Financing your IPO bets

HNIs can earn high returns if they play their cards well

Initial public offers (IPOs) are one of the most sought after avenues by high networth individuals (HNI) for earning quick bucks. They are allotted shares on a proportionate basis and are sure of getting allotments unlike retail investors who may or may not get allotments in an IPO.

That is, if an HNI has applied for 1,00,000 shares and the IPO is over-subscribed 50 times, then 2,000 shares (1,00,000/50) will be allotted in this case. So HNIs tend to apply for more shares to fetch a reasonable number of shares, in case the IPO is over-subscribed.

Many non-banking financial institutions (NBFCs) offer special loans for enabling such subscription, popularly known as ‘IPO Financing’. Edelweiss’ ECL Finance, Aditya Birla Finance and Axis Finance are among those offering such products to HNIs.

The background

IPO funding is typically provided for a period of, say, 10 days or even less. For instance, Aditya Birla Finance offers a loan tenure of 10 to 15 days. And the minimum loan amount varies across lenders. For instance, the minimum loan amount offered by Aditya Birla Finance is ₹1 crore and ₹25 crore by Axis Finance. The interest rates usually range between 6 per cent and 11 per cent .

“The interest rate charged for IPO funding depends on the point at which you are on the rate cycle at that moment and on the short-term borrowing costs” says Roopali Prabhu, Head of Investment Products, Sanctum Wealth Management. She adds that interest rates could go up as demand for IPOs increases during the IPO period. Additionally, there are processing fees, stamp duty, etc, that add to the overall cost of borrowing.

Sandeep Nayak, ED & CEO, Centrum Broking Ltd, says, ‘‘Most applications are made on the last day of the IPO. By that time, the over-subscription range can be calculated approximately and the margin charged accordingly’’. Usually, he says, the lending institutions make sure that the margin money collected will cover the cost of the shares allotted in the IPO.

The loan providers typically ask for a ‘net worth certificate’ along with regular identity and address proof etc. for getting such loans.

How it works

Say, an HNI has applied for an IPO for ₹10 crore, of which ₹2 crore is the margin money and the remaining ₹8 crore the loan amount. Assume that the interest and other charges amount to ₹1 lakh and ₹1 crore worth of shares are allotted to the HNI in the IPO. Out of the remaining ₹9 crore, the lender takes back the ₹8 crore loan amount plus the ₹1 lakh interest and other charges and leaves the balance in the account.

What happens if the shares allotted are more than the margin money paid. In the above example, say, if ₹3 crore worth shares are allotted, the lender recovers the refund amount of ₹7 crore. Lien is marked on shares worth the additional ₹1 crore.In this case, the HNI will have a few options. First could be, the additional amount can be repaid and the shares retrieved. Second, the lender can be instructed to sell the shares and recover the additional ₹1 crore and leave the balance in the account. The third option is the HNIs can provide additional shares as security and continue the loan, in which case the product will be converted as a loan against security.

Do the math

HNIs going for IPO loans should broadly look at two things. First, the interest and other costs; second, the possible extent of over-subscription and the allotment ratio. Moreover, Nishant Agarwal, Managing Partner & Head – Family Office, ASK Wealth Advisors, says, “If oversubscription is very high, the number shares allotted will be less. So, investors should make their own calculation to see that the allotment obtained and the price appreciation on listing could cover the loan cost at least”.

Risk factors

The major risk for the HNI here is that when the deviation between the expected and the actual oversubscription of the IPO is very high, it may result in lesser number of shares being allotted. In such cases, the listing gains have to be much higher to recover the interest cost.

Also, if the IPO lists lower than the offer price, there will be losses. Mukesh Kothari, Founder, warns, “IPO funding is a high leveraged bet to make quick bucks. It is a very high-risk high-reward investment which could result in a massive multi-fold losses, if things go wrong on the day of listing”. So, play it safe.

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