When an IPO is “oversubscribed” that means certain investors have committed to buy more than the available number of shares that were originally set for the initial public offering.
That’s because when new stocks or bonds are issued via initial public offerings (IPOs), they’re issued in limited amounts, based around the new company’s financing needs and desired debt-to-equity structure.
Depending on investor appetite for the new stocks, IPOs can either be under or oversubscribed; this reflects the level of demand investors have for the shares.
In most cases, though, only institutional investors and accredited investors can subscribe to an IPO stock before it actually goes public. Retail investors may hear about an IPO being over- or undersubscribed, but they typically can’t take advantage of it — although knowing the information may aid an individual’s assessment of the opportunity.
What Is an IPO?
IPO stands for “initial public offering,” which marks the first time a private corporation offers its securities for sale to the public.
In such a process, a portion of the firm’s shares are transferred from private ownership by company insiders to public markets, so that both retail and institutional investors can buy IPO shares.
IPOs are usually initiated for two reasons: 1. To raise additional capital for a firm’s operations, and 2. As a way for company insiders and early investors to cash out their holdings.
During an IPO, a company that wishes to go public will work with an underwriter, or team of underwriters, to value its business, document and register its shares with the U.S. Securities and Exchange Commission (SEC), and market its shares to the investing public.
Once a company’s board approves the IPO sale, the underwriters set the IPO valuations. The investment banks that underwrite a company’s public offering set the IPO price.
These underwriters use several variables to determine the IPO price, including an analysis of the company’s growth potential, a comparison to related firms, and a determination of market demand conditions.
Once the company has the green light to proceed, the underwriting team proceeds to market the shares and take orders from investors.
What Is Oversubscription in an IPO?
Investors interested in IPO investing may be interested in an IPO’s subscription status. If an IPO is oversubscribed, that means there aren’t enough shares of the new stock issued to meet initial investor demand at the listed IPO price.
To compensate for this mismatch in supply and demand, the underwriters selling the IPO can choose to either raise the IPO price to reduce demand, or increase the supply of shares to meet demand.
💡 Quick Tip: Access to IPO shares before they trade on public exchanges has usually been available only to large institutional investors. That’s changing now, and some brokerages offer pre-listing IPO investing to qualified investors.
How Does Oversubscription Work?
Oversubscribed IPOs generate a shortage in shares that usually results in a higher price or additional shares being issued, which can lead to more capital being raised for the now-public company. These funds are also called the IPO proceeds.
This contrasts with “undersubscription” for IPOs. Undersubscribed IPOs are caused by the converse scenario happening, where there’s insufficient investor demand to buy all available shares at the listed IPO price.
What Is Undersubscription?
When an IPO is undersubscribed, it generally signals a lack of enthusiasm for a newly public company and may be the result of either poor marketing, overpricing, or poor company fundamentals.
When an IPO is undersubscribed, underwriters may work to reduce the size of the issue, cut the share price, or pull the IPO offering altogether.
In some cases, as a result of contract terms with the issuing company, underwriters may be forced to “eat” the cost of the IPO and purchase remaining shares at a pre-agreed price themselves. This is generally an undesirable outcome for underwriters as it may force them to hold shares on their books rather than flip them to investors.
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Pros of Oversubscription
Oversubscription can be beneficial to both the issuer and underwriters of new securities, as well as to investors who manage to obtain an allocation of shares around the IPO price.
The issuing company can benefit, as the high demand for IPO shares allows the underwriting team to either reprice the IPO shares higher or offer up additional shares from company reserves to alleviate demand.
In either case, this results in additional funding for the issuing company at more favorable terms while the underwriter generates additional fees.
Early investors to an oversubscribed IPO may benefit from the initial pop in pricing that excitement can generate. This sometimes leads to positive momentum that may continue to push the price upward in the short run.
Cons of Oversubscription
For most average investors, oversubscription ends up being a net negative. First, it’s rare for individual investors to be able to subscribe to an IPO. Typically that’s reserved for large institutional or high-net-worth investors. Then, by the time the average investor can buy the stock, higher pricing may make the IPO opportunity less attractive — with the risk of being overinflated.
If you’re unable to obtain an allocation at the original IPO price, it’s likely that secondary market prices for these securities may be substantially higher due to the high demand for these shares.
While this may not be a concern for long-term investors, this can pose a challenge if initial momentum causes the price of a new security to skyrocket beyond its reasonable fundamental value. This can cause the value of shares to tumble back to lower levels in subsequent months.
This is one of many reasons that retail investors should be cautious about IPO shares. They are a high-risk proposition at best.
Strategies to Maximize the Oversubscription Opportunity
Even if you were one of the lucky few to obtain early IPO shares, there isn’t much you can do to capitalize on an oversubscription opportunity.
If you receive shares from an oversubscribed IPO, you will want to consider both the long-term prospects of the company as well as the short-term prospects for its share price.
Depending on the company and your investment strategy, this will influence whether you intend to hold the security for the long-run or flip the shares for a quick profit.
If you’re unable to obtain an allocation during an IPO, it’s likely that the oversubscribed IPO would see its shares bid up in the secondary market. In this case, it’s not a bad strategy to wait a few weeks, or even months, after the initial IPO to see whether prices come back down — and gauge the company’s prospects from there.
In some instances, shares often decline a few months later after the expiration of the initial lockup period, once insiders are free to sell their shares. However this isn’t always the case, and can vary widely from company to company.
Seek Advice From a Professional
If you’re allocated shares from an IPO and are unsure of what to do with your new holdings, it might be worth consulting with a financial advisor or investment advisor to determine your next steps.
Financial professionals can help inform your decision making on how to proceed with an oversubscribed IPO. However, the final decision will ultimately be up to you and should be made within the context of your overall investment portfolio.
Do Your Research
Regardless of whether you’re able to gain access to the IPO, you should base your investment decisions on your own due diligence and fundamental analysis, i.e. a thorough review of a company’s disclosures, financial statements, and future prospects.
Reviewing the track record of company executives and the board of directors can offer insight into how competent the company’s management may be when it comes to executing on long-term strategies.
Thoroughly reading the prospectus of the new IPO shares can help you understand the core drivers of a firm’s business, its core customer base, key markets, and major risks it might face.
Additionally, there’s a multitude of research out there that follows your stock’s performance on both fundamental and technical grounds; these can go a long-way towards informing your investment actions for new IPOs.
Oversubscriptions for hot IPOs can sometimes offer opportunities for investors who are able to secure allocation of shares; however, they can also turn into feeding frenzies for retail investors who wish to buy these securities on the secondary market.
The resulting media blitz, and (typically) wide swings in valuations, can easily end with inexperienced investors getting burned on the share price. In short: IPOs can be volatile. To protect yourself, it’s important to understand the drivers of IPO pricing and how it impacts demand.
Whether you’re curious about exploring IPOs, or interested in traditional stocks and exchange-traded funds (ETFs), you can get started by opening an account on the SoFi Invest® brokerage platform. On SoFi Invest, eligible SoFi members have the opportunity to trade IPO shares, and there are no account minimums for those with an Active Investing account. As with any investment, it's wise to consider your overall portfolio goals in order to assess whether IPO investing is right for you, given the risks of volatility and loss.
What is the meaning of oversubscription?
Oversubscription, as it pertains to IPOs, refers to a supply and demand mismatch of the newly issued IPO shares. Either the price must adjust upward, the supply of shares issued must be increased, or a combination of the two must occur to meet investor demand.
In the event that the supply of IPO shares is unable to meet all investor orders, shares will typically be issued out to investors on a partial pro rata basis, or in proportion to each investor’s requested order size, subject to minimum block sizings.
In some instances, a lottery system may be implemented to maintain impartiality. Any unfilled orders will be rejected and cash returned to investors.
How can you calculate oversubscription?
At the basic level, IPO oversubscriptions are calculated as a ratio of the aggregate order size for IPO shares relative to the total number of IPO shares available to be distributed.
For example, if there are 1,000,000 shares of new stock available for an IPO pricing, but the underwriters receive an orderbook totaling 3,000,000 shares from investors, this IPO would be considered “3X oversubscribed.”
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Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. IPOs offered through SoFi Securities are not a recommendation and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation.
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