Primary versus secondary markets, IPOs and the prospectus

Who gets the money

A security is created once and traded many times. The one sale in which the issuer receives the proceeds is a primary-market transaction; every later sale is a secondary-market transaction, investor to investor, and the issuer is not a party to it. That single test — who receives the money? — settles most of the questions this module is examined on.

Worked example — Lakehead Robotics goes public

Monday. Lakehead Robotics sells 2,000,000 new shares to the public at $10.00 through its underwriter, Northshore Securities. Lakehead's treasury receives $20,000,000 less the underwriting fee. This is Lakehead's initial public offering (IPO) — the first time its shares are sold to the public — and it is a primary distribution.

Tuesday. The shares open for trading on the TSX. Renata, who bought 500 in the IPO, sells them to Tomas at $\mathrm{10.40.}Renatareceives$5,200; Lakehead receives nothing and did not need to be asked. This is the secondary market: the security already exists, and the trade only changes whose name is on it.

Two years later. Lakehead, now a listed company, issues 800,000 additional shares from treasury to fund a plant. This is a seasoned offering (an offering by an issuer that is already public) — and because the shares are newly created and the cash goes to Lakehead, it is still primary. The word people use for it, "secondary offering", is a trap: what makes a transaction secondary is not that it comes second, but that the seller is an investor rather than the issuer. Had Lakehead's founder sold 800,000 of her existing shares through a prospectus, the money would have been hers, not the company's — a secondary distribution.

The prospectus

A distribution to the public needs a prospectus: the disclosure document, filed with the securities regulator, that describes the issuer, the securities and the risks. It comes in two stages.

• The preliminary prospectus — the red herring, so called for the warning printed in red on its cover that the document is not yet final and the securities cannot yet be sold — is used during the waiting period to gauge interest. It omits the price and the size of the issue.
• The final prospectus adds the price, the number of securities and the underwriting terms. Once the regulator issues a receipt for it, sales can close.

A reporting issuer — a company already filing its continuous disclosure (Module 5) — may use a short-form prospectus under National Instrument 44-101, which incorporates those filings by reference instead of repeating them. Lakehead's IPO needed a long-form prospectus; its seasoned offering two years later could use the short form.

Five transactions to classify

(1) Lakehead's IPO — primary. (2) Renata sells to Tomas on the TSX — secondary. (3) Lakehead's 800,000 new treasury shares — primary (a seasoned offering). (4) The founder sells her block through a prospectus — secondary (an investor is the seller). (5) A dealer buys the whole IPO as a bought deal and resells it — primary, with the dealer as underwriter; the money still ends at Lakehead.