Should I take a loan to invest in IPOs?
An investor has to have a sufficient amount of funds to invest in IPOs. And the investor has to block that money until the IPO is allotted and surplus money is returned to the investor. When the IPO value appreciates, your investment gives you good returns.
Many investors find a shortage of funds while applying for IPOs. As per Sebi guidelines, a retail investor can submit up to eight (8) applications totalling Rs 200000 for each IPO. Hence an investor has to block Rs 200000 for each IPO maximum. And if many IPOs are coming up one after another, an investor may need Rs 8 to 10 lakhs for IPO investments.
The investor knows that the fund for the IPO application is a very short-term loan and can be paid back after the IPOs are listed. The present bank lending rate is a minimum of 10.30% or more (SBI rate for a customer with no reset). Hence for Rs. 2 lakh, an investor needs to pay a little less than Rs 2000 Rs. 1717 to be precise) for a month. If the loan is for 10 lakhs, the monthly interest may be a minimum of Rs. 17170. The investor has to pay the interest if the IPOs are not sold within a month.
So, the scenario is the investor takes a loan of Rs 10 lakhs to apply for a maximum of 5 IPOs within one month or so. Within the same month, the investor gets an average allotment of IPOs and waits for the listing day. There is little chance that the investor will get all the IPOs applied. Hence some of the money will be returned to the bank account.
In recent years we have seen that all the IPOs are getting oversubscribed by a good percentage. By considering this factor, let’s consider the investor gets an allotment of an average of 70% of the total volume. Now transforming that into INR terms, we consider a total of Rs. 700000 of share value is allotted. The rest 3 lakh is returned to the bank account of the investor.
But the investor will have to pay the full interest of Rs. 1000000 for one month. After one month, the investor returns the 3 lakhs. So, from the second month, the investor has to pay the bank interest on Rs 7 lakhs until and unless the amount is released. Now let’s stop here and understand the IPO application procedure before returning to the rest of the calculations.
How to apply for IPO?
IPO is an initial public offer. When a new company wants to get listed in exchange and go public, it takes the route of IPO. It applies to SEBI for approval. Once approved, it floats share in the market through IPO. When IPO comes out, investors apply for it. After the approval of shares, investors can trade them through the exchange where they are listed.
It is how an investor looks at it. IPO application for investors comes with a prospectus with all necessary information about the company. It allows the investor to know all possible details about the company. In the prospectus, a price band is given within which the IPO will fix one price and get listed in the exchange.
An investor has to apply for a minimum of one lot of shares. The lot size is given in the prospectus. Besides the lot size and price band, the opening and closing date of the IPO application are mentioned within which an applicant will apply for the IPO.
The bank or the broker engaged in the process will block the highest possible amount necessary to buy the applied lot. After the closing date, the listing date is also mentioned. The company’s share is visible on the listing date in exchange for trading.
This is how an investor can apply for IPO and get a chance to acquire the shares of the new shares at face value or the minimum value fixed by the company.
So, we can see the IPO investment is time-consuming. Once an IPO date is published, people prepare to invest. In most cases, the IPOs are allotted based on the number of applicants.
How are IPOs allotted?
The IPO allotment entirely depends on the number of applicants. There can be three types of scenarios.
- Under subscription – If the IPO is undersubscribed. Then all the applicants get the desired number of shares per application.
- Oversubscription by a small margin – In case of oversubscription, as per SEBI guidelines, a minimum of one lot of shares are to be given to each applicant. Then, subscribers who have applied for more than one lot are allotted further lots in proportion to their investment.
- Large oversubscription – In case of large oversubscription, when a minimum of one lot of oversubscription can not be given, a computerized lottery picks the lucky investors who can get share allotment. When a long-awaited IPO comes out, many investors try to buy it. Let’s take an example. Say, 50 lakhs of shares are to be distributed through IPO. And 75 lakhs of investors are trying to buy the shares. In such a case, nobody can be assured of getting even one lot of shares. This is simple mathematics. So, a computer is given access to the identity of all applicants and their numbers. The computer randomly picks the name and number of applicants and allots shares. We have seen many investors not even get one lot. Many complain about that, but the system is such. The random lottery is the right system to follow, as everyone feels.
Once the application process is over, comes the date of allotment. After allotment, the shares are listed in the exchange on a listing day. It takes around 7 days to get the allotment after application. An IPO application can remain open for a minimum of 3 working days to a maximum of 10 working days. After the bidding process is complete, the registrar issues the shares within 7 working days. After allotment, within 10 days, the surplus money is refunded to the bidder’s bank account.
So, we can see an investor can get a return of refund money after applying within (10+ 7 +10) 27 days. But it can be minimized if the application is done on the last day. Some registrars issue the allotment after 3 working days. The refund can be done after a minimum of 3 days. All these are working days. Then also, it will take a minimum of 10 calendar days to get the refund. It is the minimum period. We have counted an average of one month to complete the loan process and get a refund to the account and repay the loan.
Now let’s come to the previous calculation. IPO is a mixed bag; some start making a profit from the first day of listing, while others go down. So here, we can assume 50% of shares will make a profit while others will go down.
Now, unless the shares of a value of Rs. 350000 (50% of Rs 7 lakhs) make a profit of more than Rs.18000, the investor will lose money on an investment. Hence, a minimum of 5% average profit within the listing day has to be gained to earn the payable interest, sell a whole lot of shares, and return the money to the lender bank. Then only the investor can reach a no profit, no loss condition.
The calculation shows that it is very hard to profit by taking a loan and investing in IPOs. Hence, it can be concluded that under normal conditions, it is not worth investing and making an effort unless it bears fruit.