How is the IPO share allotment process done?

In this post, we will discuss the IPO share allotment process. However, the previous post was an introduction to IPO or Initial Public Offering. Thus, if you have not read it, I suggest you go through that article first. Click on the below link to access it.

What is IPO or Initial Public Offering?

Investing in an IPO requires a lot of homework. For example, you need to analyze the financials, business operations, management, associated risks, peer comparison, industry outlook, and valuation, etc. However, you may not get allotment at the end of the day. Thus, all your labors become fruitless at the end of the day in most cases.

In the last decade, we have seen hundreds of companies entering into the primary market. Further, most of them have created a fortune for their investors. Thus, everyone wants to grab a piece of the cake. However, it is not possible for everyone.

Once, the popularity of an IPO increases, many people fling into the market. Thus, getting an allotment is like winning a Jackpot. So, the main problem is we don’t get allotment where we want and don’t apply where there is a chance, and it is the hard truth of the primary market.

Thus, I have tried to introduce you to the IPO allotment process in detail. Therefore, it will benefit beginners and investors with some experience who have not dug deep.

Before we begin to understand the IPO share allotment process in detail, we need to know about various investors in an IPO. Let’s begin.

Types Of Investors In An IPO

Primarily, there are three major types of investors in an IPO. They are as follows.

Types of Investors in an IPO
Types of Investors in an IPO
  • Retail Individual Investors (RII)
  • Non-Institutional Investors (NII)
  • Qualified Institutional Buyers (QIB)

Retails Individual Investors can be a Resident Indian Individual, NRI, and HUF who apply for less than 2 Lakhs in an IPO. Thus, retail investors cannot bid for more than Rs 2 Lakhs in an IPO.

Non-Institutional Investors can be a Resident Indian Individual, NRI, HUF, Companies, or Trusts who apply for more than 2 Lakhs in an IPO. We also call them HNI or High Net-worth Individuals.

Thus, if you want to apply for more than Rs 2 Lakhs in an IPO, you have to apply under the NII category only.

Likewise, Qualified Institutional Buyers are financial institutions, Banks, Mutual Funds, Foreign Portfolio Investors, Pension Funds, Unit Linked Insurance Plans (ULIPs), etc. Further, they need to be registered as QIB with SEBI. They invest Crores of rupees in an IPO.

In addition to these three major types of investors, there are two more categories of investors who are not common.

  • Anchor Investor 
  • Reserved Categories

Anchor Investor – refers to a QIB or Qualified Institutional Investor who invests 10 Crore or more in a company. They are invited to invest in an IPO before it opens to the public. Further, it boosts the confidence of retail investors and other investors.

Other Reserved Categories – The company that brings IPO may want to reserve some portion of its shares to employees or shareholders of its associated companies. Generally, these categories of investors get shares at a discounted price.

Quotas In The IPO Share Allotment Process

Each category of investors has share allotment quotas in an IPO as per the SEBI guideline. However, the company may alter it to some extent.

Quotas in an IPO allotment process
Quotas in an IPO allotment process

For example, according to SEBI guideline, the company need to reserve

  • 50% of the offer to Qualified Institutional Buyers QIB
  • Not less than 15% of the offer to Non-Institutional Investors (NII)
  • Not less than 35% of the offer to Retail Individual Investors (RII)

The combined number of shares issued to these three categories of investors is called ‘Net Offer. ‘

Further, shares allotted to other categories like employees and shareholders are over and above the ‘Net Offer.’ Thus, it does not affect the share reservation quotas of QIB, NII, and RII.

However, it is essential to note that the company can issue up to 60% shares to anchor investors reserved for QIB. For example, if the total IPO size of a company is 100 Crore shares, 50% of it means 50 Crore shares are reserved for QIB. Further, 60% of that 50 Crores that is 30 Crore shares can be reserved for Anchor investors at maximum.

Further, it is interesting to note that there is no option to transfer the unsubscribed portions from other categories if one category is oversubscribed.

What Do Under-Subscription, Full-Subscription, And over-subscription Mean?

Next, we have to learn three terms that are Under-Subscription, Full-Subscription, And Over-Subscription.

  • If the number of shares applied by the investors is less than the number of shares issued by the company, we call it under-subscription.
  • If the number of shares applied by the investors is the same as the number of shares issued by the company, we call it full-subscription.
  • Similarly, if the number of shares applied by the investors is more than the number of shares issued by the company, we call it over-subscription.

Let’s have a look at the example below.

Defining under, full, and over subscription in an IPO allotment process
Defining under, full, and over subscription in an IPO allotment process

Note: A company needs at least a 90% subscription of its total size unless it has to cancel the IPO. Further, the company has to refund in full to the IPO applicants in such cases.

Thus, in the above example, it needs at least 2,25,000 lots of subscriptions to avoid the IPO’s scrapping.

How Are Shares Allotted To Different Types Of Investors In A IPO Share Allotment Process?

You can bid in an IPO when it opens its window for the public. For example, the IPO of SBI Cards and Payment Services Ltd. was open for four days, i.e., from 2nd March to 5th March 2020. Further, once the bidding process ends, the allotment process starts.

You should note a company itself does not allot shares to subscribers. But, it works with the merchant bankers in this allotment process. The merchant bankers are also called Lead Managers or Investment Banks.

Let’s now understand the share allotment process with an example. Suppose ABC Company wants to raise Rs 350 Crores through IPO.

The Details of the IPO

  • Issue Type – Fixed Price Issue
  • Issue Size – 3.5 Crore shares (Rs 350 Crores)
  • IPO Price – Rs 100
  • Market Lot – 140 shares
  • Minimum Order Quantity – 140 shares
Category Of InvestorsQuotaNumber of SharesTotal Number of Lots
RII35%1,22,50,00087,500
NII15%52,50,00037,500
QIB50%1,75,00,0001,25,000
Total 100%3,50,00,0002,50,000
Share Reservation Quotas in ABC Company

RETAIL INDIVIDUAL INVESTORS OR RII SHARE ALLOTMENT PROCESS IN THE IPO

ApplicationLotsNumber of SharesIPO share PriceAmount (Rs)
Minimum114010014,000
Maximum141,9601001,96,000
RII Min. & Max. Lot Data

Retail investors can apply for a minimum of 1 lot and a maximum of 14 lots in the IPO of ABC Company. Thus, they have to invest between Rs 14,000 to Rs 1,96,000 as the maximum investment under the RII category in an IPO is capped at Rs 2 Lakhs.

Let’s see what happens under different subscription conditions.

What happens when the IPO is undersubscribed, fully-subscribed, or over-subscribed slightly?

Let’s take the case of ABC Company.

Category of InvestorReserved Quota in lotsApplications receivedSubscription Status
RII 87,50080,000under-subscribed
RII 87,50087,500fully-subscribed

RII has a quota of 87,500 lots or 1,22,50,000 shares. Thus, if the issue gets applications for less than 87,500 lots or equal to it, they will get whatever lot they had applied for.

However, if the IPO gets over-subscribed slightly, say it gets applications of 1,00,000 lots. The company tries to allot at least one lot to each RII. It settles the remaining allotments in proportionate who had applied for more than one allotment.

What does happen when the IPO is over-subscribed overwhelmingly?

Category of InvestorReserved Quota in lotsApplications receivedSubscription StatusTimes of over-subscription
RII 87,50021,87,500over-subscribed25.00x

Suppose, the ABC Company gets 21,87,500 applications that are 25 times of the reserved quota for RII. Thus, it is not possible to issue even one lot to each investor.

In such cases, the company executes a lottery system. However, the lottery system is computerized and transparent. Thus, the luck of a retail investor will play a role here.

However, retail investors will get only ‘one lot‘ irrespective of application size. Thus, it does not matter if you apply for one lot or 14 lots, you will get only one lot if you pass in the lottery system. Thus, the higher the multiples of over-subscription, the lower the chance of getting it.

Note: The same guideline applies to employees and shareholders.

Here is a list of IPOs that were over-subscribed heavily in the last two years. Here is a small list for your reference.

IPO ISSUER COMPANYNUMBER OF TIMES THE ISSUE WAS OVER-SUBSCRIBED IN TOTAL
Ujjivan Small Finance Bank Ltd165.66x
IRCTC Ltd111.91x
Amber Enterprises India Ltd165.38x
Apollo Micro Systems Ltd248.58x
Astron Paper and Board Mill Ltd241.75x
Credit : Chittorgarh

NON-INSTITUTIONAL INVESTORS (NII)

In case of under or full subscription, the NII will get whatever number of lots they had applied for. However, it is not possible in case the IPO gets over-subscribed overwhelmingly.

Thus, the company uses a simple formula to allot shares in such cases. The formula is as follows.

The number of shares applied / times of over-subscribed.

Let’s understand it with an example.

Category of InvestorNumber of Shares ReservedApplications ReceivedSubscription StatusTimes of Over-subscription
NII52,50,00010,50,00,000Over-subscribed20.00x

Suppose, the IPO of ABC Company receives applications for 10,50,00,000 shares that is 20 times its reserved quota. Then, the company uses the formula mentioned above to issue shares.

For example, suppose there is a mutual fund that applied for 5,60,000 shares (4,000 lots). The fund house will get 28,000 shares (5,60,000 / 20 times) or 200 lots only.

5,60,000 / 20 = 28,000

Thus, it is a simple calculation.

Note: The process is same for QIB also.

The Closing Thought On The IPO Share Allotment Process

It is important to note that a company brings its IPO when the market condition is bullish. So, what does the term ‘bullish’ mean?

You observe that sometimes people like to talk about stocks with much enthusiasm. Further, whenever you watch TV, read the newspaper, or speak with your friends, you hear about stocks. Thus, during that time, everyone is interested in investing in stocks. It is a bullish market condition.

Thus, in short, when the stock market touches new heights each day, and people invest in stocks breaking their FDs, it is called a bull market.

Thus, the Promotors of a company like to bring IPOs in bull markets so that people will not hesitate to pay a premium price. So, launching IPO during a bull market gives a handsome profit to its existing investors.

Why Am I Telling This?

My point is that you have to look into valuations whenever you decide to invest in an IPO along with other parameters. Further, valuation is not an absolute term. It is a relative term. Thus, you have to look into the valuation of other companies in the same sector to get a clear picture. However, in a bull market, the valuation of other companies in the same industry are also stretched. Thus, it becomes difficult for you to evaluate an IPO properly.

I am not against IPO investing, but I am not in favor of investing in any IPO that hits the market.

This week, I came across a piece of news where some experts estimate that 20 Crores’ new Demat accounts can be opened once Life Insurance Corporation of India finalizes its IPO timetable. To read the report, click here. It is like Gold_rush. Thus, after such a market hype, it is impossible to get the IPO at the right valuation.

Finally, it is you who have to invest your hard-earned money. Therefore, always make an informed decision to avoid inconveniences later. To sum up, I hope I have covered all the essential aspects related to the IPO allotment process. However, I need your suggestions and remarks to make things better.

Thanks and regards,

finguru@finlessons.com

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