Primary Market: Various Ways to Issue Securities
Definition of Primary Market
The primary market is the segment of the financial market where new securities are issued and sold to investors for the first time. The primary market plays a vital role in the Indian financial system, as it facilitates capital formation, economic growth, innovation, and wealth creation. The primary market enables companies, governments, and other entities to raise funds from the public by offering them ownership or debt claims in exchange for money.
Thank you for reading this post, don't forget to subscribe!The primary market is different from the secondary market, where existing securities are traded among investors. The secondary market provides liquidity, price discovery, and risk diversification for the securities issued in the primary market. The primary market determines the initial price and allocation of the securities, while the secondary market determines their subsequent price and demand.
There are various ways to issue securities in the primary market, depending on the type, size, and objective of the issuer and the nature, maturity, and risk of the securities. Some of the common ways to issue securities in the primary market are:
Initial Public Offer (IPO): It is the process of offering shares of a private company to the public for the first time.
Follow on Public Offer (FPO): It is the process of offering additional shares of an already listed company to the public.
Private Placement: It is the process of selling securities to a selected group of investors, such as institutional investors, high net worth individuals, etc.
Qualified Institutional Placements (QIPs): It is a type of private placement where a listed company can issue equity or equity-linked securities to qualified institutional buyers without going through a lengthy approval process.
Preferential issue: It is the process of issuing shares or convertible securities to a specific group of investors, such as promoters, strategic partners, etc., at a predetermined price.
Rights issue: It is the process of offering existing shareholders the right to buy additional shares of the company at a discounted price in proportion to their existing holdings.
Bonus issue: It is the process of issuing free shares to existing shareholders in proportion to their existing holdings by capitalizing the reserves or profits of the company.
Onshore and offshore offerings: These are the processes of issuing securities in domestic or foreign markets, respectively.
Offer for Sale (OFS): It is the process of selling shares held by promoters or other shareholders of a listed company through an exchange platform.
Employee Stock Option Plans (ESOPs): These are schemes that grant employees the option to buy shares of their employer company at a predetermined price after a certain period.
Each of these ways has its own benefits and challenges for both issuers and investors. In this article, we will discuss each of these ways in detail and compare their features, advantages, disadvantages, and regulatory aspects.
1. Initial Public Offer (IPO)
An IPO is the process of offering shares of a private firm/company to the public for the first time. The company has to file a draft prospectus with the Securities and Exchange Board of India (SEBI) and get its approval before launching the IPO. The company also has to appoint merchant bankers, underwriters, registrars, auditors, and other intermediaries to manage the IPO process. The company can choose between a book-building method or a fixed-price method to determine the price of the shares. The company can also offer a discount to retail investors and employees. The IPO can be either an offer for sale, where existing shareholders sell their shares, or a fresh issue, where new shares are issued.
Advantages of going public through an IPO
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It provides access to a large pool of capital from diverse investors.
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It enhances the visibility, credibility, and valuation of the company.
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It enables the existing shareholders to monetize their stake and diversify their portfolio.
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It creates an opportunity for employee stock ownership and retention.
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It facilitates mergers and acquisitions, strategic partnerships, and global expansion.
Disadvantages of going public through an IPO
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It involves high costs, time, and regulatory compliance.
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It exposes the company to market fluctuations, shareholder pressure, and public scrutiny.
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It dilutes the ownership and control of the founders and promoters.
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It requires disclosure of sensitive information and adherence to corporate governance norms.
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It increases the risk of litigation, competition, and takeover.
2. Follow-on Public Offer (FPO)
An FPO is the process of offering additional shares of an already listed company to the public. The company has to file a draft prospectus with SEBI and get its approval before launching the FPO. As previously mentioned for IPO, the company should have merchant bankers, underwriters, registrars, auditors, and other intermediaries to manage the FPO process. The company can choose between a book-building method or a fixed-price method to determine the price of the shares. The company can also offer a discount to retail investors and employees. The FPO can be either an offer for sale, where existing shareholders sell their shares, or a fresh issue, where new shares are issued.
The reasons and benefits of issuing an FPO are:
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It provides additional capital for expansion, diversification, debt reduction, or working capital needs.
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It increases the liquidity, marketability, and free float of the shares.
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It enables the existing shareholders to exit or reduce their stake at a favorable price.
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It attracts new investors and enhances the investor base and confidence.
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It reflects the growth potential and performance of the company.
The challenges and risks involved in issuing an FPO are:
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It involves high costs, time, and regulatory compliance.
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It exposes the company to market fluctuations, shareholder pressure, and public scrutiny.
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It dilutes the earnings per share and return on equity of the company.
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It requires disclosure of sensitive information and adherence to corporate governance norms.
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It increases the risk of litigation, competition, and takeover.
3. Private Placement
A private placement is the process of selling securities to a selected group of investors, such as institutional investors, high net worth individuals, etc., without making a public offer. The company does not have to file a prospectus with SEBI or get its approval before launching a private placeme`nt. The company also does not have to appoint intermediaries to price, terms, and conditions of the securities with the investors directly. The securities can be either debt or equity instruments.
The advantages of raising funds through a private placement are:
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It involves low costs, time, and regulatory compliance.
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It provides flexibility and confidentiality for the company and the investors.
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It enables the company to raise large amounts of capital from sophisticated investors.
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It avoids dilution of ownership and control for the promoters and founders.
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It facilitates long-term relationship and strategic alignment with the investors.
The disadvantages of raising funds through a private placement are:
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It limits the access to a small pool of capital from limited investors.
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It reduces the liquidity, marketability, and free float of the securities.
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It involves higher risk and cost of capital for the company and the investors.
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It requires higher due diligence and disclosure standards for the investors.
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It restricts the transferability and tradability of the securities.
The regulatory framework governing Private Placement in India
The Companies Act, 2013: It defines private placement as an offer or invitation to subscribe to securities made to not more than 200 persons in a financial year, excluding qualified institutional buyers and employees under ESOPs. It also prescribes various conditions and procedures for conducting a private placement by a company.
The SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018: They regulate the private placement of equity or equity-linked securities by listed companies or companies intending to get listed. They also specify various conditions and requirements for conducting a private placement by such companies.
The SEBI (Issue and Listing of Debt Securities) Regulations, 2008: They regulate the private placement of debt securities by listed or unlisted companies or entities. They also specify various conditions and requirements for conducting a private placement by such companies or entities.
4. Qualified Institutional Placements (QIPs)
A QIP is a type of private placement where a listed company can issue equity or equity-linked securities to qualified institutional buyers without going through a lengthy approval process. A qualified institutional buyer is an entity that is registered with SEBI as an investor in securities markets, such as mutual funds, banks, insurance companies, pension funds, foreign portfolio investors, etc. The company has to file a placement document with SEBI within one day of launching the QIP. The company also has to appoint merchant bankers to manage the QIP process. The company can determine the price of the securities based on the average of the weekly high and low closing prices of the shares during the two weeks preceding the relevant date. The company can also offer a discount of up to 5% on the floor price. The QIP can be either an offer for sale, where existing shareholders sell their shares, or a fresh issue, where new shares are issued.
The benefits of issuing a QIP are:
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It involves low costs, time, and regulatory compliance.
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It provides access to a large pool of capital from sophisticated investors.
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It avoids dilution of ownership and control for the promoters and founders.
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It enhances the visibility, credibility, and valuation of the company.
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It facilitates long-term relationship and strategic alignment with the investors.
The drawbacks of issuing a QIP are:
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It limits the participation of retail investors and employees.
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It exposes the company to market fluctuations and investor pressure.
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It dilutes the earnings per share and return on equity of the company.
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It requires disclosure of sensitive information and adherence to corporate governance norms.
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It restricts the transferability and tradability of the securities.
The eligibility criteria and guidelines for issuing a QIP are:
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The company should have been listed on a recognized stock exchange for at least one year before the date of issuance.
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The company should have complied with the listing agreement and other regulations applicable to it.
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The company should not have defaulted on any payment obligations or been restrained from accessing the capital market by SEBI or any other authority.
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The company should not have issued any securities through QIP or any other method in the preceding six months.
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The company should not issue more than five times its pre-issue net worth through QIP in a financial year.
5. Preferential issue
A preferential issue is the process of issuing shares or convertible securities to a specific group of investors, such as promoters, strategic partners, etc., at a predetermined price. The company has to obtain shareholders’ approval through a special resolution before launching the preferential issue. The company also has to file an offer document with SEBI within one day of passing the resolution. The company has to determine the price of the securities based on the average of the weekly high and low closing prices of the shares during the six months or two weeks after the relevant date, whichever is higher. The company can also offer a discount of up to 10% on the floor price for frequently traded shares or up to 25% for infrequently traded shares. The preferential issue can be either an offer for sale, where existing shareholders sell their shares, or a fresh issue, where new shares are issued.
The advantages of issuing a preferential issue are:
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It involves low costs, time, and regulatory compliance.
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It provides access to a targeted pool of capital from loyal investors.
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It enables the promoters and founders to increase or maintain their stake and control in the company.
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It attracts new investors and enhances the investor base and confidence.
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It reflects the growth potential and performance of the company.
The disadvantages of issuing a preferential issue are:
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It limits the participation of public shareholders and employees.
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It exposes the company to market fluctuations and investor pressure.
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It dilutes the earnings per share and return on equity of the company.
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It requires disclosure of sensitive information and adherence to corporate governance norms.
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It increases the risk of litigation, competition, and takeover.
The regulatory norms and disclosures required for issuing a preferential issue are:
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The company should have been listed on a recognized stock exchange for at least six months before the date of issuance.
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The company should have complied with the listing agreement and other regulations applicable to it.
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The company should not have defaulted on any payment obligations or been restrained from accessing the capital market by SEBI or any other authority.
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The company should not issue more than 75% of its paid-up capital through preferential issue in a financial year.
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The company should disclose the objects, pricing, terms, conditions, lock-in period, etc. of the preferential issue in the offer document and the explanatory statement.
6. Rights and Bonus issue
Rights issue and bonus issue are two ways of issuing additional shares to existing shareholders in proportion to their existing holdings. Rights issue is the process of offering existing shareholders the right to buy additional shares of the company at a discounted price within a specified period. Bonus issue is the process of issuing free shares to existing shareholders by capitalizing the reserves or profits of the company.
The impact of a rights issue or bonus issue on the share price, earnings per share, and dividend payout ratio of the issuing company are:
Share price: The share price usually falls after a rights issue or a bonus issue due to an increase in supply or dilution effect. However, this fall may be temporary or offset by other factors such as demand, valuation, sentiment, etc.
Earnings per share: The earnings per share usually decreases after a rights issue or a bonus issue due to an increase in number of shares or dilution effect. However, this decrease may be temporary or offset by other factors such as growth, profitability, efficiency, etc.
Dividend payout ratio: The dividend payout ratio usually decreases after a rights issue or a bonus issue due to an increase in number of shares or dilution effect. However, this decrease may be temporary or offset by other factors such as dividend policy, retained earnings, etc.
The reasons and benefits of issuing rights issue or bonus issue are:
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It provides additional capital for expansion, diversification, debt reduction, or working capital needs.
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It increases the liquidity, marketability, and free float of the shares.
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It enables the existing shareholders to maintain their proportionate ownership and control in the company.
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It attracts new investors and enhances the investor base and confidence.
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It reflects the growth potential and performance of the company.
The challenges and risks involved in issuing rights issue or bonus issue are:
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It involves high costs, time, and regulatory compliance.
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It exposes the company to market fluctuations, shareholder pressure, and public scrutiny.
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It dilutes the earnings per share and return on equity of the company.
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It requires disclosure of sensitive information and adherence to corporate governance norms.
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It increases the risk of litigation, competition, and takeover.
7. Onshore and offshore offerings
Onshore and offshore offerings are two ways of issuing securities in domestic or foreign markets, respectively. Onshore offering is the process of issuing securities in India to Indian investors or foreign investors who are registered with SEBI as foreign portfolio investors (FPIs). Offshore offering is the process of issuing securities outside India to foreign investors who are not registered with SEBI as FPIs.
The advantages and disadvantages of issuing onshore or offshore offerings are:
Onshore offering
Advantages:
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It involves low costs, time, and regulatory compliance.
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It provides access to a large and diverse pool of domestic investors.
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It enhances the visibility, credibility, and valuation of the company in the home market.
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It avoids currency risk and exchange rate fluctuations.
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It facilitates long-term relationship and strategic alignment with the domestic investors.
Disadvantages:
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It limits the access to a small and saturated pool of foreign investors.
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It exposes the company to market fluctuations, shareholder pressure, and public scrutiny in the home market.
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It dilutes the earnings per share and return on equity of the company in the home market.
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It requires disclosure of sensitive information and adherence to corporate governance norms in the home market.
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It increases the risk of litigation, competition, and takeover in the home market.
Offshore offering
Advantages:
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It provides access to a large and untapped pool of foreign investors.
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It enables the company to raise funds in foreign currency and diversify its sources of capital.
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It enhances the visibility, credibility, and valuation of the company in the global market.
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It avoids dilution of ownership and control for the promoters and founders in the home market.
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It attracts new investors and enhances the investor base and confidence in the global market.
Disadvantages:
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It involves high costs, time, and regulatory compliance.
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It exposes the company to currency risk and exchange rate fluctuations.
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It requires disclosure of sensitive information and adherence to corporate governance norms in multiple jurisdictions.
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It increases the risk of litigation, competition, and takeover in multiple jurisdictions.
8. Offer for Sale (OFS)
An OFS is the process of selling shares held by promoters or other shareholders of a listed company through an exchange platform. The company does not have to file a prospectus with SEBI or get its approval before launching the OFS. The company also does not have to appoint intermediaries to manage the OFS process. The company can determine the floor price of the shares, which may or may not be disclosed to the public. The company can also offer a discount of up to 10% on the floor price for retail investors. The OFS can be either a single day or a multiple day offer, depending on the size and demand of the shares.
The benefits and drawbacks of issuing an OFS are:
Benefits:
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It involves low costs, time, and regulatory compliance.
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It provides a transparent and efficient mechanism for selling shares through an exchange platform.
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It enables the promoters or other shareholders to exit or reduce their stake at a market-driven price.
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It increases the liquidity, marketability, and free float of the shares.
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It attracts new investors and enhances the investor base and confidence.
Drawbacks:
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It limits the participation of employees and unlisted shareholders.
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It exposes the company to market fluctuations and investor pressure.
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It dilutes the ownership and control of the promoters or other shareholders.
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It requires disclosure of sensitive information and adherence to corporate governance norms.
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It increases the risk of litigation, competition, and takeover.
The eligibility criteria, guidelines, disclosures, etc. for issuing an OFS are:
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The company should have been listed on a recognized stock exchange for at least one year before the date of issuance.
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The company should have complied with the listing agreement and other regulations applicable to it.
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The company should not have defaulted on any payment obligations or been restrained from accessing the capital market by SEBI or any other authority.
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The company should disclose the details of the offer, such as floor price, discount, number of shares, category of sellers, etc., in advance to the stock exchange and the public.
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The company should ensure that at least 10% of the offer size is reserved for retail investors and at least 25% of the offer size is allotted proportionately to them.
9. Employee Stock Option Plans (ESOPs)
Employee Stock Option Plans (ESOPs) are schemes that grant employees the option to buy shares of their employer company at a predetermined price after a certain period. ESOPs are a form of long-term incentive that aligns the interests of employees with those of shareholders and motivates them to perform better.
ESOPs work in India as follows:
1. Granting of Options: The company formulates an ESOP scheme and gets it approved by the board of directors and the shareholders. The company grants options to eligible employees based on certain criteria, such as performance, seniority, etc.
2. Exercise of Options: The options have an exercise price, which is usually lower than the market price of the shares at the time of grant. The options have a vesting period, which is the minimum time that the employee has to wait before exercising the options. After the vesting period, the employee can exercise the options by paying the exercise price and acquiring the shares.
3. Sale of Shares: After exercising the options, the employee can hold or sell the shares as per their preference. If they sell the shares, they may be subject to capital gains tax on any profit made from the sale.
Issuing ESOPs to employees as a part of a compensation package or incentive scheme has several advantages and disadvantages:
Advantages:
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It aligns the interests of employees with those of shareholders.
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It motivates employees to perform better and contribute to the growth of the company.
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It helps attract and retain talented employees.
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It provides employees with an opportunity to share in the success of the company.
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It can be used as a tax-efficient form of compensation.
Disadvantages:
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It thins out the ownership and control of existing shareholders.
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It may not be suitable for all types of companies or industries.
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It requires careful planning and administration to ensure its effectiveness.
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It may not be well understood or appreciated by all employees.
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It may not provide immediate financial benefits to employees.
Conclusion
In conclusion, primary markets play a crucial role in capital formation, economic growth, innovation, and job creation in India. They provide companies with access to capital for expansion, diversification, debt reduction, or working capital needs. They enable investors to participate in the growth potential and performance of companies. To improve the efficiency, transparency, accessibility, etc. of primary markets in India, it is important to streamline regulatory processes, enhance investor protection measures, promote financial literacy, encourage technological innovation, and foster a culture of entrepreneurship.
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