What is IPO Oversubscription And Why It Matters To Investors

IPOs have surged in popularity as companies seek to capitalize on public investment to fuel growth. The allure of potentially high returns attracts both institutional and retail investors. A key concept to understand regarding IPO is oversubscription, where demand for shares exceeds availability. This often leads to higher initial prices and reflects strong investor interest, although it can also result in limited access to shares for individual investors

What is IPO Oversubscription in IPO?

The subscription process involves several steps: setting a price range for the shares, determining the number of shares to be issued, and allowing investors to place orders within a specified subscription period. Once the subscription period closes, the demand is assessed. If demand exceeds the number of shares available, the IPO is said to be oversubscribed, meaning more people want to buy shares than there are shares available. This can drive up the share price once the company goes public, reflecting high investor interest.

Oversubscription occurs when investor demand for an IPO exceeds the available shares. This can result from a company setting an attractive price or strong investor interest.

In an IPO, there are fixed percentage allocations for different investor categories:

• Qualified Institutional Buyers (QIBs) are limited to 50% of the shares.
• Non-Institutional Investors (NIIs) are allocated 10-15%.
• Retail investors receive up to 35%.

When an IPO is oversubscribed, companies typically have two options:

• Reallocate the number of shares among different investor categories
• Issue additional shares to the market

An oversubscribed IPO is considered a hot issue due to high investor demand, leading to competition among investors. Companies cannot adjust the share price during the allocation process to address oversubscription.

How Does an IPO Get Oversubscribed?

When a company issues its initial public offering (IPO), determining the number of shares to be offered is a crucial step. This decision influences who can invest and the price they pay per share, impacting the total amount of capital raised. If a particular segment of the IPO is oversubscribed, it means that investor demand exceeds the number of shares available. This often leads to a higher share price than the company’s net asset value, reflecting strong investor interest.

Also Read: What is an IPO Valuation?

Factors Responsible for IPO Oversubscription

Given are some of the major factors responsible for IPO Oversubscription –

• Underwriting Firm: A reputable underwriting firm can significantly boost investor confidence and interest. Their track record, market expertise, and credibility can attract more investors, leading to oversubscription.
• Overall Economy: A strong and growing economy often results in higher investor optimism and willingness to invest in new offerings. Economic stability and growth can increase demand for IPO shares.
• Competition: If multiple high-profile companies are launching IPOs around the same time, it can create heightened competition and drive more investor interest in each offering, potentially leading to oversubscription.
• Company’s Market Potential: If the company has strong growth prospects, a unique product or service, or a competitive edge in its industry, it can generate substantial investor enthusiasm and demand.
• Marketing and Promotion: Effective marketing and promotional strategies by the company and its advisors can create buzz and anticipation, attracting more investors and contributing to oversubscription.

Oversubscription and Listing Gains

Oversubscription happens when the demand for an IPO’s shares surpasses the number available. This usually signifies strong investor confidence and high interest in the company. When an IPO is oversubscribed, shares are often priced higher due to the strong demand, which can result in substantial listing gains. Listing gains are the profits investors make when the share price rises significantly on the first day of trading. The relationship between oversubscription and listing gains is typically positive: an oversubscribed IPO often leads to higher listing gains because the high demand drives up the initial trading price. This means that investors who secure shares in an oversubscribed IPO are likely to see a significant increase in value as the shares begin trading. Therefore, oversubscription is often a good indicator of potential for strong listing gains, benefiting early investors.

Allotment Procedure Under IPO Oversubscription

Share Allotment Rules

The allocation of shares in an IPO is regulated by SEBI to ensure transparency and fairness in the process. SEBI sets guidelines on how shares should be distributed among different types of investors.

Investor Categories

IPOs categorize investors to manage how shares are distributed:

• Qualified Institutional Investors (QIIs): Typically large institutional investors like mutual funds or insurance companies.
• Non-Institutional Investors (NIIs): Generally high-net-worth individuals or entities that do not fall under institutional categories.
• Retail Investors: Individual investors who apply for shares worth less than Rs 2 lakh.
• Employee Category: Sometimes, there’s a separate allocation for employees of the company going public.

Also Read: How Does SME IPO Work?

Share Allocation

• A significant portion, typically 50%, is allocated to QIIs due to their substantial financial capacity
• Retail investors, who usually make up a larger group, receive around 35% of the shares

Retail Investor Allocation Process

• Shares in Lots: Shares are grouped into units called lots. This helps manage the allocation process, especially when demand is high.
• Oversubscription Handling: If more retail investors apply, than the available lots, each investor can only receive one lot to ensure equitable distribution. This means whether an investor bids for one lot or ten, they have an equal chance of receiving one lot, promoting fairness in share distribution.

Good IPOs are frequently oversubscribed, reflecting strong investor interest and confidence in the company’s prospects. Oversubscription indicates high demand, often leading to higher initial trading prices and the potential for significant listing gains for early investors.