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Chapter 4 Margin Funding In IPO

In the Indian capital markets, initial public offerings, or IPOs, are one of the most rewarding investment opportunities. Initial gains through an IPO can be extreme, as huge profits can be made within a short time if the stock makes a positive listing. The trend, recently, has been extremely encouraging with most IPOs being overwhelmingly oversubscribed.

High net worth individuals (HNIs) have realized this and jumped on to the bandwagon. They too wish to maximize their gains by making full use of the margin funding facility. HNIs tend to avail this facility by applying for a large quantum of shares under the high net worth category, where allotment is done on a proportionate basis in case of oversubscription.

What is margin funding in IPO?

Commonly known as IPO financing, margin funding in IPO is a short-term loan which is provided to apply for debut offering of shares in the primary market. The investor has to pay only a fraction of the amount upfront, while the rest is funded by the lender. This facility is primarily targeted towards HNIs who can leverage their funds and apply for a larger chunk of shares, thus maximizing their chances of allotment during the IPO.

In the domestic market, an NBFC arm of stockbrokers is the primary entity involved in IPO funding. Banks in India are not allowed to lend money for IPOs due to regulatory compliance. Hence, NBFCs borrow money from mutual funds, or banks, in most cases, and then lend it to their HNI clients.

Some leading NBFC companies in this segment are:

  • India Infoline, through India Infoline Investment Services Ltd
  • Edelweiss, through ECL Finance Ltd
  • Sharekhan, through Sharekhan Financial Services Pvt Ltd
  • JM Financial, through JM Financial Products Ltd
  • Aditya Birla Money, through Aditya Birla Finance Ltd
  • SMC Finance, through Moneywise Financial Services Pvt Ltd
  • Axis Bank, through Axis Finance Ltd

The lender provides the funds for a short-term, normally 6-8 trading days, from the closing day of the IPO till the day the shares get listed. On an average, NBFCs charge ~8% on this form of financing, which depending on the demand for the IPO, could vary in the range of 11-12%.

A key point investors should keep in mind when availing margin funding for an IPO is that they would have to pay interest on the entire loan amount. In other words, if the client applies for a loan of 2,000 shares and only manages to get 200 shares due to oversubscription, his listing gains will be for just 200 shares, while interest cost will be on the entire loan amount. Investors also have a to sell the shares allotted in the IPO at the earliest as per the agreement with the broker. In case the investor changes his mind and wants to hold on to the shares, he would have to arrange for the additional funds to repay the loan.

When does the investor end up making a profit?

The listing price that the stock records over the ‘issue price’ at which the investor obtained the shares determines whether the investor ends up making a profit or not. Listing gains on the shares allocated to the investor should be higher than the interest accrued on the entire loan amount. If the listing price is equal to or below the issue price, then the investor will be at a loss and would have to cut off his position unless he has the finances to pay the loan and wait for the stock price to appreciate.

Margin funding is good for large HNI investors looking to get a larger allotment in stocks with a high probability of listing at lofty premiums or is ready to wait for an upside in case the IPO does not deliver as expected.

Loan Margin (Margin Money)

The customer pays a margin amount right at the start to avail the loan. The loan margin is calculated on a case-to-case basis. The margin amount can be the cash deposited in the account or specified securities provided.

End-to-end process of IPO funding

  • Open a funding account with a lender
  • Open a demat account with a lender or provide power of attorney to an existing account
  • Fill forms for IPO funding and provide all required documentation
  • Let lender know about the IPO you wish to invest in, the number of shares, and the date
  • Pay the margin amount to avail the loan
  • Funds are disbursed within 24 working hours of the request
  • The lender applies for the IPO share on your behalf
  • Money is blocked while allotment is in progress
  • Allotted shares are credited into the demat account and money is withdrawn for the allocated shares
  • Customer instructs lender to sell the allocated shares upon listing
  • Upon listing, lender proceeds to sell the shares and settle the profit & loss account

What happens if the IPO fails at the time of listing?

The borrower & lender both assess the risks carefully before funding. They go through historical data, market trend, grey market premiums, margin amount and customer history among a slew of other data, before offering the loan. Despite this, things can go wrong at any time.

Some common risks involved with IPO funding include:

  • The IPO shares get listed at a discount
  • Huge difference in the IPO subscription (over/ undersubscribed)
  • The IPO process gets postponed for some reason

In most cases, lender recovers the losses from the margin provided by the borrower. In case this doesn't happen, the client has to repay the borrowed amount or keep paying interest as per the terms of the agreement.

Should an investor go for IPO funding?

The demand for IPO funding has increased over the last few years. An increase in the number of HNI investors, lower borrowing costs (low interest and shorter time for the IPO), good IPOs, positive market moments, and listing gains of IPO shares have made IPO financing attractive among HNIs.

IPO funding entails a high-risk profile, hence, funding should be considered only after carefully analyzing the IPO, the issue price, market & industry trends, and the cost of borrowing.

An HNI investor with a good understanding of the equity markets and its associated risks can make good profits with IPO funding.

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