Investors need to know the difference between oversubscription and undersubscription in an IPO. Oversubscription shows that there is a great demand for the shares, while undersubscription gives a weaker interest signal. Share allotment, pricing and market perception are affected by these factors. For a detailed explanation of these concepts, their causes, and how allotments work, continue reading our comprehensive blog below.
What Is Oversubscription of Shares?
Oversubscription takes place during an Initial Public Offering (IPO) when the total interest from investors surpasses the quantity of shares the company intends to issue, resulting in more applications than shares on offer and requiring an equitable distribution among participants. There are situations where the investors submit a higher number of applications for shares than the company is able to issue. As a consequence, not all investors will be allocated the full number of shares they asked for, which results in partial distribution or share rationing. Oversubscription signifies a positive interest towards the company but can also mean that the investors will obtain a lower number of shares than they anticipated. It is a representation of the imbalance between supply and demand.
What Is Undersubscription of Shares?
Undersubscription describes a scenario where, during an Initial Public Offering (IPO), investor interest does not meet the total number of shares a company has put up for sale, resulting in fewer applications than available shares. In simple words, the number of investors wanting to buy shares of a company is less than what the company expects. This implies lesser investor interest or confidence in the offering. Investors who do apply usually get their full allotment, as shares remain available. If the demand falls below the regulatory minimum (typically 90% of the issue size in India), the IPO can be called off and the money refunded. Undersubscription may result in lower prices of shares or delays.
Difference Between Oversubscription and Undersubscription in IPO
When a business launches its shares to the public through an Initial Public Offering (IPO), interest from investors can sometimes surpass or be less than the total number of shares presented for sale. This results in either oversubscription or undersubscription. It is important to compare oversubscription and undersubscription, as both have significant implications for investors and companies.
| Aspect | Oversubscription | Undersubscription |
| Meaning | Happens when investors request more shares than the company has offered for sale. | Happens when the total applications received are less than the quantity of shares available from the company. |
| Investor Interest | Reflects significant interest and positive sentiment from investors towards the company. | Reflects reduced investor interest or uncertainty. |
| Market Perception | Indicates that the wider market views the company and its prospects favourably. | May indicate a lack of confidence or weaker market demand. |
| Price Impact | Often results in shares listing at a premium or higher price initially. | Can lead to shares listing at or below the issue price. |
| Share Allotment | Shares are usually allotted proportionally due to excess demand. | Full allotment is generally possible since demand is low. |
| Company Impact | Generally positive, indicating successful capital raising and strong demand. | Potentially negative, possibly leading to lesser capital raised or cancelled issues. |
Why Oversubscription Happens
Oversubscription refers to the situation where investors wish to acquire more shares of an Initial Public Offering (IPO) than the company has allotted. Several reasons explain why this occurs:
- Deep Investor Interest: When a company demonstrates strong growth potential or operates in a booming industry, it attracts numerous investors eager to participate in its success.
- Popular Pricing: If shares are set at a lower price than the investors expect them to be worth, the demand picks up considerably.
- Restricted Shares Quantity: Since the company offers a fixed number of shares, strong demand naturally leads to more requests than the shares available.
- Positive Market Conditions: A confident or bullish market encourages more investors to participate in IPOs.
- Media Exposure: Extensive publicity or hype surrounding the company or its IPO is likely to attract a large number of investors.
- Recent Positive Developments: News or events that enhance the company’s prospects after the IPO launch can generate additional demand.
Why Undersubscription Happens
Undersubscription occurs during an Initial Public Offering (IPO) when investor interest does not match the amount of shares issued by the company, resulting in fewer bids than shares available. Several factors can lead to an undersubscription:
- Investor Confidence Deficiency: Investors may be uncertain about the company’s business model, financial health, or prospects, which can make them hesitant to invest.
- Unfavourable Market Conditions: When there is a market volatile period or economic downturn, investors are more likely to be cautious and avoid putting their money into new IPOs.
- High Price Band: If the IPO shares are priced higher than what investors consider reasonable compared to similar companies, there might be a decline in demand for the IPO.
- Weak Marketing and Publicity: Poor promotion or a lack of awareness about the IPO can lead to less investor interest and participation.
- Competition from Other IPOs: At the time, when several IPOs are released simultaneously, the investors might take only one or avoid subscribing due to a lack of funds.
- Lock-in Period Requirements: Some IPOs have mandatory lock-in periods, which may discourage investors who prefer more liquidity.
- Concerns About Company Performance: Issues in the past, unclear financials, and negative news can lead to a decrease in investor interest.
How Allotment Works in Each Case
A company uses an Initial Public Offering (IPO) to make its shares available to the public for the very first time, allowing investors to participate in ownership. The way shares are assigned to investors depends on the number of applications received, with the specific method varying according to whether demand for shares surpasses or falls short of the amount being released.
Oversubscription
Oversubscription occurs when the volume of investor interest in purchasing shares surpasses the total shares that the company has issued for its Initial Public Offering. The allotment process in this case involves:
- According to norms, every shareholder who qualifies for allotment is guaranteed at least one lot of shares. Eligibility typically includes having a valid Demat account, a linked bank account for Applications Supported by Blocked Amount (ASBA) payment, submitting a valid application within the subscription period, and applying for the minimum lot size defined in the IPO documents. These requirements ensure a fair basis for allotment among applicants.
- Beyond the initial lot, shares are allotted on a pro-rata basis, proportionally distributed among applicants according to demand.
- In a situation of extreme oversubscription, a lottery system might be implemented to randomly allocate shares.
The registrar is responsible for preparing and publishing the Basis of Allotment (BO) document, which details how shares will be allocated. Shares are then transferred directly to investors’ accounts, and any money paid in excess of the application is refunded.
Undersubscription
Undersubscription happens when investor interest falls short of the total shares on offer. In these cases, allocating shares is simple, each applicant receives the full quantity requested, with no need for rationing or lotteries.
- All investors who submit applications receive the complete amount of shares they asked for, as long as the total number available exceeds demand.
- But if the total subscription falls below the minimum set by the regulator, the IPO will be called off, and the money will be refunded.
Since the shares are available to meet the demand, no lottery or pro-rata allocation is required. After the confirmation of allotment, the shares are instrumental to the investors.
Investor Impact & Market Outlook
Typically, oversubscription is a sign of great investors’ trust in the public issue, resulting in a positive market sentiment and listing prices going up. The over-subscription reflects the extensive interest of both retail and institutional investors, enhancing the company’s reputation and potentially driving future growth.
On the other hand, undersubscription indicates weaker demand and may create negative perceptions about the company’s market readiness. As a consequence of this, share prices may go down, trading may slow down, or even the IPO could be withdrawn if it doesn’t meet the required amount of shares by the regulator.
Knowing these effects is a useful tool for investors to understand the market environment and take the right steps.
Conclusion
Oversubscription and undersubscription are the two main investor demand scenarios in IPOs, which have different implications for allotment and market sentiment. By understanding how these scenarios affect share allocation and company performance, market players will be able to better grasp the outcomes of IPOs and make their investment decisions in the future with ease and assurance.
FAQs
Strong investor interest, attractive pricing, positive market conditions, and good company prospects are some of the reasons why certain IPOs are oversubscribed. Others are undersubscribed because of weak investor confidence, high prices, poor market sentiment, limited publicity, or concerns over the company’s performance.
Shares in oversubscribed IPO are allocated via a pro-rata system or a lottery to ensure that the limited shares are distributed among applicants fairly. Each eligible investor is given one lot at least, and the rest of the shares are distributed either proportionally or by chance. When undersubscription occurs, all applicants usually get their full requested shares, since demand is lower, and there is no need for a lottery or rationing.
Yes, an IPO may be withdrawn in the case of undersubscription. If the demand for shares is lower than the regulatory minimum, generally 90% of the issue size in India, the company might call off the IPO and return the money to investors. Low investor confidence, adverse market conditions, or a high IPO price are frequent causes of this situation.
Oversubscription often indicates strong investor demand, which can influence the IPO to list at a premium. However, this is not guaranteed, as listing prices also depend on factors like market conditions, pricing, and investor sentiment at the time of listing.
When an IPO is oversubscribed, the money from investors who do not receive shares is refunded. This refund happens within a specific time frame, ensuring investors are not charged for shares they did not get, maintaining fairness throughout the process.
