Noesis
1.3.2Primary vs Secondary Market & IPOs

Understand the IPO process end to end

1,868 words8 min readdifficulty · medium
🇮🇳 Yeh note Hinglish mein padho →

WHAT is happening — primary vs secondary in one breath

WHY this distinction matters: money flows to the company only in the primary market. All the daily buying/selling you see later is secondary — pure investor-to-investor.

HOW the IPO works — the end-to-end pipeline

Figure — Understand the IPO process end to end

Step 1 — Decision & appointing bankers

The company's board decides to go public and hires merchant bankers (Book Running Lead Managers).

  • Why this step? The company itself doesn't know how to legally sell shares or price them; the banker brings expertise, buyers, and (sometimes) a guarantee.

Step 2 — Due diligence & DRHP filing

The company + bankers prepare the Draft Red Herring Prospectus (DRHP) and file it with the regulator (SEBI in India / SEC in the US).

  • Why this step? Investors must know the risks, financials, promoters, and use of funds before they trust the company with their money. The regulator reviews for disclosure, not for whether the stock is "good."

Step 3 — Pricing method

Two ways to set the price:

IPO price={Fixed Pricestated upfront in prospectusBook Buildinga price band [Plow, Phigh] + investor bids\text{IPO price} = \begin{cases}\text{Fixed Price} & \text{stated upfront in prospectus}\\[4pt]\text{Book Building} & \text{a } price\ band\ [P_{low},\,P_{high}]\ \text{+ investor bids}\end{cases}

In book building, the final cut-off price emerges from demand.

Step 4 — Marketing (Roadshow) & IPO opens

Bankers pitch to big institutions (roadshow); the IPO opens for 3–5 days. Categories bid:

  • QIB — Qualified Institutional Buyers (mutual funds, banks)
  • NII / HNI — Non-Institutional Investors (big individuals)
  • RII — Retail Individual Investors (small public)

Step 5 — Subscription & the cut-off price

Bids pile up. We measure demand by the subscription ratio:

Subscription=Total shares bid forTotal shares offered\boxed{\text{Subscription} = \dfrac{\text{Total shares bid for}}{\text{Total shares offered}}}

Derivation of the idea from scratch:

  1. The company offers a fixed pool of NN shares.
  2. Investors collectively bid for BB shares.
  3. If B>NB > N → oversubscribed, ratio >1>1, not everyone gets shares → allotment by lottery / proportion.
  4. If B<NB < N → undersubscribed, ratio <1<1; if it falls below the minimum (90% in India) the IPO fails / is withdrawn.

Step 6 — Allotment & refunds

Shares are allotted (via ASBA — money only debited if you get shares); non-allottees are refunded.

  • Why ASBA? Your money stays blocked in your own bank account earning interest until allotment, instead of leaving your hands.

Step 7 — Listing Day (secondary market begins)

Shares list on the exchange (NSE/BSE). The first trade sets the listing price.

Listing Gain (%)=Plisting−PissuePissue×100\text{Listing Gain}\ (\%) = \frac{P_{\text{listing}} - P_{\text{issue}}}{P_{\text{issue}}}\times 100

  • Why this step? From here on, all trading is secondary — the company already got its Step-6 money.

Worked Examples

Common Mistakes (Steel-manned)

Recall Feynman: explain to a 12-year-old

Imagine your friend's lemonade stand is doing great and she wants a big stand. She can't afford it alone, so she says: "I'll sell tiny ownership cards. Buy a card and you own a piece — if we make money, you get a share!" First she asks a smart helper (banker) to organize it, writes a booklet explaining everything (prospectus), and a fair judge (SEBI) checks the booklet is honest. She sets a price range, everyone says how many cards they want, and if too many people ask (oversubscribed) she does a lucky draw. She collects the money (this is the only time the stand gets cash). After that, kids trade the cards among themselves in the playground (the stock exchange) — the stand doesn't get money from that trading anymore.

Flashcards

In which market does the IPO happen and who gets the money?
The primary market; the company receives the money.
Does the company earn money from secondary-market trading?
No — that's investor-to-investor; the company only got paid at allotment (issue price).
What is a DRHP / Red Herring Prospectus?
The disclosure document that omits final price & share count, decided later via book-building.
Formula for subscription ratio?
Total shares bid for ÷ total shares offered.
An IPO offers 5,00,000 shares, bids come for 20,00,000. Subscription?
4× (oversubscribed).
What does SEBI's approval of an IPO actually guarantee?
Adequate disclosure, NOT investment quality or safety.
What is book building?
Price discovery via a price band [Plow,Phigh][P_{low},P_{high}] where investors bid; final cut-off price set by demand.
What is ASBA?
Application Supported by Blocked Amount — money stays blocked in your account, debited only if allotted.
Listing gain if issue ₹200, lists ₹260?
(260−200)/200 ×100 = 30%.
What happens if an IPO is undersubscribed below the minimum?
The IPO fails / is withdrawn and money refunded.
Who are QIB, NII, RII?
Qualified Institutional Buyers, Non-Institutional (HNI) Investors, Retail Individual Investors.
Why is proportionate allotment ≈ bid ÷ oversubscription ratio?
Because shares are shared across excess demand proportionally (subject to lot rounding/lottery).

Connections

Concept Map

needs capital

happens in

money flows to

managed by

prepares

filed with

checks

omits final price via

price band yields

then listed on

investors trade

company gets nothing

Private Company

IPO First Public Sale

Primary Market

Merchant Banker Lead Manager

DRHP Prospectus

SEBI or SEC

Disclosure not quality

Book Building

Cut-off Price

Secondary Market

Existing Shares

Hinglish (regional understanding)

Intuition Hinglish mein samjho

Dekho, IPO ka simple matlab hai — jab koi private company pehli baar apne shares public ko bechti hai, taaki bada paisa (capital) raise kar sake aur stock exchange par list ho jaye. Yeh sab primary market mein hota hai, aur yaad rakho — paisa sirf isi time company ko milta hai. Baad mein jab log aapas mein shares kharidte-bechte hain, woh secondary market hai, jahan company ko ek rupaya bhi nahi milta.

Process ka flow yaad karo: pehle company merchant banker hire karti hai, phir DRHP file hoti hai SEBI ke paas (SEBI sirf disclosure check karta hai, yeh nahi batata ki stock accha hai ya bura!). Phir price band set hoti hai book-building se, roadshow hota hai, IPO 3-5 din khulta hai, log bid karte hain. Agar demand zyada ho gayi (oversubscribed) toh lottery ya proportionate allotment hota hai. ASBA ki wajah se aapka paisa apne hi bank account mein blocked rehta hai — sirf allotment mile toh debit hota hai.

Sabse important insight: listing day ka jo profit hota hai (listing gain), woh company ka nahi, investors ka hota hai — kyunki wahan se secondary market shuru ho jaata hai. Aur ek common galti — oversubscription ka matlab yeh nahi ki listing gain pakka milega. Hype alag cheez hai, company ke fundamentals alag. Isliye subscription number dekh ke andha investment mat karna!

Test yourself — Primary vs Secondary Market & IPOs

L1 RecognitionL2 RecallL3 ProductionL4 ApplicationL5 Mastery

Connections

Learn about book building vs fixed price IPOsStock-Market · 1.3.3Learn role of SEBI as regulatorStock-Market · 1.4.9Understand the role of underwriters - merchant bankersStock-Market · 1.3.4