to the general public.

For instance, Airbnb raised about $3.5 billion in its public market debut. Facebook (now Meta) went public in 2012, raising $16 billion from its IPO.

An IPO is a great source of funding for a company. Before the IPO, the company’s only shareholders would be the founders and/or some private investors. After an IPO, the company’s shares are opened to a wider range of investors.

2. Rights issue (or rights offering)

A rights issue refers to the process in which a company raises additional capital in the primary market. This is done by giving its current shareholders the right to purchase additional shares, normally offered at a discount. 

The rights given to existing shareholders can be seen as a type of option rather than an obligation to purchase additional company shares. 

A rights offering dilutes the value of each company share as it increases the total number of shares. However, because the existing holders are given the right to purchase more shares, they can maintain their current stake in the company by buying more shares. 

For instance, in 2021, Blue Apron, the American ingredient-and-recipe meal kit company, started a $45 million rights offering as a part of its $78 million capital raise plan.

3. Private Placement

A private placement is an alternative to an IPO. Instead of issuing new financial security to the open market, a company that chooses to do a private placement would sell its stocks or bonds to pre-selected investors.

The pre-selected investors can be high-net-worth individuals (HNWI), banks, investment funds, insurance companies, or other financial institutions. 

Different from the traditional IPO process, a private placement doesn’t require the issuer to be subjected to the registration process required by the SEC. A private placement is a common way to offer securities among start-ups and smaller companies. 

There are, however, some other requirements a company needs to meet to go through a private placement. These requirements vary according to the type of private placement. 

4. Preferential Allotment

Preferential allotment refers to when a company issues shares on a preferential basis to a small group of selected individuals, such as the directors or existing shareholders, at a price that may or may not be related to the market price

Even though preferential allotment and private placement are used interchangeably, there are some crucial legal differences between the two. One is the types of financial products allowed to be issued under the two securities offerings. 

Mergers and Acquisitions (M&A)

M&A (mergers and acquisitions) refers to consolidating two companies into one, in which partial or full ownership of a company is transferred to other entities. M&A deals are normally completed to help a business expand and gain more profit.

Despite the fact that mergers and acquisitions are often used interchangeably, they are different. A merger takes place when two companies combine forces to form a new joint organization, while an acquisition happens when one company is absorbed by another. 

Mergers typically happen among two companies that are of similar size and are pursued to minimize operational costs, enter into a new market, and/or increase profits. Mergers lead to the dilution of each company’s power but require no cash to complete. 

The megadeal between telecommunication titan AT&T and media and entertainment giant Time Warner in 2018 is a good example of a merger. It brought cost efficiency to the new combined entity. 

Unlike in a merger, a new company does not get formed in an acquisition. The smaller company is often absorbed into the larger company. Hence, acquisitions are sometimes referred to as takeovers.

An acquisition happens when one financially stronger entity acquires at least 51% of a relatively weaker company’s stock to gain absolute control over it. As a result, the smaller company ceases to exist and continues its operations under the larger company’s name.

The reasons behind an acquisition are similar to those of a merger. The basic goal is to secure a competitive advantage by integrating resources. 

A classic acquisition example would be Amazon’s $13.7 billion acquisition of the supermarket chain Whole Foods in 2017. By obtaining Whole Foods, Amazon aimed to gain a trove of consumer data and secure Whole Foods’ private label products.

Primary Market Key Players

Let's take a look at the key players who play vital role in this market:

  • Issuers (or the party that looks to sell itself or combine itself with other companies)
  • Corporations 

A corporation is a legal organization created for business purposes. It is owned by its shareholders but exists as an individual entity that possesses the same rights and responsibilities as a single person.

In the primary market, corporations are either looking for funding to expand their operations, trying to sell themselves, or looking at opportunities to combine themselves with other companies.

Possible career paths for corporations operating in the capital market are financial planning and analysis (FP&A), business analytics, corporate development, and investor relations. 

Examples of publicly listed companies:

Investment banks, in a nutshell, are financial advisors, providing a variety of services to their clients, including HNWI, corporations, investment funds, and government entities. 

In the primary market, investment banks function as intermediaries. They facilitate deals between businesses and buy-side institutions, assisting with financial product offerings and M&As.

Investment banking is the most common primary market job in investment banks. It requires strong financial modeling and valuation analysis skills

Examples of investment banks:

Public accounting firms provide accounting and advisory services to other companies. 

They specialize in multiple functions crucial to the primary market, especially in M&A deals, such as financial reporting, financial statement auditing, and taxation. 

If you are interested in pursuing a career in accounting/working in the primary market, you should look into specializing in purchase accounting. 

Examples of some of the most well-known public accounting firms:

1. Investors (buy-side)

  • Institutional investors (both domestic or foreign):
  • Private Equity (PE) Firms

A private equity firm is an investment company that uses capital raised from its limited partners (LP) to invest in promising, private, well-established businesses to enhance their value over time before reselling them for a profit. 

When investing in companies, PE firms typically take a majority stake (50% or more ownership)

PE jobs are highly desirable as employees typically earn top-dollar salaries and generous performance bonuses. As a result, competition for PE jobs is extremely intense. 

PE firms generally prefer hiring candidates with at least two years of investment banking analyst experience as their entry-level staff. As a result, openings for undergraduates fresh out of college are very limited. 

To be considered for a PE position, you must have top-notch financial modeling and analytical skills and sound interpersonal skills. If you are interested in PE, check out our Private Equity Interview Prep Course here.

Examples of PE firms:

2. Venture Capital (VC)

A venture capital firm funds startups and early-stage businesses with high growth potential. Similar to PE firms, VC firms pool limited partners’ capital to make investments. 

Unlike PE firms, VC firms typically take a minority stake (50% or less ownership) when investing.

Venture capitalists work on sourcing new deals, funding early-stage, high-growth companies, and helping existing deals grow. 

VC firms tend to focus their investments in a specific sector, and different types of VC firms seek different talents. 

Examples of VC firms:

Researched and authored by Hongmo Liu | LinkedIn

Reviewed and edited by James Fazeli-Sinaki | LinkedIn

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