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What is a Primary Distribution?

A. Gabrenas
A. Gabrenas

A primary distribution is the first sale of a company’s stock or the sale of a bond directly from a company to investors. In the case of a primary distribution of stock, this process may also be called an initial public offering (IPO). Experts often agree there are certain potential benefits and drawbacks to investing in a primary distribution of stock. The case of bonds issued directly from a company is slightly different from that of an initial stock offering, as any issue of a new bond is considered a primary distribution, including those from well-established companies that have issued many other bonds in the past.

Many companies begin as privately held ones, meaning the money invested to start the company comes from the company founder or founders and/or a select group of private investors. A primary distribution can help a previously privately held company raise capital by selling shares in the company to public investors. Essentially, when an investor buys primary distribution shares, his or her money goes directly to the company. In return, he or she then owns a set portion of the company. One of the key differences between this type of stock offering and the more common secondary market offerings, which make up the majority of traded stocks, is that in the case of secondary offerings, shares are resold among public investors and the money from the purchase of the shares goes to the investors they are purchased from rather than directly to the company.

Man climbing a rope
Man climbing a rope

In general, experts tout certain advantages for primary distributions. For example, many IPOs are for young companies that are showing initial promise but that need more capital to expand their business. If the company continues and accelerates its success after a primary distribution of stock, there is a potential for the value of the stock to rise significantly and for initial investors to be able to sell their shares at a generous profit. On the other hand, experts also warn that the main disadvantage to buying an IPO is that companies offering them may yet be unproven in the broader marketplace. Due to this, there is a risk that the value of the stock may fall or that the company will fail, in which case a primary distribution investor would lose money. The degree of risk often can't be determined, as there is no history of stock performance to assess.

Another type of primary distribution that is slightly different than an IPO is a bond offering. When a company sells a bond, it is essentially taking a loan from an investor. An investor can make money off the interest rate the company agrees to pay for this loan, but unlike stock, the investor never actually owns part of the company when buying a bond. Any time a company offers bonds for sale to investors, it is considered a primary distribution because the money goes directly to the company. This can be done by both start-up companies and by long-established companies. As with any investment, there is always a risk that the investment will not be profitable. Compared to IPOS, however, experts may be better able to evaluate this risk for primary bond offerings, especially for companies with established track records.

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