Understanding Oversubscription in an IPO

An Initial Public Offering (IPO) lets a private company sell its shares to the public for the very first time. When investor demand for shares surpasses the number offered by the company during the IPO, it leads to oversubscription.

 

For example, a company might issue 1 lakh shares for its IPO. If the number of applicants reaches 3 lakhs, the IPO is oversubscribed. It would be considered three times oversubscribed.

Here are some key reasons for an oversubscribed IPO:

1. Strategic Offerings

Companies may choose to offer only a limited number of shares during the IPO, even if demand is expected to be high. This is done to capitalise on the potential price increase after listing.  This is also known as post-IPO boost.

2. Low Demand

The underwriters managing the IPO might misjudge the market interest. This can lead to setting the offering size too low, resulting in the IPO being oversubscribed.

3. Convertible IPO 

Some IPOs may offer shares that can be converted into debt securities in the future. This additional feature can make the offering more attractive to a wider range of investors, potentially leading to an oversubscribed IPO.

4. Economy Conditions

When the economy is healthy, investors may feel more confident and be more willing to take investment risks. This could lead to more individuals investing in companies going public through IPOs.

5. Underpriced IPO

If an IPO closes its first day of listing with a price above the set price, it is considered as underpriced. These tend to attract even more investors in the next offering.

Here are some methods for allocating shares to investors:

1. Pro-rata Allotment

This is a common method for allotting shares. Investors receive a portion of their requested shares based on the oversubscription ratio. For example, if an IPO is 3 times oversubscribed, investors applying for 6 shares would receive only 2 shares.

 

(6 Requested Shares / 3 Times Oversubscribed)

2. Scrutiny and Rejection

SEBI regulations prevent companies from outright rejecting investor applications. They cannot reject solely on the basis of oversubscription. An application may be rejected during standard scrutiny. This can happen if it contains incorrect information. 

3. Lottery System

The company may even consider using a lottery system to allocate shares. This is used solely for specific investor categories. Here's the allocation breakdown: 

• 50% of the shares will be allocated to Qualified Institutional Buyers (QIB)

• 35% of the shares will be allocated to Retail Investors

• 15% of the shares will be allocated to Non-institutional Investors (NII)

Here are a few benefits of oversubscription of shares for any business offering an IPO:

1. Increased Capital

High investor demand allows companies to raise more capital. They can often exceed their initial targets. This can be done by selling shares at a higher price. 

2. Enhanced Reputation

Oversubscription may signify investor confidence in the company's future. This positive market perception could boost brand recognition.

3. Broad Spectrum of Investors

Oversubscription attracts a broader pool of potential investors. Companies can choose suitable investors for their business venture from this wider pool.

4. Market Confidence

Oversubscription of shares indicates investors confidence in the company. This demand allows the investors to believe in the company’s growth potential and financial stability.

 

If an IPO is oversubscribed, investors may receive only a portion of the shares they applied for. They might even receive none at all. This is because demand exceeds supply.  

 

To invest in the stock market or take advantage of an upcoming IPO, having a Demat account is a must. On Bajaj Markets, you can easily open a Demat account and enjoy benefits such as low brokerage fees and multiple subscription plans. There is also zero annual maintenance charge. Begin your investment journey without a hassle.