What Is Oversubscription in IPO?

Introduction

Oversubscription is the number of shares in an IPO applied for more than the total number of shares on offer. The phenomenon occurs when the public has been so keen to invest in a new company that they have offered more money than the company needs or is prepared to accept.

Trying to figure out the best offering size for your IPO? It can be challenging as there are many factors to consider.

What Does Oversubscription in IPO Mean?

When a company is preparing for an Initial Public Offering (IPO) of its stock, it must choose the number of shares to offer. This is called determining the "offering size." The offering size is one of the most critical IPO decisions. It affects the amount raised in the offering, who gets to invest, and how much they pay for their shares.

When a portion of an IPO offering is an oversubscribed IPO, it means more people have shown interest in investing than there are available shares. For example, if 1 million shares are offered for sale, and 2 million people want them, there will be an oversubscription.
Oversubscription is a situation in which demand for a particular fund's IPO is higher than the fund's supply. This results in a price for the stake that is more than the company's net asset value (NAV).

What Are the Reasons for Oversubscription in IPO?

When a company decides on offering size, it sets aside a particular share amount for institutional investors (like mutual funds and hedge funds). It also sets aside some shares to be sold in a separate purchase only to individual investors. The portion available only to individual investors is referred to as being "over-allocated" (or "oversubscribed IPO") because more people want those shares than there are available.

There are various reasons behind companies getting listed through the oversubscription route.
The company uses the funds received by an IPO to expand its business. If demand is higher than supply, it becomes possible for a company to raise more funds through market mechanisms than from banks or financial institutions at a high cost. It makes sense to list through oversubscription. It allows retail investors to invest in IPO early and make good returns. If demand for IPO is high, it helps the company get listed with premium valuation and generate better returns for investors.

How Does Oversubscription in IPO Work?

Oversubscription occurs when demand for an issue exceeds supply; this happens when the company offers more shares for sale than it wants to sell. This can happen either because a company has set an unrealistic price or because investors are very interested in buying the shares on offer.

The company offers many more shares for sale than it needs, and thus, these additional shares are oversubscribed. The oversubscribed IPO is also known as a hot issue since there is great demand for these shares, and investors have to fight against each other.

You may consider all these additional shares as excess stock. Oversubscription of shares can be divided into short-run and long-run oversubscription. Short-run is when more than 100% of subscription is offered. For instance, if a company offers to sell 10% of its total shares, then 30% of the total shares will be oversubscribed (i.e., 30% > 10%). Long-run oversubscription happens when less than 1% of the offering amount is oversubscribed.

An IPO oversubscription occurs when the demand for a company's shares is higher than the number offered. When this happens, the issuer will increase the number of shares provided to accommodate the demand for their stock. If a company's IPO is oversubscribed, it means there is a lot of interest in the stock and that it could be anticipated to perform well after trading begins.

What Are the Key Factors Responsible for Oversubscription in IPO?

Trying to determine whether or not an IPO will be oversubscribed can be challenging due to the multiple factors that are taken into account. These include:

The size of the underwriting syndicate: A smaller syndicate may create less demand for shares, while a larger syndicate can cause more investors to participate in an IPO. The type of security being used may also influence interest in an IPO.

For example, convertible debt securities are more attractive than traditional bonds because they convert into equity upon maturity.

The overall health of the economy: The state of a company's business activities can influence investors' decisions of participating in an IPO.

The strength of competition: If other companies are launching IPOs around the same time, this can reduce investor interest and make it harder for them to generate strong demand for their stocks.

Which Parameters Are Involved in Oversubscription in IPO?

Over-allocation or oversubscription of shares refers to allocating a proportion of shares in an IPO above the maximum amount required by the issuer. Strictly speaking, over-allocation refers to the proportion of shares issued beyond the maximum amount specified, and IPO oversubscription refers to the demand for shares above those on offer.

It is often called a "bounty allocation" and is used by companies to raise additional funds through allocations given to large institutional investors, typically at very favourable terms. Typically, a company will offer such institutional investors a small proportion of shares in the IPO and then allocate any remaining shares at its discretion, usually based on an investor's willingness to purchase at a specific price.

The most common form of over-allocation is institutional investors (such as investment banks) acting on behalf of clients (usually high net worth individuals). The other form is known as "relationship over-allocation," where companies allocate shares directly to existing shareholders or clients on preferential terms.

Wrapping Up

IPO oversubscription occurs when demand for an IPO exceeds the number of offered shares. This phenomenon occurs when the public has been so eager to invest in a new company that they have offered more money than the company needs or is prepared to accept. 

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