Kurlon Enterprise Unlisted PRE IPO shares
Investing in a Initial Public Offering (IPO) can be highly profitable as the IPO price is typically lower than the market price it gets listed at. This means that by flipping stocks one can earn high returns on their investments.
But what if one does not have the monies to invest at the right moment? Not an issue - some NBFCs are willing to finance this investment.
This article is divided into 4 major sections highlighted below and discusses how IPO funding happens in India.
Who can avail IPO funding?
This section talks about, who all can avail IPO funding
What are the terms?
How does the lender mitigate risk?
Retail investors have no guarantee that the would be allocated shares when an IPO closes and therefore are not an ideal target for IPO funding.
On the other hand, high net worth individuals (HNI) are allocated shares on a proportiantate basis in case of oversubscription and hence are guaranteed to be allocated shares.
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NBFC arms of broking firms offer loans to HNIs for applying in primary stock market, this practice is called IPO funding or IPO financing. The investor has to pay only a small margin amount and the remaining is funded by the lender.
Remember that it is up to the investor to apply for IPO under HNI or retail investor categories. Any investor who is applying for shares worth more than Rs.
October 10, 2017
2,00,000 is considered a HNI investor as per the SEBI guidelines. Therefore, if an investor can arrange for the margin, up front payment of processing charges and interest - he or she can apply for IPO funding.
Though remember that loan providers will have their own criteria on top of an application under HNI category - including a minimum amount that they will be willing to fund as will be discussed below.
What are the terms?
This short term loan is typically extended for the period between close of an IPO and the date of listing i.e 6 days.
The margin amount varies from issue to issue, but it is based on expected oversubscription of the issue. For example, if an issue is expected to oversubscribe 10 times, the HNI will have to pay a 10% margin upfront.
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The loan provider will have the right to liquidate the allocated shares in case of a default. NBFCs will also take the interest payment upfront. An interest is typically charged at the rate of 10%-11% per annum on IPO funding.
The lender may also charge a processing fee, typically of about Rs. 1,000.
Further, the borrower is expected to pay the stamp duty for Loan Agreement and other documents.
The amount of loan offered varies from lender to lender for example Sharekhan offers loans from Rs 1 lakh to Rs 18Cr, Aditya Birla Finance offers minimum loan amount of Rs 1Cr. and Axis Finance offers minimum funding of Rs 25 Cr.
Banks cannot offer such loans because of the regulatory restrictions from SEBI.
Some of the NBFCs that offer IPO funding are:
- Edelweiss through ECL Finance Limited
- Sharekhan through Sharekhan Financial Services Private Limited
- JM Financial through JM Financial Products Limited
- Aditya Birla Money through Aditya Birla Finance Ltd
- SMC Finance through Moneywise Financial Services Pvt Ltd
- Axis Bank through Axis Finance Limited
Typical terms and conditions to be fulfilled to avail IPO funding include:
- The borrower must be an HNI
- The borrower should have a valid PAN card.
- The borrower must open a new bank account on which he should grant Power of Attorney to the lender.
That is, only the lender can operate this account. This account is used for the sole purpose of securing the loan amount.
- The borrower must open a new demat account and give the operational control to the lender as above.
- The margin amount and the interest on the loan has to be paid upfront.
How does the lender mitigate risk?
NBFCs raise capital for IPO funding through issue of short-term debt instruments, of say 7 days.
They structure the loan such that risk is minimized.
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For one, they insist on upfront payment of the interest levied. Application supported by blocked amount (ASBA) ensures that if the expected oversubscription does happen, the principal amount is safe. Since the loan is issued on the day the issue is to close, the lender has a good estimate of the extent of oversubscription. Since the operational control of the bank account is with the lender, he has full control over the money lent and shares allocated.
Let us look at an example to understand this.
Say an HNI wants to bid for 100 shares in an IPO at a bid price of Rs.
50 per share. The lender estimates that the issue will be oversubscribed 10 times, and therefore requires the HNI to pay 10% margin.
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Therefore, the loan amount would be 90% of Rs. 5,000 or Rs. 4,500. Now, if the issue is actually oversubscribed 10 times - the HNI will be allocated 10 shares for Rs.
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500. The remaining Rs. 4,500 will still be in his account and the lender can claim the same towards the original loan amount. Since the interest was paid upfront, lender carries little risk, In case of oversubscription being less than estimated, the allocated shares can be liquidated to meet the liabilities.
Though, here the risk of the shares listing a lower than ipo price exists.
In addition, the lender also earns interest for the period the money is blocked under ASBA.
End to end workflow
Open bank account and transfer operational control to the lender
Open a demat account and transfer control to the lende
Fill forms for IPO funding and provide all required documents including proof of identity,proof of address, last 3 year financial statements and net worth certificate
Finalize the IPO bid details
Pay the margin and interest amount
The lender applies for the IPO on behalf of the borrower
Money gets blocked while while IPO allotment is in process
Allotted shares are credited in to the demat account and money is withdrawn for the allocated shares
Borrower permits the lender to sell the allocated shares
Settle the profit/losses with the lender
While IPO funding is on the up with the recent IPOs being grand successes, it is a high risk - high reward situation.
In case the issue is not subscribed as expected or is listed below the IPO price, heavy losses may result. Further, NBFCs may get stressed because of the temporary high leverage they take on for IPO funding. Therefore,only take on IPO funding if one has a good understanding of the company valuation and risks involved.