Undersubscription

Introduction

An Initial Public Offering (IPO) is a significant event for any company looking to raise capital by offering shares to the public. When a company issues an IPO, one of the key factors that determine its success or failure is the level of subscription that is, how much interest the market shows in buying the company’s shares. While terms like oversubscription often dominate discussions about IPOs, undersubscription is equally important to understand. In this guide, we will delve deep into the concept of undersubscription, its implications, and the potential outcomes for investors and the company involved.

What is Undersubscription?

Undersubscription occurs when the demand for shares in an IPO is less than the number of shares offered by the company. In other words, the IPO fails to attract enough buyers to fully subscribe to the shares the company offers. This indicates that fewer investors are willing to purchase the shares at the offered price, which may point to a lack of confidence or interest in the company’s growth prospects, market conditions, or other factors.

An undersubscribed IPO typically occurs when the company fails to generate sufficient interest in its offering, which can impact its stock price and its ability to raise the desired amount of capital. If the IPO is undersubscribed, the company may adjust its offer or even cancel it altogether.

Understanding Subscription in IPOs

To understand undersubscription, it is essential to first grasp the concept of subscription in IPOs.

• Subscription of Shares: In an IPO, investors indicate the number of shares they want to buy compared to the total number of shares the company offers. If investors demand more shares than are available, the IPO becomes oversubscribed. Conversely, if demand falls short of the shares on offer, the IPO becomes undersubscribed.
• Oversubscription: This term refers to when the demand for shares exceeds the number of shares available for purchase. Oversubscription of shares typically signals high investor confidence and can result in a higher issue price and potential gains for investors. The more oversubscribed an IPO is, the more interest it garners from the market, often leading to significant price increases on the listing day.
• What is Over Subscription of Shares? When investors request more shares than the company offers, this is termed oversubscription. For example, if a company offers 1 million shares and investors request 3 million shares, the IPO becomes oversubscribed by 3 times.

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The Dynamics of Under Subscription

When an IPO is undersubscribed, the company sells fewer shares than it originally anticipated. This situation can arise for several reasons, including:

1. Lack of Investor Confidence: If investors do not believe in the company’s business model, growth prospects, or financial stability, they may choose not to participate in the offering.
2. Market Conditions: In periods of market volatility, investors may be hesitant to buy shares, especially in IPOs, as they may prefer more stable investments.
3. High Price Band: If the company sets the price band of the IPO too high, potential investors may view the shares as overpriced, leading to undersubscription.
4. Weak Company Fundamentals: If the company’s financials are weak or there are concerns regarding its management, growth prospects, or past performance, it may fail to attract investors.
5. Lack of Public Awareness: Insufficient marketing or public relations efforts can also cause the company to undersubscribe the IPO.

What Happens When an IPO is Undersubscribed?

If an IPO is undersubscribed, the severity of the under subscription can lead to several outcomes:

1. Price Adjustments: The company may decide to lower the issue price in order to attract more investors. This is particularly common in cases where the undersubscription is significant.
2. Reduced Offering Size: In some cases, the company may reduce the size of the IPO by offering fewer shares to the market. This can help mitigate the impact of the undersubscription but may still signal weaker demand.
3. Delayed IPO: If the IPO severely undersubscribes, the company may delay or cancel it entirely. This usually happens if the company believes that the market conditions are not conducive for an offering at the time.
4. Post-IPO Performance: If the IPO launches despite the undersubscription, the stock may face downward pressure post-listing because the market perceives the offering as less attractive. In some cases, the stock price may even fall on the listing day.

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Differences Between Under subscription and Oversubscription

Oversubscription often signals a successful IPO, while undersubscription negatively impacts both the company and investors. Here’s a comparison:

Implications of Under subscription for Companies and Investors

• For Companies: Undersubscription can damage a company’s reputation in the market and make it harder to raise capital in the future. It may also result in the company having to adjust its business strategy or issue new shares at a later time to raise funds.
• For Investors: For investors, an undersubscribed IPO can indicate potential issues with the company. While it may present an opportunity to buy shares at a lower price, it could also be a signal of underlying problems with the company that might affect long-term performance.

What Happens if an IPO is Fully Subscribed?

When investors fully subscribe to an IPO, their demand matches the number of shares the company offers, enabling the company to raise its targeted capital. If investors oversubscribe, the company allocates fewer shares than applied for and often experiences higher demand after listing.

SEBI Guidelines on Under subscription

The Securities and Exchange Board of India (SEBI) regulates the IPO process in India and provides guidelines to manage under subscription:

• Minimum Subscription Requirement: SEBI regulates that companies must secure a minimum subscription level, usually around 90% of the issue size, to avoid voiding the IPO.
• Impact on Future Offerings: A company with a history of undersubscription may find it difficult to raise capital in the future, as investors might lose confidence in the company’s ability to deliver value.

Conclusion

Undersubscription in an IPO can be a warning sign for both investors and companies. It suggests that the market is not confident in the company’s prospects or that other market conditions are unfavorable. Investors make better decisions and prepare for any IPO outcomes by understanding the dynamics of undersubscription or oversubscription.