Often heard or experienced, one person got the shares in an IPO while the other did not. Ever wondered why this discrimination when all the parameters were the same? Is there someone inside who chooses whom to allot shares? Ever wondered about the share allocation process for retail investors in an IPO?
First of all, let us agree that there is absolutely no discrimination, no subjectivity. The share allocation process is entirely transparent and highly regulated. No mystery involved, as many newbies tend to believe. The companies follow a scientific and impartial way to determine the share allocation.
What is an Initial Public Offer (IPO)?
Unlisted companies offer their shares to the public, and in that process, the promoters offload a portion of their holdings. The process where unlisted companies offer their shares to the public is called the Initial Public Offer (IPO).
There can be (1) a fresh issue of shares; (2) an offer of existing shares (aka Offer For Sale) by the current shareholders, or (3) a combination of both. The Securities and Exchange Board of India (aka SEBI) governs the IPO procedure and issues guidelines. Here, we will understand how does share allocation happen for retail investors in an IPO.
Sometimes, listed companies also offer existing share or issue new shares. That is out of the scope for this discussion since it is not an IPO.
Who is a Retail Individual Investor (RII)?
Until August 2003, SEBI (Disclosure and Investor Protection) Guidelines 2000 defined Retail Individual Investor (RII) for public issues. The definition said RII is the one who applies for allotment of 10 or less marketable lots in fixed price issue or one who applies up to 1,000 securities in book built issue.
The definition got revised a few times since then. It was someone who bids for securities of value up to Rs 50,000. In March 2005, SEBI increased the limit to Rs 100,000. Subsequently, SEBI further amended the definition.
Retail Individual Investor (RIIs) mean any investor who applies or bids for securities of value not more than Rs 200,000.
Let us understand some important terms.
Minimum order quantity (also called as Market Lot)
A Market Lot is the minimum order quantity, and application for a lesser number of shares is not acceptable. The issuer will reject any such application with lesser number of shares. However, you can apply for more than one lot, subject to limits of retail participation.
Consider a recent example of an IPO; details given below:
Here, the minimum lot size is 1, which means 30 equity shares.
IPO Price Band
Every IPO specifies a low and a high price point called the cut-off price. To increase the chances of getting the allocation, applicants should bid at the cut-off price, especially in popular issues.
Rs 483 is the low end of the price band in the above example, while Rs 486 is the cut-off price.
Subscription status of the IPO
The rule of economics apply here, and demand-supply determine the extent of subscription.
Assume the company wants to offer 1,00,000 (one lakh) lots of 30 equity shares each.
If the company received more than 1 lakh lots of applications, then the issue is considered Over-subscribed.
Alternatively, if the company received applications for fewer lots, the issue is considered to be Under-subscribed.
Share allocation process to Retail Individual Investors (RIIs)
When demand is less than or equal to the supply, the company makes full allotment to the applicants.
If demand is higher than the shares offered, the company must follow the prescribed share allocation process. A few ground rules:
- Reject applications with incorrect details
- No allotment lesser than the minimum lot size
- Allocation happens at the cut-off price
For instance, there will be an allocation of a minimum of 30 equity shares (1 lot size) in the above example. Under no circumstances you will be issued a lesser quantity.
There can be two scenarios, small over-subscription and large over-subscription.
Situation of a small over-subscription
In the above example, the company had to offer 1 Lakh lots of 30 shares each, i.e. 30 lakh shares in total.
Suppose the company got 75,000 applications for one lot (75,000*30 = 22.5 lakh shares) and 20,000 applications for two lots (20,000*30*2 = 12 lakh shares). In total, 95,000 applications were received for 34.5 lakh shares, more than the shares the company has to offer.
In this case – one lot is allotted to all the 95,000 applicants, i.e. 28.5 lakh shares. The remaining 1.5 lakh shares are allocated proportionately to all the applicants who applied for more than one lot.
Situation of big over-subscription
A big over-subscription situation arises when the total number of applicants is more than the maximum possible lots. In this case, allotment happens on a draw of the lot, i.e. lottery system.
In continuation of the above example, if 90,000 applicants applied for one lot (90,000*30 = 27 lakh shares) and the same 20,000 people made application for two lots. Accordingly, 110,000 applicants made the application which is more than 100,000 lots available on offer. In this case, the company will follow a lottery system.
How to make sure that shares get allotted in an IPO?
There is no guarantee to get an allotment and any such promises are false. The article illustrates the share allocation process to retail investors. The best a share applicant can do is to fill in the application form correctly, provide all the required details, and apply for shares at the cut-off price.
Suppose there is an over-subscription to the issue, allotment will happen through a lottery-based process, and there is no guarantee whatsoever.
Investing in initial public offers is critical part of equity investing. Read here about ‘Major asset classes’ here. Equity shares are subject to market risks, and so is the participation in Initial Public Offers. Evaluate the offer based on your risk profile and accordingly decide whether to apply to not. In case of any doubts, reach out to your financial advisor for guidance.
The author is a senior finance professional with over fifteen years of work experience in corporate finance and has an affinity for personal finance and investment management. Please leave your comment or share thoughts on this article via email at firstname.lastname@example.org. For more articles, please visit the website www.decodefinance.in.
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