Initial public offers (IPOs) where on one hand help companies raise capital for the long term, on the other, they give investors a chance to make big gains in a short span of time. Many non-banking financial companies (NBFCs) lend money to high net worth individuals for investing in the primary market -- such funding is called IPO funding. Currently, only NBFCs can offer margin funding to HNIs for investing in the primary market. But trying their hand at investing in an IPO through the funding route is a risky game for investors.
What is IPO funding?
Most banks and financiers provide funding to HNIs for investing in IPOs. This is known as IPO funding, which helps HNIs participate in the bidding process by paying only a small portion of the actual cost of shares. Typically, HNIs take a loan of 6-8 trading days to cover the period between the completion of an IPO to the day of listing. For borrowing these funds, HNIs have to bear interest, which usually ranges from anywhere between 8 percent and 15 percent. This interest along with certain other charges is together known as funding cost.
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Most banks and financiers provide funding for investing in IPOs. This facility is usually only offered to non-institutional investors (NII) such as HNIs.
Tapping this route HNIs them to increase their chances of getting allotment at little capital compared to the actual cost of shares. But there's a catch. For such investors to cover their funding costs, the shares must list at a certain premium and the portion meant for non-institutional investors must not be too oversubscribed.
So all in all, it is a risky game for HNIs.
Also read: IPOs prove unlucky for HNIs in August
How does it work?
How do HNIs make profit?
The IPO funding route delivers good returns only if the stock makes a strong listing following a moderately oversubscribed IPO. This is because high oversubscription and lukewarm listing raises the funding cost for the investor.
For example, high subscription in the NII segment leads to fewer shares for the investor, in turn raising the funding cost -- fewer shares will need a much higher listing price for an investor to cover funding costs. Similarly, even if a stock lists at a premium, it is no guarantee of the investor covering the funding cost.
For non-institutional investors, share allotment takes place differently compared to the retail segment. In the retail segment, all valid applicants get at least one market lot, in the NII category, it is done on a proportionate basis -- the number of shares allotted depends on the extent of subscription.
HNIs only emerge winners through the funding route of investing in IPOs in case of high allotment and bumper listing. Remember: the investor has to bear the interest on the funding amount till the finalisation of allotment. Once the allotment takes place, the unutilised amount is returned to the lender.
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So the catch is, even if you get fewer shares than applied for, you must pay interest on the entire loan amount.
Sometimes HNIs even choose to hold shares after listing; they can do this by settling their funding obligations by other means after the allotment. The investor has to clear the outstanding dues or continue to pay interest according to the agreement.
Currently, HNIs are allowed to pay 1 percent margin money to bid for entire portion reserved for the NII category. For example, for a Rs 500-crore IPO 50 percent of which is reserved for HNIs, an investor can pay Rs 2.5 crore (1 percent) to bid for shares worth Rs 250 crore -- which is the entire portion.
A trap for small investors
It is because of IPO funding that sometimes subscription to an IPO exceeds investors' expectations, giving an impression that the company's shares are in high demand. This often leads to retail investors getting trapped in IPOs that are not as promising as they appear to be.
(Edited by : Aditi Gautam)
First Published: Aug 29, 2021 9:06 AM IST
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