Launching an IPO is actually a big decision for any company. It is mainly due to associated benefits of IPO in financial markets. This great event is also an opportunity for several investors to diversify their portfolio.
According to a post published in TheWeek, IPO market is booming again as several companies get ready to go public.
The success story of a number of IPOs in current year is further boosting the investor’s confidence to a much higher level. But, all investors are not lucky enough to get applied lots of IPO shares. Some of the investors receive requested amounted of lots while others not even a single lot.
What makes the IPO share distribution process a complicated task? How shares are distributed in a typical IPO? Here we will understand the basics of IPO share allotment process in simple words.
Initial Public Offer (IPO), is the process by which a privately owned company goes public by selling its shares to different categories of investors for the first time in stock market. An IPO allows the underlying company to raise funds for business purpose.
In a typical IPO, share allotment process begins completely as per the guidelines of stock exchange regulator such as SEC in US & SEBI in India:
IPO Share Allotment On The Basis Of Category Of Investor
Generally, shares in a typical IPO are divided among 3 different categories of investors:
Institutional or Qualified Institutional Buyers (QIBs): It includes mutual funds, financial institutions, foreign portfolio investors, commercial banks, anchor investors, etc.
Retail Institutional Investors (RIIs): It includes resident Indian individuals, non-resident Indian individuals (NRIs), & Hindu Un-divided Families (HUFs). In this category, maximum possible investment is Rs 2 lakh. Anyone who is willing to invest more than Rs 2 lakh should apply under NIIs category & not RIIs category.
Non-Institutional Investors (NIIs) or High Networth Investors (HNIs): It includes resident Indian individuals, non-resident Indians (NRIs), Hindu Un-divided Families (HUFs), corporate bodies, companies, trusts, & societies. These are those who are willing to invest more than Rs 2 lakh.
Each category has a fixed division of share allotment. It is often referred as Issue Structure. For example, issue structure of a Company ABC is QIB (50%), HNI (15%) and RII (35%). This indicates that 50% of the total shares in an IPO issue are reserved for QIB, 15% of total shares are reserved for HNI and remaining 35% of total shares are reserved for RII.
This issue structure can change from one IPO to another. However, the underlying company has to specify this share allocation in IPO details. Additionally, oversubscription, if happened, can impact the share allotment process.
The rules or guidelines for share allotment in such circumstances are not same for all categories of investors. It differs from one category of investors to another.
IPO Share Allotment to QIBs
In this category, IPO share allotment is done by merchant bankers. Furthermore, in case of oversubscription, if happened, the shares are alloted proportionately to QIBs. For example, if a QIB applied for 20 lakh shares, & the IPO got 5 times over-subscribed in QIB category, then it will get only 4 lakh shares (i.e. 20,00,000/5 = 4,00,000 shares).
IPO Share Allotment to RIIs
In this category, IPO share allotment is done as per SEBI norms. In an IPO, share price can either be fixed or discovered after assessing the demand of stock by book building process.
In first case, when share price is fixed, investors need to place bids at that particular fixed price only.
In second case, when share price is not fixed, investors are asked to place bids within a certain price range. Finally, a price is fixed within the price range after assessing the demand of stock through book building process. All those investors who have placed bids at the fixed price & above get shares.
On the other hand, those investors who have placed bids below the fixed price are rejected. However, the whole process of share allotment in an IPO is not as simple as one might think. It can be a complicated task too depending on the demand of shares from investors. Generally, there are two scenarios as far as demand of shares in an IPO is concerned:
(1) Demand Is Less Than Or Equivalent To Shares Offered In IPO Issue
When demand of shares from buyers in an IPO is less than the total shares being offered in the retail category then it is a case of underbooking. An underbooked IPO is also referred as Undersubscribed IPO.
In this critical situation, the issue price could have been any price in the price band that ensures maximum subscription. Additionally, every investor will receive as many lots as he/she have applied for in the IPO issue.
However, if an IPO is undersubscribed below 90%, the shares are forfeited & money collected from investors is refunded back to them.
The taint of undersubscription can affect any company depending on different circumstances. It can even force a company to slash its IPO issue price. For example, Google, one of the technological giant, has also faced this issue of undersubscription in the past. Back in 2008, Google were compelled to slash the issue price from original $108 – $135 per share to $85 – $95 per share. Finally, it fixed the issue price at $85 per share due to low demand.
On the other hand, when demand of shares from buyers in an IPO is equivalent to the total shares being offered in the retail category then it is a case of complete subscription. A completely subscribed IPO will also ensure that every investor will get full allotment of shares that they had bid for.
(2) Demand Is More Than The Shares Offered In IPO Issue
When demand of shares from buyers in an IPO is higher than the total shares being offered in the retail category then it is a case of overbooking. An overbooked IPO is also referred as Oversubscribed IPO.
In this complicated situation, the issue price is most likely to be the cut off price. Therefore, investors are advised to place bids for shares at cut off price in issues where there is high possibility of oversubscription.
In oversubscribed IPO, underwriters can adjust the issue price & attract more capital. For example, a social media giant’s IPO in 2012 was oversubscribed multiple times. As a result, the company not only increased the issue price but it also offered more securities than it had decided earlier.
If an IPO get subscribed multiple times, then retail investors will either get one lot or nothing. In such situation, lucky investors are selected on the basis of computerized lottery system.
In oversubscribed IPO, there are two possibilities:
(a) Small Oversubscription
In this situation, minimum 1 bid lot will be distributed among all qualified applicants (retail investors). Then the remaining shares of retail category will be distributed proportionately among those investors who have applied for more than 1 bid lot.
For example, 10 lakhs shares are offered to retail investors & minimum lot size is 50. In this IPO issue, total 18,000 qualified investors applied for the allotment. However, among all qualified applicants (retail investors), 5000 investors applied for 2 bid lots (1 bid lot consists of 50 shares).
Thus, total number of shares applied = (13,000 x 1 lot) + (5,000 x 2 lots) = (13,000 x 50) + (5,000 x 100) = 11.5 lakh shares
Therefore, it is clearly a case of small oversubscription as the total shares offered to retail investors is the issue is only 10 lakhs. In such circumstances, minimum bid lot (i.e. 1 bid lot of 50 shares in this example) is allotted to maximum number of retail investors (i.e. 18,000 investors in this example). Finally, the remaining 1 lakh shares (or 1,00,000/50 = 2000 bid lots in this example) will be allotted to lucky investors selected on the basis of computerized lottery system from 5,000 investors (these are investors who applied for 2 bid lots).
(b) Large Oversubscription
In this situation, even one lot can’t be allotted to every qualified retail investor. Therefore, whole share allotment takes place through computerized lottery system. There is no provision for any form of cheating or partiality. Every qualified retail investor has the equal chance to get the allotment depending on his/her own luck.
SEBI Guidelines For IPO Stock Allocation
As stated earlier, retail investors need to apply for an IPO as per the guidelines of SEBI. Some of the common regulatory guidelines or rules for share allocation process include:
(1) Minimum bid lot is defined on the basis of minimum application amount, which in turn can’t exceed or fall below Rs 10,000 to Rs 15,000 (earlier it was Rs 5,000 to Rs 7,000).
(2) Investors need to apply atleast for 1 IPO bid lot or bid size. If investors want to bid for more shares in an IPO then it should be done in multiples of IPO bid lot or lot size of shares. For example, Minimum 1 lot in IPO of Company ABC is 10 shares of Price Band 1000 to 1200. It means retail investor can’t apply for less than 10 shares in that given IPO issue. The application for more than 10 shares should be in multiples of 10 such as 20, 30, 40, etc.
(3) Shares less than the minimum bid lot or bid size can’t be applied for & nor allocated.
(4) Bids placed at or above the IPO issue price only qualify for share allotment process. Balance shares left thereafter are allocated on the basis of draw of lots.
(5) Allotment status of an IPO investor can’t be pre-determined before the closure of IPO issue. Allotment status can only be determined after all the bids have been received & the IPO issue is closed. Once the issue is closed, all bids are cumulated to follow the share allotment process as per the SEBI norms.
(6) All qualified investors will receive shares in Demat mode only not in physical mode.
(7) The whole process of IPO share distribution takes around 10 business days. In case, the shares are not allocated/partially allocated, the amount paid would be refunded.
(8) Investors can check their IPO allotment status online for any IPO from given link: http://linkintime.co.in/ipo/IPO.aspx. Link Intime is an integrated player in the IPO & Corporate Registry business with Pan India reach & reputation.
(9) IPO shares will normally get shares in their account on the fifth day from the IPO closing date. These newly issued shares will start trading on stock exchanges, within 2 weeks from the date of closure of an IPO issue.
(10) Investors are always advised to avail ASBA facility for applying in an IPO issue. ASBA stands for Application Supported by Blocked Amount (ASBA). This facility allows investors to bid for shares in an IPO issue without the amount getting deducted from your account. This amount will only be deducted when shares get allocated. Only the amount for which shares have been allotted would be deducted from your bank a/c & not the total value of shares which were applied for in the IPO application.
IPO Share Allotment to HNIs
As stated earlier, High Networth Investors (HNIs) are individuals or entities who are willing to invest more than Rs 2 lakh. In this category, IPO share allotment is done differently as compared to retail investors.
If there is an oversubscription in this category, HNIs may be allotted lesser number of shares than what they had applied for in the issue.
Here, share allocation is done proportionately to HNIs. It can be calculated by dividing total shares applied by the number of times it has been oversubscribed. For example, if a HNI applied for 10 lakh shares & HNI category is oversubscribed by 150 times. The total shares that will be allotted to him will be only 6666 shares (i.e. 10,00,000/150 = 6666 shares).
Further, several times, the financial institutions or stock brokers provide funding to HNIs for short period. This is also done to provide the benefit of leverage buying in IPOs for listing gains.
Image Source: Moneycontrol
- IPO share allotment process: Moneycontrol