Allotment

Introduction

Allotment, in the context of finance and stock markets, refers to the process by which securities (such as stocks or bonds) are distributed to investors. It typically occurs during events like Initial Public Offerings (IPOs), Further Public Offerings (FPOs), or other issues of shares. The allotment stage follows the subscription phase where investors apply for shares. The allocation can be based on various criteria such as the number of shares applied by each investor, pro-rata basis, or preferential allotment.

Initial Public Offerings (IPOs)

An Initial Public Offering (IPO) represents the first time that a company offers its shares to the public. During an IPO, an allotment is decided based on the demand and supply of shares. The primary goal is to ensure a fair distribution and to help price discovery in the market.

Steps in IPO Allotment

  1. Application Submission: Investors submit applications to subscribe to the IPO shares.
  2. Subscription Analysis: The total demand for shares is analyzed.
  3. Allocation Criteria: Shares are allocated based on predefined criteria.
  4. Announcement: The final allotment is announced, and shares are transferred to the investors’ Demat accounts.

Reasons for Raising Shares

Companies opt to raise shares for myriad reasons, ranging from expansion plans to restructuring debts. The reasons can be broadly categorized into the following:

Funding Expansion Plans

Companies looking to expand their operations, enter new markets, or invest in new projects often require substantial capital. Raising shares is one way to generate the necessary funds without increasing the company’s debt burden.

Reducing Debt

Firms burdened with significant debt might raise shares to pay off loans. Issuing shares can provide the necessary liquidity to manage and reduce overall debt, thereby improving the company’s financial health.

Enhancing Liquidity

A company might issue more shares to increase the liquidity of its stock. Greater share availability can improve market perception and attract a broader investor base. Enhanced liquidity can result in more stable stock prices.

Strategic Acquisitions

Raising shares can help a company finance mergers or acquisitions. The capital raised can be used to execute strategic acquisitions that align with the company’s long-term goals and growth plans.

Strengthening Balance Sheet

Raising shares increases the equity base of the company, thus strengthening its balance sheet. This can help in improving financial ratios, which can be favorable for future borrowings and investment opportunities.

Methods of Allotment

Different methods can be employed to allocate shares during an IPO or any other issuance of shares. Each method has its implications and is suitable for different scenarios.

Pro-rata Basis

When the issue is oversubscribed, shares may be allotted on a pro-rata basis. This means that each applicant receives shares in proportion to the number of shares applied for. For example, if an investor applies for 1000 shares and the subscription is twice the number of shares available, the investor might only receive 500 shares.

Lottery System

Particularly relevant for retail portions in heavily oversubscribed IPOs, the lottery system is a random selection process ensuring each applicant has an equal chance to receive shares.

Preferential Allotment

In this method, shares are allotted to specific investors based on pre-agreed terms. This is often seen in private placements where securities are sold to a select group of investors.

Book Building Process

Here, investors bid for the shares within a specified price range, and based on the bids, the final issue price and allotment are determined. This method helps in efficient price discovery.

Detailed Example: XYZ Tech IPO

To understand the allotment process better, consider the hypothetical example of XYZ Tech, a tech startup going public:

  1. Pre-IPO Stage: XYZ Tech decides to go public and files for an IPO with a total offering of 1 million shares.
  2. Investor Applications: The IPO opens, and investors apply for 3 million shares in total, making it 3 times oversubscribed.
  3. Allotment Process:
    • Retail investors’ portion is oversubscribed and allotted through a lottery system.
    • Institutional investors receive a pro-rata allocation.
  4. Final Allocation: XYZ Tech announces the allocation result:
    • Retail investors who applied through lottery get a proportional share.
    • Institutional bidders like investment banks and mutual funds receive shares based on their bid strength.

XYZ Tech successfully raises capital while ensuring fair and transparent allotment to various investor categories.

Prominent Companies and Their IPOs

A few companies that have recently gone public and followed the above allotment process include:

Airbnb (NASDAQ: ABNB)

Airbnb, the vacation rental giant, went public on December 10, 2020. The IPO was a milestone, offering 51.55 million shares, and it was oversubscribed multiple times.

Snowflake Inc. (NYSE: SNOW)

Snowflake, a cloud-based data warehouse company, had one of the most anticipated IPOs in 2020, raising around $3.4 billion by issuing 28 million shares.

DoorDash, Inc. (NYSE: DASH)

DoorDash, the food delivery service, raised around $3.37 billion by offering 33 million shares in its December 2020 IPO.

Conclusion

Allotment is an integral part of the equity issuance process, ensuring a fair distribution of shares to investors. Whether via an IPO, FPO, rights issue, or any other issuance method, companies utilize share allotment to raise necessary capital to fund growth, reduce debt, and achieve strategic objectives. The process involves several steps and criteria to ensure transparency and equitable access for investors.