What is Oversubscription?
When the demand for a new issue of the stock exceeds the number of shares available, the term "oversubscribed" is used. When a new issue is oversubscribed, underwriters or other financial institutions selling the asset might raise the price or provide more securities to account for the higher-than-expected demand.
In contrast to an oversubscribed offer, where demand exceeds the available supply of shares, an undersubscribed issue occurs when demand exceeds the available supply of shares.
When a company decides to go public or issue new shares, it does so via IPO (Initial Public Hearing). That company asks for applications from buyers, and based on that; it allots shares.
However, in realistic scenarios, it is improbable that a firm receives the same number of applications equal to the shares issued. It is either oversubscribed or undersubscribed.
What is Oversubscription of Share?
Oversubscription of shares is a situation that occurs when a company receives more applications to purchase their shares compared to the number of shares that they have issued. It is a situation in which buyers show so much interest in a new stock that demand exceeds supply.
Before issuing new shares, underwriters study the market to understand the number of potential investors, people who may or may not purchase these new shares. Based on such calculations, firms issue a fixed number of shares.
When investors order more than what has been issued, it creates an oversubscription. This situation of oversubscription of shares may affect the prices of an individual share.
Thus, the issuing house or firm is responsible for dealing with this situation. They take the necessary measures to manage this scenario.
How to Deal With Oversubscription?
According to the guidelines of SEBI (Securities and Exchange Board of India), companies cannot reject applications outright. However, they can do so if there are any mistakes with the applications like –
Incomplete information
Absence of required documents
Discrepancies with signature
Submission of incorrect application amount.
Last but not least, improperly filled application form
What are the Ways?
In a scenario of oversubscription, a company can't fulfill the market demand. Therefore, opt for the following measure to counter this situation.
Pro-Rata Allotment
Pro-rata allotment means no applicant is rejected. However, they will not receive the desired amount of shares. Everyone receives shares according to the ratio of the total number of applicants/ total number of shares issued.
For instance, ABC Ltd. is planning to offer 40,000 shares to the public via IPO. However, it receives 80,000 share applications. Therefore, the company opt for this method, where it has allotted the total shares to every applicant.
Thus, the ratio here will be 80,000:40,000, i.e. 2:1. Hence, every applicant for their application of two shares will now receive one share. Pro-rata allotment makes sure that every applicant receives at least some shares against their application.
Rejecting Applications
The easiest way to deal with over-subscription shares is to reject some applications. According to the SEBI guidelines, companies can do so if they find any incomplete applications. In such cases, the application money is refunded. For example, if a company receives 10,000 applications against their 6,000 share, it can reject the remaining 4,000 in case there are any discrepancies.
A Combination of Both
However, among the excess applications, not everyone makes a mistake and cannot be rejected on that ground. In such a scenario, a company opts for a middle ground. Here, firms accept the first set of applications in full. Amongst the remaining ones, shares are allotted on a pro-rata basis.
For example, XYZ Ltd. is planning to release 20,000 shares in the market. However, they receive 30,000 applications against it. Therefore, in this scenario, this company can accept the first 20,000 applications in full and among the remaining 10,000 distribute shares to 6,000 as per a pro-rata basis.
A Real-Life Example of Oversubscription of Shares
In 2012, market analysts indicated that Facebook is finally issuing its long-awaited IPO. The company was looking to raise around USB10.6 billion via 337 million shares. Prices of stocks were in the range of USB28 to USB35. Once this news broke, it created an enormous buzz in the market and resulted in an oversubscribed IPO.
As a result, the company took advantage of this situation. It increases the number of shares from 337 million to 421 million. Additionally, it increases the share price to USB34 to USB38 per share. Thus, Facebook and its underwriters made the most of this situation generated more capital and increased its market valuation.
Benefits of Oversubscription
Companies aim to make the most of it in a situation of oversubscription. They can manage this scenario via different techniques like increasing the number of allotted shares, rejecting applications, trying combinations of both, etc. They aim to meet market demand and raise as much capital as they can.
How can a Company Issue More Shares?
Every company holds back a substantial amount of shares for a future capital generation or to distribute as management incentives. Therefore, firms can add further shares in case an IPO is oversubscribed.
Share Price Management in an Oversubscribed IPO
In case the underwriters of the company can predict that there is enough buzz in the market about their IPO, they intentionally set the share prices low to sell all the shares. They do not want to be left with the remaining shares. Therefore, if there is any situation of oversubscription in the future, it leaves them with the scope of hiking up the share price.
However, universal trends show that oversubscribed shares are mostly under-priced to some extent. It allows a post-IPO hike in prices and robust trading of respective shares.
Are there any Disadvantages of Oversubscription?
Well, a complaint against this situation is that investors often get snubbed. When firms cannot issue any more shares, they reject applications. On the other hand, investors often receive a lower amount of shares compared to what they have applied for.
Oversubscription of shares is a vital topic to cover for every commerce student. Apart from this, if they want to learn more about other topics of commerce, they can visit the official website of Vedantu.
Key Takeaways of Oversubscription of Shares
An oversubscribed stock offering is one in which the demand for the stock outnumbers the supply.
An oversubscribed initial public offering (IPO) indicates that an investor may want to buy a company's stock, resulting in a higher price and/or more stock being available for sale.
The demand must eventually reconcile with the security's underlying corporate fundamentals, therefore an overcrowded offering does not automatically indicate the market will support the higher price for long.
FAQs on Oversubscription of Shares: Key Insights
1. What do you Mean by Oversubscription and Under Subscription?
Oversubscription means when the number of applications to buy a particular company's share is higher than the actual number of shares they have issued.
For example, JKL Company has issued 10,000 shares for its IPO. However, they have received 15,000 applications for purchasing their shares. This scenario is called oversubscription of shares. Under subscription is precisely the opposite of this scenario.
2. What is Oversubscription in Accounting?
In terms of accounting, oversubscription is entered in the company books according to the situation. For example –
Receiving application money is Bank A/c Dr. to Share application A/c
For allotted shares, share application A/c Dr. to share capital A/c
Refund, share application A/c Dr to Bank A/c
Adjustment, share application A/c Dr to share allotment A/c
Combined entry, Share application A/c Debit, Share Capital A/c Credit, Share Allotment A/c Credit, Bank A/c Credit.
3. What are the Processes of Managing Oversubscription?
There are three methods used to manage oversubscription. These are, rejecting excess applications, using the pro-rata allotment process, and combining these two methods.
4. What are the benefits and Costs of Oversubscribed Securities?
When security is oversubscribed, corporations can either offer more securities, raise the price of the asset, or do a mix of the two to meet demand and raise additional capital. This implies they'll be able to raise more money in better conditions.
Companies most often withhold a significant portion of their stock to meet future capital needs and management incentives. Therefore, there is usually a stock reserve that can be added if the IPO is likely to be significantly oversubscribed without the need to register new securities with the regulatory agency. Of course, more capital is beneficial to a business. However, investors must pay higher prices, and if the price increases above their desire to pay, they may be priced out of the issue. It could also damage investors who flock to a hot IPO, driving the initial market price much above fundamentals, only to see the price plummet in the weeks and months ahead.
5. What is the oversubscription of shares?
Over-subscription of shares occurs when a firm receives more applications for shares than the number of shares it has offered to the public. Oversubscription of shares is usually reserved for companies with a strong financial history, a high market reputation, or profitable future prospects.
According to SEBI norms, a corporation cannot reject an application outright. It can, however, do so if the information is missing, the signature is missing, or the application money is insufficient.
In this circumstance, the corporation will not be able to provide each applicant with the exact amount of shares that he desires. As a result, the corporation must properly distribute the shares. The following are the three options available to the company:
Reject some applications totally.
Accept some applications in full.
Make Pro-Rata Allotment to the remaining applicants.
Prorated distribution means the allotment of shares related to the tendered shares. In the case of a prorated distribution, the company will adjust the surplus received when the application was submitted to the distribution and refund the surplus.
6. What is oversubscription?
Oversubscription occurs when a company receives more stock offerings than is publicly available. When demand exceeds supply, the firm may raise the price of its stock and issue new shares to reflect the higher than expected demand. However, even if demand is great, a corporation cannot generally raise the number of shares available.
In other words, when a company receives a large number of applications for a large number of stocks that are available to subscribers. Oversubscription is the term for this situation.
7. What are Oversubscribed Issues?
When interest in a security offering considerably outnumbers the issue's available supply, it's known as an oversubscribed security offering. Over-subscription can occur in any market with a limited supply of new securities, but it is most commonly linked with the secondary market sale of freshly issued shares via an initial public offering (IPO). The entire number of shares issued by the IPO'ing business is insufficient to meet demand. The degree of oversubscription is expressed as a multiple, for example, the ABC IPO was oversubscribed twice. A two-fold multiple indicates that there is effectively twice as much demand for shares as there are available in the scheduled offering.
The price of a share is purposefully established at a level that will, in theory, sell all of the shares. In an undersubscribed IPO, the underwriters often do not want to be left with nonpurchased shares.
8. What risks are involved in investing in an IPO?
The risks are:
The biggest danger of investing in an IPO is that you may not receive your shares. Any number of people can apply for the shares if they are subscription-based. The company would then allot the shares proportionally, and if you are a small-time investor with a large number of individuals, the Indian Pre-IPO share procedure will scarcely obtain you any shares.
When you acquire Pre-IPO shares, you incur the chance of getting back less than you put in. The price of Pre-IPO shares is determined only after they are listed, and there have been numerous instances where the posted price is less than the purchase price.
External influences can affect prices, particularly when businesses operate under government regulation that is subject to change depending on the country's current political circumstances.
