Oversubscription in IPO: Meaning, Causes and Effects

9 min read • Updated 18 January 2023
Written by Anuj Agarwal
What Is Oversubscription In IPO?

As an investor, you may be excited to invest in upcoming Initial Public Offerings (IPOs) of well-known businesses. However, you should know some important terms related to IPOs and how it affects your investment plan.

Oversubscription in an IPO happens when there is excess demand for it. As a result, there are more bids for shares than the company can allot. However, an investor can avoid the effects of oversubscription and benefit from it. 

Read the details below to understand oversubscription in IPOs.

What Is Oversubscription in IPO?

When there is a lot of market demand and hype for a company’s IPO, numerous investors may invest in the IPO. This creates an excess demand for the offered IPO. 

The issuing company allots a fixed number of shares to the public as per its offer size stated in the IPO’s draft papers. When there are more bids put in the IPO than the number of available shares, it is called an oversubscription of the IPO. Because of this, not everyone who bids gets the shares.

For example, if an IPO’s offer size is 50,000 shares and the total number of bids entered for its subscription is 70,000, the public issue has been oversubscribed. In this case, a company cannot offer shares to all bidders as there is a shortage of shares. 

What Are the Causes of Oversubscription in IPO?

There are several causes for an oversubscribed IPO. Read the reasons given below for the oversubscription of shares:

  • Underestimating the Demand

Determining an appropriate offer size is very important for a company. If a company underestimates its demand and allots a comparatively smaller offer size, it can result in an oversubscribed IPO.

  • Wrong division of Offer Size

Sometimes IPO allotments are partially oversubscribed as they are divided into different parts. When an IPO is launched, its offer is usually divided into 3 categories: Retail Individual Investors (RII), Non-Institutional Investors (NII), and Qualified Institutional Buyers (QIB). Sometimes, there are additional placements for Anchor Investors and employees.

Each segment is allotted a specific offer size estimated by the company. If the demand for a particular segment is very high, it could be oversubscribed.  

  • Recent Development of a Company

After an IPO is launched, if there is any positive news about the business that can hype the subscriptions, it will also result in an oversubscription. This happens because when offering an IPO, a company’s estimation is based on the present situation. Thus, a sudden rise in demand because of news leads to oversubscription of the IPO.

How Is an Investor Affected by Oversubscription in an IPO?

When an IPO is oversubscribed, it becomes a bit complex to allot shares to investors. Due to this reason, companies apply several methods to allocate shares as reasonably as possible under the guidelines of the Securities and Exchange Board of India (SEBI). SEBI is a government body that regulates all trading-related activities in India’s capital markets. 

Companies often reject ineligible applications and allot the rest through the lottery system if they cannot offer adequate additional shares. However, you can increase your chances of selection by following the given suggestions.

  • As an investor, you must ensure your application is completely eligible and has no grounds for rejection.
  • In addition, you should check for the subscription process, maximum lots per investor, and the total number of applications (if available).
  • Take help from friends and family and apply through multiple accounts belonging to different PAN numbers. This will increase your chances of allotment as compared to a single application.
  • Be an early applicant as it improves your selection chances, as per analysts.

How Do Companies Handle Oversubscription in IPOs?

Oversubscription is a challenging situation for the issuing company. Under the guidelines of SEBI, companies are not allowed to reject applications unless it is ineligible. Hence companies opt for the following steps in case of oversubscription:

  • Rejection of Application

Companies cannot reject applications even in the case of oversubscription. As per the SEBI guidelines, eligible investors’ applications can be partially allotted but cannot be rejected completely. 

However, the company can reject applications that are incomplete as per company requirements or have missing or wrong details and other similar flaws. In case of a rejection, the collected funds are also returned to the rejected investors.

  • Pro-rata Allotment

Instead of rejecting any application, companies can allot lots of shares to investors in proportion or a fixed ratio. This is called a pro-rata allotment. In this, the company distributes shares in the following ratio: number of applicants/ total number of shares issued.

For example, an IPO offers 80,000 shares and 10,000 applicants have applied for 1,60,000 shares in total. Then as per pro-rata, each investor will receive 8 shares (80,000/10,000) in a 2:1 ratio instead of 16 shares each. 

  • Fully Allotted + Pro-rata

If none of the applications has flaws, it results in zero rejection. In that case, a company offers fully complete applications on a first-come, first-served basis, and the remaining applications are allotted on a pro-rata basis.

  • Lottery Allotment + Rejection

Companies often opt for a lottery system to allot shares in case of oversubscription. In this case, the company allots a total number of issued lots/ shares to a select number of investors chosen via a computerized lottery draw. The rest of the applicants are rejected, and their subscription money is returned.

As per the SEBI, companies are allowed to allot through a lottery. However, in that case, each investor selected through the lottery will be allotted a minimum of 1 lot of shares. 

How to Subscribe for an IPO?

It is important to have a clear idea about the subscription process for an IPO. As an investor, you may understand how to buy a share and add it to your portfolio; however, the process of subscribing to an IPO is not the same. Follow the steps given below to apply for an IPO:

  1. Pre-Subscription Process

Here are the steps you need to follow to prepare for an IPO:

  1. Broker Selection

You should select a good broker with an efficient online brokerage platform. A reputable broker will offer a trading account that provides a seamless experience and helpful customer service. It is also possible to apply offline via a broker or a bank. 

  1. Access to a Demat Account

As per the SEBI, a Demat account is necessary for all investors to keep all their securities in one account. Before investing in an IPO, ensure that you have a Demat account to hold shares and a trading account for selling/buying them.

  1. Budget Selection

Before applying for an IPO, allot a budget for your investment. The number of lots you apply for will be determined by this.

  1. Subscription Process for an IPO

Follow these steps to apply for an IPO:

  1. Do Your Research

Research is one of the key steps to investing in an IPO successfully. After completing the broker and Demat account opening process, you should research and understand basic concepts about the IPO. Learn about the fundamentals of the company, its market position, strengths, and weaknesses.

  1. Finalising an IPO

After completing your research, you should select the most suitable IPO and stay updated about the company and IPO-related announcements. You should know its launch date, allotted lot, minimum lot size, etc., and stay updated about any news on the company.

  1. Fund Transfer

To successfully apply for an IPO, you should have funds in your bank account. You can make payments through the account by entering the UPI ID. 

A payment made to an IPO is secured by the ASBA (Application Supported by Blocked Amount) protocol. It blocks the funds in your account and debits them only when you receive the IPO allotment.

  1. Apply for IPO

Once you are ready for your IPO investment, wait for the launch date. When the IPO launches, complete the necessary steps and apply for the IPO with the help of your broker of choice. It is better to apply as early as possible to increase your allotment chances.

It is crucial to have proper documents like PAN and Aadhaar card and contact details like email ID, phone number, and bank account number to open a Demat account and apply for an IPO.

Final Word

When an IPO is oversubscribed, applicants are usually allotted a minimum of 1 lot of shares to ensure fair distribution. In this case, several investors may be rejected based on a lottery and they will not get any shares.

Applications that have not met all requirements can be rejected straight away in case of oversubscription. You can maximise your chances of getting an allotment by ensuring no faults in your application and applying as soon as the IPO opens.

Frequently Asked Question

What is the maximum investment for an IPO?

The maximum investment for a retail investor in an IPO is limited to a sum of ₹2 lakhs. This amount is as per the instructions of SEBI.

What is the difference between institutional and non-institutional investors?

Institutional and non-institutional investors (NII) are differentiated based on their scale of investment and operations. Institutional investors are large-scale financial companies like mutual funds, financial institutions, and other professionally managed funds.

NIIs are individual businesses and firms that invest in IPOs. These investors are not registered under SEBI, unlike institutional investors. NIIs are also willing to invest more than ₹2 lakhs, unlike retail investors.

What is the minimum investment for an IPO?

The minimum investment is not fixed as per SEBI. It is as per the minimum lot size and price per share of a particular IPO as stated in its draft papers. IPOs often have a minimum investment amount, and as per that requirement, investors buy IPO subscriptions in lots. Generally, the minimum amount is kept between Rs. 14,000 – Rs. 15,000.

Who are retail investors?

Retail or individual investors are those who invest in the market for personal financial gain and through a PAN-linked Demat account. These investors do not invest or manage market investments on behalf of any 3rd party. As per SEBI, such investors are limited to a maximum investment of ₹2 lakhs for IPO subscription.

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Anuj Agarwal

Investment Principal
Anuj is an investment professional with a demonstrated history of working in Debt Capital Markets. He has completed his B.Com (Hons) in St. Xavier’s College, Kolkata and holds PGDM (Finance) degree from GIM. He is currently working as Investments Principal at Wint Wealth. He has been working in the debt capital market space for the past 4+ years and is also an NISM certified mutual fund expert.

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