Understanding IPO Allotment When Oversubscribed: Methods and Factors

When an Initial Public Offering (IPO) is oversubscribed, the allocation of shares can be a complex process. This article explores the common methods used to allocate shares in such instances, considering various factors and regulatory requirements.

Common Methods for Allocating Oversubscribed IPO Shares

When the demand for shares exceeds the number of shares available during an IPO, several methods are typically employed to ensure a fair and rational allocation. These methods include:

Pro-rata Basis

The pro-rata method involves allocating shares proportionally based on the number of shares applied for. For example, if an investor applies for 100 shares and the IPO is oversubscribed 200 times, they might only receive 50 shares, assuming shares are halved.

Lottery System

The lottery method is used in cases of very high oversubscription. Eligible applicants are randomly selected to receive shares, ensuring a fair chance for all participants. This method ensures that no single investor gains an unfair advantage due to the volume of their application.

Priority to Institutional Investors

In some IPOs, a certain percentage of shares is reserved for institutional investors such as mutual funds, pension funds, and other large investment entities. The remaining shares are allocated to retail investors. This can mean that retail investors may receive a smaller portion of their applied shares if the IPO is heavily oversubscribed.

Minimum Allocation

Some IPOs may have a minimum allocation for retail investors to ensure that a certain number of smaller investors receive shares. This is particularly useful when the number of retail applications is large enough to ensure a fair distribution of shares.

Scaling Back

In some cases, a formula may be used to scale back the number of shares for all applicants. This ensures that the allocation remains fair while considering the total number of applications received. The formula is typically predetermined and is used to adjust the number of shares allocated to each applicant proportionally.

Reservation for Existing Shareholders

Companies may reserve a portion of shares for existing shareholders or employees, which can affect the overall allocation for other investors. This practice is often used to reward long-term investors or incentivize employees.

Understanding the IPO Allotment Process: Key Terms and Concepts

For a detailed understanding of the IPO allocation process, it is crucial to familiarize oneself with certain terms and concepts:

Types of Investors

Investors can be categorized into different types, which include:

Retail Investors Non-Institutional Investors Qualified Institutional Buyers (QIBs) Anchor Investors

Each category has specific criteria and eligibility requirements for participating in an IPO.

Bid Lot

The bid lot is a predetermined quantity of shares specified by the company. Investors must bid a minimum number of shares at a time, usually denoted as one lot. For instance, if an IPO has a bid lot of 50 shares, the minimum number of shares one can apply for is 50.

Cut-off Price

The cut-off price is the final price at which the IPO is issued, determined after the closing of the issue period. Investors must bid within the given price band. This ensures that the company can issue shares at a fair and market-relevant price.

Understanding the IPO Allotment Process in Over-Subscription Cases

When an IPO is oversubscribed, SEBI mandates that IPO allotment must be proportional. Here’s a detailed example of how this works:

Example Calculation

Assume an IPO has 50 lakh shares set aside for retail investors, and the bid lot is 50 shares. This means the total number of lots available for retail investors is 1 lakh.

For example, if there are 4 lakhs retail applications, the IPO would be oversubscribed 4 times. The allotment ratio would be 4:1. In other words, one out of every four applications would receive shares, and the remaining three would be automatically rejected. This allocation is typically done using a lottery system to ensure fairness.

Understanding these methods and factors is essential for investors to navigate the complex world of IPOs and make informed decisions during the application and allocation processes.